Howey Test
What is the Howey Test, and why does it matter in cryptocurrencies?
The first thing we need to establish is the difference between a utility token and a security token:
A utility token gives access to your network or platform and provides consumptive value within your network. For example, a token that gives access to an online game would be a utility token. In the US, the SEC has announced that the onus is on the ICO issuer to prove that their ICO is a utility, rather than a security, because a utility token does not have to abide by security laws. The main difference in a security token is that the holder of a security token has an expectation of profit.
The SEC uses the “Howey Test” to determine if a coin is a security token and basically asks the company “are you investing money in a common enterprise with the expectation to profit?” If so, then this is considered a security token, but again, in the eyes of the regulators, everything is a security token until proven otherwise, and therefore must now abide by security laws. In essence, altcoins and initial coin offerings are classified as either a utility coin or a security coin and their classifications bring different guidelines to follow.
The American legal case Securities & Exchange Commission vs. Howey 1946 outlined what is known today as the “Howey Test”, and it is a test that determines if an asset class is a security. Howey was the name of an agricultural company in South Florida. The company was primarily selling oranges, but they gave people the opportunity to eventually come down to Florida and buy pieces of their land. People would purchase a plot of land that had citrus trees on it and Howey would run business as usual by taking care of the trees, harvesting and packaging the fruit, and selling the fruit. Howey would then share the profits with the person who bought the plot of land. Howey eventually went bankrupt and ceased business operations, but still expected the purchasers of the land to pay their debts for the land. The purchasers refused and stated that they only bought the land because they were promised an investment opportunity where the profits from the agricultural business would make their payments for the land and also reward them a profit each year. They said that if the business was not operating and they were not getting any revenue from their land then they would not be able to make payments. This case went to the SEC and it then determined that this was an investment in a security and developed the “Howey Test”.
The Howey Test defines a security as “an investment of money in a common enterprise with the expectations of profit through the efforts of the promoter”. This test is important in the cryptocurrency space to determine if coins need to abide by securities law, and the SEC still uses the Howey Test to distinguish utility tokens from security tokens.
