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The SEC’s Crypto Bait and Switch and Losing $15 Billion to Investors

Four years ago this week, the Security Exchange Commission’s (SEC) Director of Corporation Finance, William Hinman, detailed a vision for regulating digital assets. The speech was a decoy and switch. It promised to open a blockchain revolution, the next chapter in America’s innovation success story. In practice, the SEC wants to eliminate crypto from the world. On that fateful day, Hinman said that the decentralization of a blockchain ledger, where tokens are “used to purchase a good or service over the network on which it is created,” turned a digital asset into a commodity outside of the purview of the SEC could transform. He opined that once a token and its network are “sufficiently decentralized,” they can operate without fear of SEC enforcement action because they don’t register like a stock. How wrong he was.

Decentralization was the goal from the start

Anyone involved in launching the first blockchain ledgers like Bitcoin, XRP, and Ethereum understood that decentralization mattered. Blockchain technology was developed to eliminate friction in business and increase the power of peer-to-peer activities. Bitcoin developed the idea of ​​a currency to trade or store value without the involvement of bankers. XRP became a bridge token for clearing and processing cross-border cash payments without an intermediary. Ethereum became a network for conducting complex peer-to-peer agreements, nicknamed “smart contracts”. The millions of hours of code writing and billions of dollars of investment to build these groundbreaking 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 e-mail instead of letters) and lower its cost.

Hinman’s speech highlighted Bitcoin’s and Ethereum’s native token ether, saying that they are not securities, which is pushing up the price of ether. But all hope ended there when the SEC made a 180-degree turn on Hinman’s speech and launched a barrage of enforcement actions against Hinman’s guidance.

The SEC’s bait and switch

On his last day in office in December 2020, then-SEC Chairman Jay Clayton, Hinman’s boss and chief human resources officer, filed a lawsuit against Ripple, an enterprise software company that sells cross-border payment solutions to banks and uses XRP to process remittances. The SEC claimed that the only utility of XRP is an investment contract in Ripple. Furthermore, any sale of XRP by anyone – be it Ripple, another company using the XRP ledger, or XRP holders who have traded it on the secondary markets without knowing anything about Ripple – is an unregistered securities transaction involving Ripple stocks. XRP itself is a security, not the way it is packaged and sold. Worse, the SEC has made the startling claim that everyone should have known XRP is a security since 2013, when their network debuted. (That would include Hinman and all the SEC staff who helped him write his 2018 speech, one would assume.)

The enforcement action against Ripple is the opposite of what Hinman said. XRP was designed as 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. Additionally, 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 Ripple case, the SEC is suing XRP and anyone who trades it, even if they use it to buy groceries or gas in a transaction unrelated to Ripple.

Ripple’s attorneys 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 — and apparently some Ethereum-affiliated investors – had a hand in writing.

Transparency could reveal SEC fraud

The SEC has relentlessly fought requests for transparency over the genesis of Hinman’s speech, which exposure could expose potential agency fraud. Innocent XRP holders lost $15 billion in value and joined the case as friends of the court against the agency. They collected documents showing Hinman had multimillion-dollar financial interests in a law firm promoting Ripple’s competitor Ethereum.

Hinman’s speech could have been a revolutionary turning point for American innovation, but it turned out to be an absolute disaster. Not only did Hinman mislead the public and cause material harm to thousands of investors, he and his cohorts severely damaged the credibility and integrity of the SEC. The SEC scoffed at its mission to protect investors.

However, regulatory scientists are not surprised. They have shown for decades that captive authorities like the SEC favor their favored actors like regulated banks over innovators and consumers. As regulation has increased, Congress has made the problem worse. Now the courts are the only place where aggrieved innovators seek a fair shake-up. Magistrate Judge Sarah Netburn can order the SEC to end her obstruction and release the internal documents related to Hinman’s speech. This could expose the SEC’s market deception and force a deal with Ripple. The first step in a long overdue settlement for the agency could be at hand.

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