Ripple CTO Offers Simple Metric To Distinguish Securities From Commodities

Schwartz attempts to dispel the confusion on what constitutes a security and commodity in the crypto space.

Ripple’s chief technology officer David Schwartz has offered a simple method to identify what constitutes a security or commodity.

The Ripple executive did this in a tweet yesterday, surmising his thoughts on arguments made by lawyers of former Coinbase product manager Ishan Wahi in a motion to dismiss a civil suit filed by the US Securities and Exchange Commission (SEC). Schwartz surmised that securities give holders rights while commodities give holders abilities.

There's a very simple way to tell if something is a security or a commodity. If it gives you rights, it's a security. If it gives you abilities, it's a commodity. https://t.co/FsY9qGLCY6

— David "JoelKatz" Schwartz (@JoelKatz) February 7, 2023

The arguments cited by Schwartz in a previous tweet specifically relate to governance tokens which the Ripple executive previously believed were ” more security-like.” In the excerpt, the lawyers assert that these tokens do not confer rights on holders enforceable against the developer. Instead, they argue that these tokens only offer holders “limited technological ability” with no legal obligation to do anything on behalf of users.

The Wahil motion to dismiss contains an interesting counter-argument to my position that tokens that include governance "rights" are more security like, arguing they're not rights but simply technical abilities. pic.twitter.com/hALc98NCNn

— David "JoelKatz" Schwartz (@JoelKatz) February 7, 2023

Notably, Schwartz demonstrates the point using IBM stock. As explained by the Ripple executive, holders of IBM stock have the legal right to participate in governance but with no ability to do so. According to Schwartz, IBM has the legal obligation to provide you with that ability by notifying you of impending decisions and counting your vote. 

Conversely, Schwartz says with governance tokens, you are not conferred the legal right to vote, but you can, touting this as a critical legal distinction.

Furthermore, Schwartz clarified that it does not necessarily mean that on-chain governance votes are not binding. Using the example of an orange, the Ripple CTO posits that while oranges are commodities, you can file charges against a third party for interfering with your ability to eat yours. According to Schwartz, this will be a tort claim, not a contract breach.

Notably, Tort encapsulates civil wrongs without contractual agreements.

The Ishan Wahi Case

Recall that in July last year, the US Department of Justice (DoJ) and the SEC filed charges against the former Coinbase product manager, his brother Nikhil Wahi and his friend Sameer Ramani for an alleged insider trading scheme. Per the filings, Wahi allegedly tipped off his friend and brother on tokens Coinbase planned to list, allowing them to make over $1 million in profit from trading on this information from June 2021 to April 2022.

However, the SEC civil case came with a twist alleging that 9 of the digital assets traded by Wahi and his accomplices are securities.

Notably, Wahi’s brother, in September, pleaded guilty to a wire fraud conspiracy charge, and on Tuesday, Wahi pleaded guilty to two counts of conspiracy to commit wire fraud.

But Wahi is seeking to dismiss the SEC case as his lawyers argue against the regulator’s claim that the assets represent securities. Per the motion to dismiss, the defense argues that there is no investment contract, investment in a common enterprise, or expectation of profits as the tokens are utility tokens with value decided by market forces. In addition, it notes that previous cases where the courts have ruled that initial coin offerings (ICOs) constitute security do not apply as the case is concerned with activity in the secondary market.

SEC v. Ripple

Meanwhile, it is worth noting that Ripple is locked in a similar battle with the SEC. The regulator in December 2020 accused Ripple and its executives of engaging in the sale of unregistered securities.

The regulator asserts that XRP tokens, even those purchased in secondary markets, represent unregistered securities.

The case, which has spanned over two years, now awaits the decision of Judge Analisa Torres as everything has been briefed.