What Is The Howey Test And How Does It Relate To Cryptocurrency?

The emergence of cryptocurrencies, on one hand, has made life easier for entrepreneurs and investors, but on another, it created a lot of problems for authorities. Some issues of regulation and legalization of crypto assets still remain unsolved. For example, the big question is whether or not cryptocurrency is equal to securities. Should it obey traditional regulation rules or does it need the development of new methods? In order to help with some tricky situations, authorities today use different tools, one of which is called Howey Test.

WJ Howey Company case and Howey Test development

Howey Test allows to determine if a particular asset belongs to the class of securities or not. It was developed in 1946 when the US Supreme Court was conducting proceedings in the W.J.Howey Company case.

Company founder W.J. Howey owned large pieces of land with orange groves in Florida. To solve his financial problems, he sold several plots to investors who didn’t know anything about agriculture. The enterprising Howey made a deal, according to which the buyers leased their pieces of land to his own company. So he would pay rent, but will keep rights to the collected products and the profit from its sale.

The Supreme Court has decided that Howey’s deal was an investment contract:

• The transaction featured an investment of money (invested in the plots of the W.J. Howey Company).
• Investors put money with the expectation of profit (investors initially agreed on rental payments).
• Investments were made in a common enterprise (all financial schemes were carried out within the framework of the W.J. Howey Company).
• The profit expected by the investor was related to the activities of others (investors received their profits from the activities of employees of the W.J. Howey Company).

The scheme described above now is called the Howey test. Today authorities use it in order to determine the status of securities or to prove if the transaction was an investment contract.

What about cryptocurrency?

With the creation of Bitcoin (BTC), the financial world faced a problem — it wasn’t easy to regulate a decentralized currency. Equating it with the category of securities immediately came to mind, and the Howey test would be a great helper in this. But transferring such an outdated model to new realities also was not an easy task. Experts and analysts of the crypto market are sure that new solutions are needed to determine the status of crypto assets, taking into account the peculiarities of cryptocurrencies and blockchain technologies.

While there is no new solution, the U.S. Securities and Exchange Commission (SEC) relies on the Howey test. Translated into cryptoeconomics, its points are as follows:

• Investing money = investment.

ICO issuers, for instance, had to change the word “invest” to “contribute” .

• Waiting for profit

Tokens tend to grow in value as they are distributed and adopted over time. So, the profit should be fixed in advance, and the scheme will become more like a crowdfunding project.

• Common Enterprise

If there’s a common cause, then it’s security.

• Profit received by a third party

Profit from the token should receive its owner. Otherwise it will be a security.

Is the settlement of cryptocurrencies important?

The lack of regulatory clarity might hold back the cryptocurrency industry. Legalization could be a good thing, as it protects user funds from fraudulent attacks and resolves financial disputes.

Some supporters of the idea of absolute decentralization are sure that the desire of states to control the digital economy sector may ruin the blockchain industry. But not everyone agrees with this point of view. Increased regulation might clear the market of dishonest participants, secure investor funds, help reduce the volatility of cryptocurrencies, and encourage people to embrace the digital economy.

Final thoughts

In 2023, SEC began to actively regulate the digital asset market in order to make this area of the economy as transparent as possible. And it relies on the rather outdated, but still effective Howey test technology. For example, let’s recall what has happened with BUSD, a fiat-backed stablecoin that is pegged to the US dollar. Not so long ago SEC recognized the BUSD as an unregistered security.

What do you think about crypto regulations? Have you heard about the Howey Test before? Share your thoughts in the comments! If you want to learn more interesting facts about crypto then check out our blog! You might like our article “Hermès MetaBirkin Lawsuit” and “Binance USD Price Prediction”.

The easiest way to buy, sell or exchange coins is to use SimpleSwap services.

SimpleSwap reminds you that this article is provided for informational purposes only and does not provide investment advice. All purchases and cryptocurrency investments are your own responsibility.

Originally published on our Publish0x blog.