The Howey-Test

The Howey Test is a legal assessment used by the US government to determine whether an asset qualifies as a security under federal securities laws. Its name derives from the landmark 1946 US Supreme Court case, SEC v. W.J. Howey Co.

The test is made up of a four-pronged framework that focuses on the economic realities of a transaction rather than its form:

Investment of Money: There must be an investment of money or other valuable consideration.

Common Enterprise: The investment must be made in a common enterprise where investors pool their funds or rely on the efforts of others.

Expectation of Profit: Investors should have a reasonable expectation of earning profits from their investment, primarily resulting from the efforts of others.

Dependence on Promoter or Third Party: The success or failure of the investment must depend predominantly on the efforts of a promoter or a third party.

If a transaction satisfies all four elements of the Howey Test, it is deemed a security and is subject to the regulations of the SEC. This means that issuers of securities assets must comply with registration requirements and provide necessary disclosures to protect investors. With the novel emergence of cryptocurrencies in the last 15 years, digital assets remain ambiguously classified by the SEC. This provides regulatory uncertainty for American exchanges and investors. As of the time of writing, Bitcoin and Ethereum are classified as commodities by the SEC.

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