Ripple Urges SEC to Abandon Decentralization as a Legal Test

• Ripple contends that decentralization is a vague and ever-changing concept, making it a weak basis for deciding whether a crypto token is a security under the law.
• The company called for a clear, rights-based regulatory framework that focuses on legal rights and enforceable obligations rather than vague technical criteria.
• Ripple pointed out that decentralization depends on a range of factors like who contributes code, how nodes are spread out, who participates in governance, and the token’s economic model, all of which can change as a network evolves.

Ripple Labs submitted a formal letter to the SEC’s Crypto Task Force, urging regulators to move away from the subjective decentralization test often used to classify digital assets under securities law. The company contends that decentralization is a vague and ever-changing concept, making it a weak basis for deciding whether a crypto token is a security under the law.

In its submission, Ripple called for a clear, rights-based regulatory framework that focuses on legal rights and enforceable obligations rather than vague technical criteria.

The company pointed out that decentralization is not a binary state, but rather exists as a spectrum. It depends on a range of factors like who contributes code, how nodes are spread out, who participates in governance, and the token’s economic model, all of which can change as a network evolves.

Ripple claims that using decentralization as a test can lead to two types of errors. False negatives occur when risky assets look decentralized enough to avoid regulation. False positives happen when mature, actively traded tokens are still treated as securities well after their launch, even though they no longer function like one.

As such, the company wants regulators to separate the legal treatment of the original investment contract from the asset itself once the issuer’s contractual obligations end.

A Rights-Based Framework

Ripple’s letter calls for a regulatory test that focuses on the legal promises tied to the original sale of a crypto token, not on how decentralized its network is. The core argument is that once the issuer’s obligations have ended, trading that token on the open market should not be regulated as a security, no matter how distributed the network has become.

This approach fits with Ripple’s earlier ideas, such as a network maturity test, which aims to set clear, measurable rules for when a crypto token moves beyond its original fundraising purpose. These rules might include factors like the token’s total market value, whether the network is open for anyone to use, and whether no single person or group can control it.

Ripple’s stance is part of a longstanding push for crypto regulatory reform. In the past, the company has warned that unclear language in SEC actions and draft laws could keep crypto tokens under open-ended regulatory review or trapped forever under securities laws, which would slow down innovation.

Related: Ripple Wins Major Regulatory Approval from UK’s FCA