The long awaited “Hinman docs” have finally been unsealed, a move that some believe could play a crucial role in the ongoing legal battle between the U.S. Securities and Exchange Commission (SEC) and Ripple. Ripple is being sued by the securities regulator for an allegedly illicit sale of $1.3 billion worth of XRP, a cryptocurrency the SEC is treating as a security.
Ripple has fought hard to get these documents into the court record, which supposedly show the agency is unfairly targeting the company. CEO Brad Garlinghouse yesterday said the document dump was “well worth the wait.” While not everyone is convinced the document dump proves Ripple’s claims, the hundreds of internal messages from SEC higher ups do show that the SEC has never really been clear on whether and how to regulate the cryptocurrencies that were created after Bitcoin.
It all started in 2018, when then Director of the SEC’s Corporate Finance Division William Hinman gave a speech at a Yahoo! Summit, where he argued that ether (ETH), the native token of the Ethereum blockchain, should not be classified as a security essentially because the network had become “sufficiently decentralized” from its time of creation. Even if ETH was a security at launch – a very real possibility, the SEC notes, given how the token sale was conducted – blockchain networks can evolve and the circumstances can change (a similar line of thinking that supports live regulatory proposals like Hester Peirce’s “Safe Harbor” guidance).
That public speech was based on Hinman’s understanding of the Ethereum network at the time, and, although Ripple is arguing that XRP is not a security, the company does not view Hinman’s thinking as particularly helpful. Instead of arguing on similar grounds that XRP has “decentralized” over time, Ripple is trying to argue that Hinman’s theory was not grounded in a proper understanding of securities law.
In short, Ripple fought to see these documents and then fought to release them to the public because they sowed discord. On Twitter, Garlinghouse said it's "absolutely unconscionable" that Hinman gave his speech despite the lack of consensus agreement within the SEC, adding that the speech “deliberately created confusion.” This is apparently supportive of the company’s actual defense that the SEC sued Ripple and its executives without a clear legal basis. Further, Ripple is arguing on procedural grounds that the SEC violated its due process rights by failing to provide “fair notice” of potential securities regulation violations.
For months, the SEC, now run by Chairman Gary Gensler, has fought to keep these conversations out of the public view, based on the view that Hinman’s statements were his and his alone, did not represent the agency’s understanding and are irrelevant to the lawsuit. Indeed, while the internal communications at the SEC concerning Hinman’s presentation – including feedback he solicited from colleagues before the summit – show that many SEC officials were aligned, it’d be hard to say it represented everyone’s views.
For instance, SEC Director Brett Redfearn, suggested Hinman use stronger language to make it clear that ETH circa 2018 was not a security while others noted that Hinman’s speech would lock the agency into a position if it wanted to take a “different position on ether in the future.” It turns out that that wouldn’t be a problem for Gensler, who seems entirely unconcerned about contradicting earlier views he or his predecessors have held.
Perhaps that is par for the course at the SEC. During Ripple's protracted fight to get the documents into the public, the judge overseeing the case said the agency was acting immorally by trying to keep the speech drafts out of court. Moreover, one of Ripple’s key arguments in that Hinman’s speech showed a clear conflict of interest, considering that he had a stake in a law firm that was a member of the Enterprise Ethereum Alliance at the time (which he rejoined after leaving the SEC), according to an email exchange between Hinman and the SEC’s ethics office.
For its part, Ripple argues a few things about XRP. First, the for-profit company has for years said that it did not create the network or the token, although it is a primary developer on the chain and perhaps the organization that stands to gain the most materially from XRP’s adoption. Further, perhaps confusingly, the company has argued that XRP is commodity money, a type of resource that has trade value for a diverse cast of investors, coders and companies – like bitcoin (BTC) and ether (ETH).
There are a few things that point in favor of the idea that the XRP network has decentralized over time. Like any public blockchain, anyone can build using XRP or use the network to transfer assets. In late-2013, Ripple Labs released Ripple’s full code base, which was not always public, theoretically offering tools to the world necessary to maintain the network without the involvement of any specific party. Several companies, most notably MoneyGram, rely on the network for some types of cross-border transactions.
But, for many people outside of the XRP Army, Ripple has been something like a canker on the blockchain industry. This perhaps started with Ripple Labs’ token distribution plan, the very thing being questioned by the SEC. Similar to some token treasuries today, Ripple decided it would control the disbursement of the 100 billion XRP units that will ever exist, distributing them to the community, early investors and the company’s founders. This is partially why Jeb McCaleb, the founder of Ripple who left to found the competing payments-focused blockchain Stellar, has had so many tokens available to dump on the market over the years.
And while the company may argue against this point, Ripple the network really hasn’t decentralized much from its point of creation. For years, all of Ripple’s clients (the implementation of its code) were set to trust only Ripple’s validation nodes by default. Unlike Bitcoin or Ethereum, where “trustless transactions” are the default, Ripple uses validators to help untrusting partners find trusted routes to trade: meaning if Ripple the company controls the validators, it basically controls the XRP ledger.
This is a point the SEC latched onto in its suit. “During the process to achieve consensus with respect to a new proposed state of the XRP Ledger, each server on the network evaluates proposed transactions from a subset of servers it trusts not to defraud it, also known as the server’s UNL,” the SEC wrote, referring to Unique Node Lists (UNLs), or the gateways that control who can participate in the blockchain consensus mechanism. While users can control their own UNLs, most use the XRP Foundation’s dUNL (“d” is short for default).
Rarely do discussions of Ripple’s suit discuss technical details like this. In fact, most of the conversation seems to be rooted in a total misunderstanding of the company’s strategy. Part of the reason the XRP Army has been dragging someone like Vitalik Buterin, the creator of Ethereum, today is because he took a call with the agency as Hinman was drafting its speech.
Ripple’s case absolutely matters for the future of the blockchain industry. It was hugely significant when Coinbase and other U.S. exchanges delisted XRP in 2020, when the SEC first alleged the token was a security – a type of action it would be hard to imagine happening today (Cpinbase didn’t even delist all the so-called “securities” its former executive turned insider trader Ishan Wahi was accused of frontrunning).
The case specifically involves a legal interpretation of cryptocurrencies as meeting the prongs of the SEC’s Howey Test, which asks whether an “investment contract” is an investment of money in a common enterprise with the expectation of profit to be derived from the efforts of others. Ripple denies that XRP qualifies as a security, because there was no “investment contract” and that XRP has more in common with diamonds, gold, soybeans and cars (i.e. commodities).
In other words, Ripple cares whether the SEC is right or wrong. But it never cared about decentralization.