Crypto Security or Just a Token? The Howey Test Uncovered

Law and Ledger is a news segment focusing on crypto legal news, brought to you by Kelman Law – A law firm focused on digital asset commerce. Because who doesn’t love a good legal mystery in the world of shiny digital doodads? 🎩✨

Applying the Howey Test

Following our Introduction, posted last week, today’s adventure is Part I of our multi-article saga: Is Crypto a Security? Spoiler: It’s about as clear as mud, but we’re diving in anyway. 🌊🔍

The opinion editorial below was written by Alex Forehand and Michael Handelsman for Kelman.Law. Because nothing screams “legal clarity” like a pair of attorneys hashing out the meaning of a token.

U.S. securities law apparently didn’t get the memo that digital assets exist. Instead, the SEC and courts cling to the relic called the investment contract doctrine, originating from a 1946 Supreme Court case about orange groves-not exactly blockchain friendly. Despite this historical oversight, Howey remains the go-to test for figuring out whether a token is just digital junk or a federally regulated security. 🍊➡️💻

It’s worth noting that the Howey definition of an investment contract is merely one of dozens that can classify an asset as a security. The SEC has made it crystal clear that even tokenized stocks or bonds are securities, and putting an asset on a blockchain isn’t some kind of magical transformation. No, you just get to keep the same rules, but with more pixels. 🎨🔒

Since Howey is king in security law, this part focuses on its four elements, how regulators and courts twist them to fit crypto, and why telling a token from an investment contract is now the legal equivalent of telling a cat from a pineapple.

The Four Elements of Howey

In August 2019, the SEC rolled out a fancy new framework-because clearly, they’re huge fans of complicated jargon-to analyze whether a digital asset passes the Howey test. To call something an investment contract, four things must be in place:

an investment of money
in a common enterprise
with a reasonable expectation of profits
to be derived from the efforts of others.

(1) Investment of Money

If you’re handing over cash, crypto, a llama, or even a rusty garden rake-if it’s worth something-you’re likely in. Time and effort count, so if you’re volunteering to help run the project, congratulations, you’re probably a securities buyer. Because, apparently, labor is the new money. 💸🤹‍♂️

(2) Common Enterprise

This one involves whether everyone’s fortunes are linked-think of it as investors riding a rollercoaster together or just being tossed into the same pool. The courts are split: horizontal commonality pools funds, while vertical focuses on the efforts of the project’s creators. Spoiler: It’s a hurdle most projects trip over, especially when selling on the secondary market. The Ripple case is a prime example-original investors got the jackpot, but secondary buyers? Not so much. 🎢🤷‍♀️

(3) Expectation of Profits

If people think buying your token will make them rich, you might be in hot water. Courts look at what was said or implied-promises of moon landings, future exchanges, or hype about scarcity. If your website or social media screams “HODL for gains!” then get ready for legal fireworks. 🎆💰

(4) Efforts of Others

This is the “Did they do all the work?” part. If buyers rely on a team building, coding, or promoting the project, then the court might see your token as an investment contract. Think of it as the difference between a DIY project and hiring a team of tattoo artists. If your project is still under construction or heavily dependent on the team’s efforts, watch out. Even decentralization isn’t a free pass-early reliance on central efforts can make everything seem more securities-like. 🏗️🤖

How Courts Adapt Howey to Token Transactions

Tokens are like the chameleon of the blockchain world-they don’t quite fit into the old Howey box. Courts focus on what’s really happening: the economic substance, not whether you called it a utility token or whether it has fancy staking features. Transparency of intentions, promises of future growth, and marketing hype tend to tip the scales. When a token’s sale is all about future profits and speculation, the courts see it as an investment. Who knew? 🐍⚖️

The Supreme Court advises that it’s about the entire picture-the sale, the marketing, the promises, and the actual conduct of the issuer. The code isn’t the boss; the context is. So, promising profits, future integrations, or a “just around the corner” listing often turns a friendly utility token into a securities nightmare. And that’s before the network even goes live. 🚧🎯

Early sales, pre-launch token offerings, or “beta” ecosystems are particularly susceptible-because they’re basically promising the moon before you’ve even built the spaceship. Courts are skeptical of brave promises and entrepreneurial efforts that hinge on future efforts of the issuer. Even a project promising to decentralize later can still get flagged if early buyers depended on the team’s efforts. 🚀🕵️‍♂️

Token v. Investment Contract

The biggest breakthrough: courts and the SEC now agree that a token isn’t automatically a security. Instead, the defining factor is how it’s offered or sold. If you’re selling a token to tip the scales into investment territory, then beware. The XRP case was the poster child-original sales to institutions? Investment contract. Secondary market sales? Not so much. Confusing? Absolutely. Welcome to crypto law! 🎭🔍

In a recent SEC speech, the idea was reinforced: tokens are like land-once used for a specific purpose-except now they host golf courses and resorts instead of orange groves. The asset itself isn’t necessarily a security; it’s about the transaction’s context. Fancy that. ⛳🏝️

This means that if your ecosystem is decentralized enough, and the token no longer depends on a single “boss,” then secondary trades might dodge security rules altogether. In theory. Good luck with that! 🤞

Conclusion

The Howey test remains the tried-and-true method for understanding whether a digital asset is legally just a fancy digital toy or a full-fledged security with all the legal bells and whistles. Courts are getting smarter, focusing on the real-world incentives and behaviors, rather than just labels or blockchain hot air. 🚀⚖️

At Kelman PLLC, we’re experts in navigating these choppy legal waters-because in crypto, the only certainty is uncertainty. Contact us if you want to stay out of hot legal water or need someone to explain whether your project is a security or just a very expensive paperweight. Visit here for more details. Your smart legal partner in this wild digital wilderness. 🌲🦄

2025-12-04 11:05