The SEC’s Crypto Bait-and-Swap and $15 Billion Investor Loss

Four years ago this week, the Securities Exchange Commission (SEC) Director of Corporate Finance, William Hinman, detailed a vision for regulating digital assets. The speech was a bait and switch. It promised to usher in a blockchain revolution, the next chapter in the success story of American innovation. In practice, the SEC wants to eliminate cryptocurrencies. On that fateful day, Hinman said that the decentralization of a blockchain ledger, where tokens are “used to purchase a good or service through the network in which it is created,” could transform a digital asset into a commodity outside the scope of the SEC. He opined that once they became “sufficiently decentralized,” a token and its network could operate without fear of SEC enforcement action for failing to register as a stock. How wrong I was.

Decentralization was the goal from the start

Everyone who participated in the launch of the first blockchain ledgers like Bitcoin, XRP, and Ethereum understood that decentralization was the point. Blockchain technology was developed to remove friction from the economy and enhance the power of peer-to-peer activity. Bitcoin developed the idea of ​​a currency to trade or store value without the involvement of bankers. XRP became a bridge token to clear and settle cross-border cash payments without intermediaries. Ethereum became a network for carrying out complex peer-to-peer agreements, dubbed “smart contracts”. The millions of hours spent writing code and billions of dollars in investment to build these innovative networks were not intended as get-rich-quick schemes. Rather it was careful engineering to improve the technology of money (think computers instead of typewriters, or email instead of letters) and to reduce its cost.

Hinman’s speech highlighted Bitcoin and Ethereum, Ethereum’s native token, saying that they are not securities, causing the price of Ethereum to skyrocket. But all hope ended there, as the SEC turned Hinman’s speech 180 degrees and launched a barrage of measures contrary to Hinman’s guidance.

The SEC bait and switch

On his last day in office in December 2020, then-SEC Chairman Jay Clayton, Hinman’s boss and hiring manager, filed a lawsuit against Ripple, an enterprise software company that sells cross-border payment solutions to banks and uses XRP to settle transfers. The SEC alleged that the only utility of XRP is as an investment contract in Ripple. Furthermore, he characterized every sale of XRP by anyone, whether it be Ripple, some other company using the XRP ledger, or XRP holders who traded it on secondary markets without knowing anything about Ripple, is a transaction of unregistered securities involving Ripple shares. XRP itself is a security, not the way it is packaged and sold. Worse yet, the SEC made the mind-boggling claim that everyone should have known XRP was a security back in 2013 when its network debuted. (That would include Hinman and all the SEC employees who helped him write his 2018 speech, you might guess.)

The enforcement action against Ripple is the opposite of what Hinman said. XRP was designed to be a decentralized network from the start, and Ripple controlled less than 5% of the nodes in the network’s consensus protocol when it was sued. Furthermore, the lawsuit contradicts the core logic of Hinman’s speech, that tokens themselves are not securities, but the way they are packaged and sold can create securities transactions. In the case of Ripple, the SEC charges XRP and everyone who trades with it, even if they are buying groceries or gasoline with it in a transaction that has nothing to do with Ripple.

Ripple’s lawyers have used Hinman’s speech in their defense, prompting the SEC to tell the court that Hinman’s speech was “irrelevant” and his own “personal opinion” despite a long list of SEC officials. SEC, and apparently some investors connected to Ethereum. he had a hand in writing it.

Transparency Could Expose SEC Fraud

The SEC has relentlessly fought transparency requests about the genesis of Hinman’s speech, the disclosure of which could expose potential fraud by the agency. Innocent XRP holders lost $15 billion in value and entered the case as friends of the court against the agency. They obtained open collaboration documentation showing that Hinman had multi-million dollar financial interests in a law firm promoting Ripple competitor Ethereum.

Hinman’s speech could have been a revolutionary turning point for American innovation, but it turned into an unmitigated disaster. Hinman not only misled the public and materially harmed thousands of investors, but he and his minions caused serious damage to the credibility and integrity of the SEC. The SEC flouted its mission to protect investors.

However, regulatory scholars are not surprised. They have shown for decades that captured agencies like the SEC favor their pet players, like regulated banks, over innovators and consumers. With increased regulation, Congress has made the problem worse. Now the only backup is the courts, where aggrieved innovators try to get a fair deal. Magistrate Judge Sarah Netburn can order the SEC to end obstruction of her and provide internal documents about Hinman’s speech. This could expose the SEC market hoax and force a deal with Ripple. The first step in a long-overdue reckoning for the agency may be near.

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