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What is XRP? Will the Ripple Lawsuit Crush It?

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Editorialist

Last updated March 18, 2021

Ripple and XRP made a name for themselves in the cryptocurrency space in the last years.

They promised to provide a highly usable cryptocurrency for international business payments, and the public was overjoyed by the idea. And this can be seen in the fact that XRP managed to keep the 3rd position by Market Cap for such a long time. 

But lately, the situation has turned around as the Ripple Lawsuit seems to overshadow XRP’s purpose.

Since the U.S. Security and Exchange Commission (SEC) charged Ripple and two executives with conducting a $1.3 billion unregistered securities offering back on December 22, XRP’s growth seems to have halted.

Due to this, Ripple’s trust wavered to the point some crypto exchanges have already stopped XRP trading. 

The situation seems dire. However, Ripple and XRP do not plan on going gentle into that good night.  

What is XRP, and what is Ripple?

Is XRP a currency or a security

First things first, XRP is not interchangeable with Ripple.

XRP is a digital currency issued and partly controlled by Ripple Inc. The currency runs on a digital payment platform called RippleNet, built on top of a distributed database called XRP Leger.

It is important to mention that while RippleNet is owned and run by the Ripple company, the XRP Ledger is an open-source protocol that is not really based on blockchain. It is a Distributed Ledger Technology in its own right.  

Companies that want to access the Ripple network can do that by using gateways that act as entry points to Ripple for people outside the network.

Ripple is a for-profit entity that offers companies and businesses an alternative to the banking system in the form of a fast payment and financial settlement system called RippleNet.

As a for-profit company, Ripple’s target consists of financial institutions, payment providers, and corporations.

The XRP ledger

The XRP ledger

XRP Ledger is a distributed database, an open-source protocol supporting the RippleNet and its solutions. 

The XRP Ledger follows the Federated Byzantine Consensus model. The network achieves consensus by having nodes vote on whether a transaction should or should not be included in the ledger. The validator nodes come to an agreement on the order and validity of XRP transactions. This agreement, called consensus, serves as a final and irreversible settlement. 

It takes 3-5 seconds for the ledger to reach a consensus. Once a transaction is broadcasted, anyone accessing the XRP ledger can view the network’s most recent state.

The network is formed by computers holding the roles of validators. The validators are spread around the world and maintain a shared database of who owns what, just like in the case of Bitcoin.

Trust-based validator nodes

The trust-based validator nodes system receives its name from the fact that the validators will be honest at all times. If a validator is caught trying to act sketchy, he will be immediately muted, and the other nodes won’t listen to it anymore.

Anyone can be a validator, and active validators on the ledger today include universities, exchanges, and financial institutions. 

There are currently 36 validators, and Ripple runs 6 of them.

While theoretically, anyone can run a validator node to help maintain and expand the XRP Ledger, Ripple operates a default list of trusted validators. 

As mentioned before, the XRP Ledger is inspired by the Federated Byzantine Consensus model. Therefore, the nodes organize rounds of voting to agree on which transactions follow the rules. 

For a transaction to be allowed to proceed, the validators consult with each other and vote on the legitimacy. If the transaction obtains at least 80% positive feedback, it will be broadcasted in the network.

David Schwartz (Ripple CTO) considers that the only disagreement that can appear is when two participants see transactions in a different order. One may see a transaction taking place before another or a transaction taking place before the round, while another validator may see it in the exact opposite. 

The system is meant to automatically solve this kind of issue, deferring the problematic transaction for the next round in which it will be executed if it is valid.

The XRP crypto

The XRP crypto

XRP is the native currency of the XRP Ledger. It runs on the RippleNet but only as a settlement solution. Furthermore, Ripple Inc. affirms that the XRP is not imperative for RippleNet to use in order to work.

Ripple issued the XRP cryptocurrency back in 2012 to help transfer payments through the RippleNet. Through it, banks and financial institutions can convert their money to XRP and transfer the amount to the recipient account (even another bank) without going through multiple intermediaries.

XRP is characterized by having a 3-5 second transaction settlement speed with a capacity of 1,500 transactions per second. It was issued in a number of 100 billion units, and it cannot be mined.

In terms of distribution, the founders are keeping 20 billion XRP at hand, Ripple Inc. holds 7 billion, and 46 billion are circulating. The rest of the XRP is locked in a smart contract which releases 1 billion every month.

Is XRP a currency or a security?

Is XRP a currency or a security

SEC has threatened Ripple to declare XRP unregistered security for a long time. And in December 2020, SEC finally took the initiative. Now, Ripple is going through a severe lawsuit that seems to have halted the XRP’s growth.

Even before the lawsuit, many have considered XRP to be centralized rather than decentralized. But Ripple always argued that XRP is not a security but a bridge currency. Furthermore, the United States Department of Justice and the Financial Crimes Enforcement Network classified XRP as a virtual currency when they settled their suit against Ripple in 2015. 

Despite that, SEC is accusing Ripple, Brad Garlinghouse, and Chris Larsen that they have sold XRP as an unregistered security between 2013 and 2020.

No matter how much Ripple dismisses the allegation, according to the SEC vs. Ripple lawsuit analysis published by Cointelegraph, SEC has built quite the strong case passing XRP through the Howey Test.

The Howey test

The Howey investment contract test defines an asset to be a security if it meets the following criteria:

A beneficiary buys the asset in order to (1) make an investment (2) of money or something else of value, (3) in a common enterprise, (4) with the expectation of profits, (5) from the essential managerial efforts of others.

The fourth and the fifth criteria go hand in hand, and in the cryptocurrency space, tokens usually meet the first three criteria except for these ones. That’s due to sufficient decentralization.

However, in Ripple’s case, XRP is the native currency of a network maintained by 36 nodes, of which Ripple Inc. holds 6. 

The lawsuit also revealed that Ripple raised more than $1.38 billion from the sale of XRP. Furthermore, Ripple seems to have done various actions to promote profitability, including statements suggesting potential appreciation for XRP as a purchase reason.

There is also the matter of the huge amount of XRP held by the company, which can be translated in a strong case to be made that the profitability of XRP is highly dependent on the efforts of Ripple.

The odds seem to favor SEC, but that doesn’t mean that Ripple’s law team is giving up. And neither is the XRP community. 

XRP being declared a security doesn’t affect the company only, but holders as well. Therefore, XRP holders are asking to join the SEC lawsuit as third parties in Ripple’s defense.

Key takeaways

  • XRP is a digital currency native to the XRP Ledger that runs on the RippleNet. The cryptocurrency was issued and is partially controlled by Ripple Inc.
  • Ripple is a for-profit entity that offers companies and businesses an alternative to the banking system in the form of a fast payment and financial settlement system called RippleNet.
  • XRP Ledger is a distributed database, an open-source protocol supporting the RippleNet and its solution. The XRP Ledger follows the Federated Byzantine Consensus model, and it takes 3-5 seconds to reach consensus.
  • The trust-based validator nodes system receives its name from the fact that the validators will be honest at all times. There are currently 36 validators, and Ripple runs 6 of them.
  • The XRP cryptocurrency was issued by Ripple back in 2012 in a number of 100 billion units, and it can provide 1,500 transactions per second.
  • The SEC lawsuit against Ripple is not yet settled. However, SEC makes a strong case that XRP can be registered as a security according to the Howey Test.
  • Ripple is arguing against the allegations as XRP holders request to join the lawsuit in the company’s defense.
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