When They Howey, We All Howey


A large portion of the cryptocurrency regulatory debate has centered around the Howey test.[1],[2]  The Howey test is a framework articulated by the Supreme Court to decide whether an investment contract is a security, subjecting that investment contract to the federal securities laws.[3]  This is because cryptocurrency and other blockchain innovations do not fit squarely into the Howey test.[4]  The four elements of the Howey test are: (1) the investment of money (2) in a common enterprise (3) with the expectation of profit (4) through the effort of others.[5]  All four of the prongs must be satisfied for the analyzed “thing” to be a security.[6]

I.      Investment of Money

The investment of money is the easiest prong of the Howey test to analyze in the cryptocurrency context.[7]  The prong speaks for itself; the investment of money is purchasing something or providing money for a purpose.[8]

The investment of money in a token or cryptocurrency, in my own view, is the same as purchasing a commodity.  An orange may be a bad example,[9] buying gold is a good example for analysis.  A purchaser is generally indifferent to the gold that they are receiving if it is the same quality from all sellers.[10]  This is the same as a single cryptocurrency; aside from idiosyncratic preferences of where or who to purchase it from, it is a fungible commodity with each unit being no different from another.[11]

II.      A Common Enterprise

The common enterprise prong of the Howey test is where the ambiguity increases.  The Second Circuit has stated that this prong is satisfied where “shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed by the enterprise.”[12]

Is a token or an amount of cryptocurrency a nominal interest in an enterprise?  It is generally safe to say that a cryptocurrency, that is not a stablecoin[13] or another collateralized coin, holds no interest in physical assets.[14]

The next question is whether a coin or token represents a formal certificate which evidences value in a common enterprise. This is perilous as different biases will lead to vastly different opinions.  Director Hinman of the SEC claims that if a cryptocurrency is sufficiently decentralized such as Bitcoin or Ethereum, it no longer fits into this framework.[15]  If this is true, why would a centralized blockchain be a common enterprise?  The mining pool which allows the transferability of cryptocurrency and valuation is a necessary for functionality.[16]  Since it is also a necessary to have Apple’s communication with your iPhone to fully function or sometimes necessary for resold devices, is an iPhone purchaser buying an interest in Apple or the iPhone itself?[17]  Apple is not a decentralized company, the obvious answer is still that the iPhone purchaser bought a physical asset and not an interest in Apple.  Creating an intangible digital asset instead of a physical asset does not suddenly make it something it is not.  Therefore, those that consider a blockchain as a common enterprise are not amenable to the change in infrastructure that blockchain technology allows.

III.      Expectation of Profit Through the Efforts of Others

The next two prongs are better combined for analysis.  They are the expectation of profit and that the profit is realized through the effort of others.[18]  The Second Circuit has further interpreted this part of the Howey test to provide that there must be a line drawn between “companies that seek the ‘passive investor’ and situations where there is a ‘reasonable expectation…of significant investor control.’”[19]  This is because the securities laws were enacted as protection for the passive investor.[20]

Cryptocurrencies, if being held to appreciate in value, are for the passive investor.  Cryptocurrency holders are generally not required to mine and thus do not participate in the upkeep of the network which provides utility and transferability of the cryptocurrency.[21]  Cryptocurrency may be considered a passive investment, but one issue left open is who “the efforts of others” refers to.  When miners are paid by transaction fees instead of just rewards, is that transaction fee to be considered an investment in the network?  After all, miners are the entities deciding which protocols to use.[22]  There is no easy answer to this question.  Instead of purporting to solve it, for the purposes of this writing, it is easier to solely illustrate the interpretive vulnerability.

For an alternative to investor control, return to the gold example discussed above.  The supply and demand of gold determines the price.[23]  Many different entities mine and sell gold, the mined gold may then be resold on a secondary market.[24]  The physical commodity of gold only differs from cryptocurrencies in that a person can hand another the physical asset, for a digital asset a network must be functional to transfer the asset.  Some investors purchase gold with the primary expectation of profit, but the SEC and CFTC do not regulate people who wish to sell gold on the spot market.[25]

An additional test which the SEC uses to determine whether there was an expectation of profit is the risk-capital test.[26]  The risk-capital test focuses on “the likelihood that the investor’s initial contribution will result in an ultimate loss due to failure of the product.”[27]

For cryptocurrencies, the asset purchased may not provide any economic utility if the blockchain fails.  The digital asset is still held by the owner, the owner still holds some value and not all is lost.[28]

IV.      In Totality?

The SEC believes that non-“sufficiently decentralized” cryptocurrencies are securities.[29]  The above arguments demonstrate how susceptible the Howey test is to interpretation.  The ambiguity in the Howey framework, particularly as applied to cryptocurrencies, leaves a reviewing court limitless possibilities on how to rule on the SEC’s interpretations.



[1] This blog post is a passage from an assigned paper for Professor Redel’s and Professor Maloney’s Cryptocurrency and Blockchain Regulation course at Fordham University School of Law.  This passage was used with permission from the Professors.

[2] Cf. Oliver Dale, What is the Howey Test & How Does it Relate to ICOs & Cryptocurrency?, Blockonomi (July 31, 2019), https://blockonomi.com/howey-test/.

[3] Id.

[4] Id.

[5] S.E.C. v. W.J. Howey, Co., 328 U.S. 293, 300-01 (1946).

[6] See id.

[7] Id.

[8] Definition of Investment, Merriam-Webster, https://www.merriam-webster.com/dictionary/investment (last visited Nov. 20, 2019).

[10] A purchaser may have an idiosyncratic purpose to pick a preference of supplier, but generally a fungible commodity should allow the purchaser to have no preference.  Cf. Definition of Fungible, Merriam-Webster, https://www.merriam-webster.com/dictionary/fungible (last visited Nov. 20, 2019).

[11] See David Canellis, The difference between fungible and non-fungible cryptocurrency tokens, Hard Fork (Nov. 23, 2018, 11:58 AM), https://thenextweb.com/hardfork/2018/11/23/fungibility-cryptocurrency-token/.

[12] United States v. Leonard, 529 F.3d 83, 88 (2d Cir. 2008).

[13] Stablecoin, Binance Academy, https://www.binance.vision/glossary/stablecoin (last visited Nov. 20, 2019) (discussing stablecoins and how they hold value).

[14] This is an inference made by the author.  The inference is based in the fact that there are no physical assets backing most cryptocurrencies excluding stablecoins and possibly some other coins.  See Amber McLennan, What makes an asset-backed cryptocurrency different?, Medium (Oct. 24, 2018),  https://medium.com/reitium/what-makes-an-asset-backed-cryptocurrency-different-f1b649be3daa (discussion of asset-backed cryptocurrencies).

[15] Cf. William Hinman, Digital Asset Transactions: When Howey Met Gary (Plastic), U.S. SEC (June 14, 2018), https://www.sec.gov/news/speech/speech-hinman-061418.

[16] See What is Bitcoin Mining and How Does it Work?, Buy Bitcoin Worldwide, https://www.buybitcoinworldwide.com/mining/ (last visited Nov. 20, 2019).

[17] See Sam Costello, What To Do When You Can’t Activate a Used iPhone, Lifewire (Nov. 9, 2019), https://www.lifewire.com/when-activating-a-used-iphone-1999377 (discussing Apple’s activation locks from Find My iPhone on used iPhones).

[18] United States v. Leonard, 529 F.3d 83, 88 (2d Cir. 2008).

[19] Id. (quoting SEC v. Aqua-Sonic Prods. Corp., 687 F.2d 577, 582 (2d Cir. 1982)).

[20] Id.

[21] Tuwiner, supra note 77.

[22] See Alex Galea, Bitcoin development: who can change the core protocol?, Medium (Mar. 30, 2018), https://medium.com/@galea/bitcoin-development-who-can-change-the-core-protocol-478b8ac5fe43.

[23] Eric Sepanek, Understanding How Gold Prices Are Determined, Scottsdale Bullion & Coin (July 12, 2017), https://www.sbcgold.com/blog/how-gold-prices-are-determined/.

[24] See id.

[25] See id.

[26] Gritz, 19 N.C.J.L. & Tech. On. 193, 198 (2018)

[27] Id.

[28] The author’s favorite example is buying trading cards for a card game (i.e. Magic the Gathering or Pokémon).  If the card game drastically fails nobody will be able to play with the owner of a deck and that owner’s cards will be devalued because there is no demand for them.  Regardless of such, the owner has title to that deck of cards and they represent some value.

[29] See The DAO, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934, Release No. 81207 (S.E.C. July 25, 2017).


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Fordham Journal of Corporate & Financial Law