Ripple of Change?
The recent rally of XRP suggests that the market takes a more crypto-positive view on the long-standing legal battle between Ripple and the U.S. Securities and Exchange Commission (SEC). Should traders follow the rally and how will it affect broader crypto?
XRP Rally
XRP (Ripple) skyrocketed by about a third in the last two weeks (since March 20) due to market optimism that the company will win its legal battle with the SEC.
XRP/USD
The token price rally likely reflected real flows, as futures open interest rose to a multi-month high, plus there were reports of inflows into spot XRP. At Binance, which is the most popular venue for futures trading, XRP futures open interest on March 29 reached the highest level since December 2021 in USD terms, slightly exceeding the previous high of October 2022.
XRP futures open interest on Binance
Many traders were caught off-guard, as there were two episodes of large short-covering during the rally. The first one was at the very beginning of the uptrend. On March 21, short positions worth $12 million were liquidated. The second one was during the final (so far) push-up, as a further $19 million were liquidated on March 27-30.
XRP total liquidations
A primary reason behind the XRP rally seems to be a filing by Ripple, the parent company of XRP, which may turn a long-standing legal battle between Ripple and SEC in favor of the former. “The filing referenced rulings on SEC objections in the Voyager Digital Holdings bankruptcy case. It noted that in rejecting the SEC's objections, Judge Michael Wiles of the U.S. Bankruptcy Court for the Southern District of New York endorsed many of the arguments that Ripple defendants have presented.” - CoinDesk reported.
The nature of the legal battle is relevant for most other cryptos too. The question is whether crypto is a security or a commodity in legal terms, and it’s widely discussed now in the context of how to regulate cryptocurrencies. Securities are strictly regulated, while commodities rules are generally less stringent. If crypto represents securities, it will likely be severely limited in the US and many other countries. If cryptocurrencies are commodities, they may remain regulated loosely.
Origins of the battle lie in the Initial Coin Offering (ICO) boom of 2017. In May 2018 there was a class-action suit against Ripple, alleging that the coins offered in ICO were unregistered securities. The then-Chairman of the SEC said that cryptocurrencies must follow long-standing rules of securities offerings, which would not be changed for ICOs. In 2020 the SEC initiated a legal case against Ripple and two of its most senior executives (founder Christian Larsen and current CEO Bradley Garlinghouse). “According to the SEC, Ripple executives have sold 14.6 billion units of XRP for more than $1.38 billion to fund the company’s operations and acquire personal wealth without registering their offers and sales of XRP with the SEC. Those actions have broken several securities laws, the complaint says. The SEC seeks to permanently ban Ripple and its leaders from selling unregistered XRP, make defendants "disgorge all ill-gotten gains" from the transactions, and impose unspecified civil money penalties.” the American Banker reported in 2020
The question of whether crypto is a security or a commodity will probably be solved via the so-called Howey Test, which is usually used to determine whether a transaction is an investment contract and so should be treated like a security. Under the Howey Test, security must involve the following four elements:
- An investment of money (later “money” definition has been expanded to include other assets, so Bitcoin and Ethereum likely qualify as money),
- In a common enterprise,
- A reasonable expectation of profit,
- Derived from the efforts of others.
Although I’m not a legal expert, in my view crypto is much more similar to commodities than securities, but most ICOs pitched crypto as securities, advertising a potential profit from participation in the cryptocurrency project. XRP looks more similar to security than other cryptos because it’s centralized.
To Chase or Not to Chase
I believe one should need a certain degree of legal expertise to trade the rally. Before the recent rally, XRP was arguably a forgotten asset with a little downside if Ripple loses. After the rally, the market probably priced in a significant probability of a Ripple victory over the SEC, so there are both an upside and a downside depending on the court ruling. Moreover, even Ripple’s success does not guarantee further price growth, since markets famously like buy-the-rumor and sell-the-news trades.
An illustrative example of a sell-the-news market reaction was the Merge, when Ethereum successfully transitioned to a proof-of-stake mechanism in September 2022. Despite a lot of previous hype, the price action during the Merge itself was quite boring. Ethereum reached a local high about a month before the Merge and failed to rally on the Merge news despite the Merge being technically very smooth and successful.
Ethereum price (ETH/USD)
Conclusion
Although I don’t like investing in the XRP rally, it does look like a positive signal for broader crypto, suggesting a more positive market view on prospects that crypto will not be treated like securities in legal terms. XRP is one of the most vulnerable cryptocurrencies in this regard because it’s centralized and has carried out the ICO which did seem questionable in a legal sense. If Ripple wins over the SEC, other cryptos will have almost no chance to be regulated like securities, which is very positive for all crypto. But I suspect that even if current optimism regarding XRP proves wrong, Bitcoin and some other old-fashioned cryptocurrencies may not be treated like securities, since they are too different from XRP. The trade I like is to buy the dip in Bitcoin if Ripple loses against the SEC.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.
