This year, as the U.S. Securities and Exchange Commission (SEC) escalates enforcement against businesses accused of offering unregistered crypto securities to American investors, regulators, attorneys, and judges have increasingly turned to the Howey Test to determine whether specific crypto assets constitute an “investment contract” and thus fall under U.S. securities laws. Below is an in-depth examination of the Howey Test and its application to digital assets.
What Is the Howey Test?
The Howey Test derives from the 1946 Supreme Court case SEC v. W.J. Howey Co., which established four criteria for defining an “investment contract”: (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits, (4) derived solely from the efforts of others (promoters or third parties). If an asset satisfies all four prongs, it is considered a security and must comply with federal registration and disclosure requirements.
In the crypto space, the SEC applies the Howey Test to initial coin offerings (ICOs) and token sales. For instance, ICOs that promised returns primarily driven by the efforts of developers or third-party promoters have been classified as securities offerings. Bitcoin (BTC) is widely regarded as a commodity, while Ethereum (ETH) remains in a gray area—SEC Chair Gary Gensler has declined to clarify whether ETH is a security.
SEC’s List of Crypto Securities
Through enforcement actions, the SEC has identified at least 70 crypto assets it considers securities. In its lawsuit against Binance, the SEC listed Solana (SOL), Cardano (ADA), Polygon (MATIC), Decentraland (MANA), Flow (FLOW), and Cosmos (ATOM) as securities. In the Coinbase case, the regulator flagged Axie Infinity (AXS), Chiliz (CHZ), and The Sandbox (SAND), among others.
However, applying the Howey Test to crypto assets is notoriously complex because a single token can function as a currency, commodity, utility token (used as “gas” for transactions), or a staking asset in a decentralized application. Each use case may imply different expectations of profit and reliance on third-party efforts, leading to inconsistent regulatory outcomes.
Industry Backlash: A 1946 Rule for 2024 Assets
Crypto businesses have strongly criticized the SEC for failing to provide clear regulatory guidelines, instead engaging in what they call “regulation by enforcement.” They argue that the Howey Test, developed in 1946, is ill-suited for modern digital assets with multifaceted utility. This uncertainty stifles innovation and pushes companies to relocate to more crypto-friendly jurisdictions. There is a growing consensus that a tailored regulatory framework—one that accounts for decentralization, token utility, and evolving network governance—is long overdue.
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