Amini & Conant | Cryptocurrency and The Howey Test | IP Attorney (2024)

FAQs

What is the Howey test law? ›

In deciding Howey, the Supreme Court created a test that looks at an investment's substance rather than its form. The substance is the determining factor for whether it is a security. Even if an investment is not labeled a stock or bond, it may be a security under the law.

The Howey test is a legal framework outlined by the U.S. Supreme Court to determine whether a transaction qualifies as an investment contract and should be regulated. The Howey test consists of four criteria: an investment of money, expectation of profits, common enterprise, and reliance on the efforts of others.

In order to pass the Howey test, the transaction must receive a "yes" answer for each of the four questions. This test is important because it determines if a transaction qualifies as an investment contract and thus is covered by U.S. federal securities law.

Under the Howey test, the offer and sale of an asset like ETH constitutes an investment contract if (1) someone invested money, (2) in a “common enterprise,” (3) in the expectation of profit and (4) where that expectation is based on the “essential managerial efforts of particular others.”

Securities are fungible and tradable financial instruments used to raise capital in public and private markets. The public sales of securities are regulated by the SEC. The definition of a security offering was established by the Supreme Court in a 1946 case called SEC v. W.J. Howey Co.

Generally courts in states that apply the risk capital test will use both the Howey test and the risk capital test to determine whether something is a security. If an instrument meets the definition under either test, the court will conclude that it is a security.

Howey is used to determine whether an instrument is an “investment contract” as that term is used in the definition of a security contained in the Securities Act of 1933 and the Exchange Act of 1934; Reves is used to determine whether a “note” is a security as defined in those Acts.

Prong 1: Proportionality. Prong 2: Expansion. Prong 3: Accommodating Interests.

A non-security is an alternative investment that is not traded on a public exchange as stocks and bonds are. Assets such as art, rare coins, life insurance, gold, and diamonds all are non-securities. Non-securities by definition are not liquid assets.

What are restricted digital assets? ›

If, for example, a token was obtained by one person via airdrop or through a digital commodity exchange, that token would be deemed a Digital Commodity. But if another person acquired that token through other means—g., over the counter—it would be deemed a Restricted Digital Asset.

Bitcoin does not meet this criteria because it does not have any issuer or promoter who controls its supply or value. It is also decentralized and distributed among its users who validate transactions and secure the network through proof-of-work mining.

The main difference between a commodity vs. security lies in what you own. Commodities are raw materials and basic goods, while securities represent an ownership stake (e.g. stock) or a debt obligation (e.g. bonds). As such, investing in commodities and securities can offer two different paths to diversification.

If Ethereum is classed as a security, we'd see much stricter controls on how you can buy and sell Ethereum. One crypto attorney told CoinDesk it would be "devastating" for American investors. For example, centralized cryptocurrency exchanges are not registered with the SEC.

Bitcoin is a commodity, for sure; CTFC classified it under the U.S. Commodity Exchange Act (CEA) in 2015. The SEC Chairman, Gary Gensler, further confirmed that Bitcoin is a commodity in 2022.

To pass strict scrutiny, the legislature must have passed the law to further a "compelling governmental interest," and must have narrowly tailored the law to achieve that interest. Strict scrutiny is the highest standard of review which a court will use to evaluate the constitutionality of governmental discrimination.

The reasonableness standard is a test that asks whether the decisions made were legitimate and designed to remedy a certain issue under the circ*mstances at the time. Courts using this standard look at both the ultimate decision, and the process by which a party went about making that decision.

While Bitcoin meets the test's first prong, it doesn't satisfy the second and third elements. With Bitcoin, there is no common enterprise where investors are pooling their funds, there's no promoter or issuer, and an investor's success isn't reliant on the efforts of others.

A four-prong test is utilized in deciding to authorize criminal charges: Was there a crime? Do we know who did it? Can we prove the case beyond a reasonable doubt at jury trial? Is charging the right things to do?