What Is The Howey Test?

In this article, we will study the topic “What Is The Howey Test? “. Also, we will see how it relates to Howey in cryptocurrency, four points of the Howey test, the meaning of securities, types of securities, etc.

Meaning Of The Howey Test

The U.S government is in charge of knowing which resources possess security. It applies the use of the Howey Test to ascertain this. This is under the Securities Act of 1933. Also, under the Securities Exchange Act of 1934. At the point of confirming its security state, the U.S imposes some restrictions on it. However, the Securities and Exchange Commission (SEC) issues licenses to all assets to inform of security.

Why does the U.S adopt the Howey test? It is basically to know what a transaction stands for. Majorly, if it is an investment purpose transaction or not. The role SEC plays is as a determiner of gains from the advertising of an advertiser. This gain is from the investment of an individual. At a point where it is certain to make again, then SEC can declare its security.

The influence of SEC v. W. J Howey Co.’s court case gave rise to the name “Howey Test”. This issue was regarding the misplacement of assets as a security. The judgment was in favor of the SEC. Therefore, it made use of it to develop the Howey Test.

Subsequently, in the Cryptocurrency world, the Howey Test has become scalable. Once the Howey test validates any cryptocurrency as a security, SEC takes charge to license it.

It is necessary to apply this principle in blockchain and digital assets to be sure of the investment contacts. This way, one can decide to invest in it.

Important Note

  • The role of the Howey Test is as an investment contract determinant. Also, the U.S government oversees its functionality.
  • What validated an investment contract exists is the investment and ROI from a company.
  • Using this principle in blockchain and cryptocurrency will be beneficial to investors.
  • Most digital assets qualify to be in the rank of investment contracts.

The Topic’s Overview

The incident of SEC v. W.J. Howey Co. cut across the whole of Florida. A lot went on during this period. From the selling of the citrus to buyers to the leasing of land to the Howey company. Some transactions were made and both parties shared the proceeds. Due to some irregularities, SEC came into the picture and brought everything under resolution. All these took place in 1946.

Let’s look at the four qualities to know an investment contract.

  • Is it an investment of money
  • Can it be in a common enterprise
  • Does it generate profit
  • Lastly, does the action of others influence it?

The involvement of the citrus merchants from Florida in the situation of Howey is due to the efforts of others. So, they only need to put their funds in it.

Howey In Cryptocurrency

This aspect is simply the involvement of cryptocurrency in the above category. The quality of decentralization makes it difficult to place them in this category. Nevertheless, constant reviews are on, to verify their qualification as an investment contract. It meets the requirement of investing money for a return of profit. But then, is it at the action of others?

To clarify, there are certain situations that can back this requirement. For instance, when people build up a digital asset, they are rendering services to the benefit of an investor. Also, when a cryptocurrency holder ensures scarce means of a coin, it creates an increase in the value of the coins. This more or less validates the efforts of others. So, the achievement of this measure approves the investment in digital assets as investment contracts.

Unique Situations

Bear in mind the decentralization of cryptocurrency. Once SEC approves it as a security, it has the power to control its application. It may restrict or permit its involvement with U.S traders and investors.

A similar situation like this took place some years back. Consequently, the transaction of DAO tokens was put into suspension after Ether bridged a security measure. This made the cryptocurrency space to be more speculative of the situation. However, some years ago, the chairman of SEC led the reinstatement of ICOs as security.

FAQs

Ways to determine an asset as a Security?

There are certain criteria it must meet. It is an investment contract or security if it is under the Securities Act of 1933. Also, it is under the Securities Exchange Act of 1934. Secondly, if there is an investment of money for profit, through the actions of others.

Can one regard Bitcoin as a Security?

From the desk of Jay Clayton who is the former chairman of SEC, Bitcoin is not a security. Due to the fact that Bitcoin does not seek crowd funding or public assistance, it fails the Howey test. On the other hand, some ICO tokens are securities. They met the requirements of being a security.

Meaning Of a Security

Various platforms define security in various ways. According to the commission of Security Acts, any investment material at all is security. For any item to be a security, it must undergo certain procedures. Most importantly, the SEC must register and license it. However, there may be some exclusions. It follows this process to reveal vital pieces of information

  • A narration of enterprise purpose and assets.
  • Description of the security made available.
  • Rundown of the company’s managerial format.
  • Company’s financial statement.

Types Of Securities

Apparently, there are four main types of securities:
  • Equity securities: This shows that one is a member of a company. As a result, hold a level of share in that company. Therefore, the shareholder enjoys both the gain and loss of the company.
  • Debt securities: This has to do with loan repayment. Bonds and promissory notes are notable examples.
  • Hybrid securities: Here, the securities can be for loan repayment or to show ownership in a company. It is a combination of debt securities and equity securities.
  • Derivative securities: Whatever the prevailing asset is worth, influences the value of the security. Here many people can take part.

Some say digital assets are not securities. While some consider it to be. So, what is the final verdict? The likes of Kristin Smith, who is the leader of the Blockchain Association, don’t feel that cryptocurrencies are securities.

What Is Pertinent, Quality Or Quantity?

The principle of Howey concentrates more on quality than quantity in selecting security. It mustn’t necessarily be a stock or bond to be a security. Once it is under the security law, it is a security. Similarly, it must be under registration. However, there were some malicious acts being set to bypass the registration requirements. But their economic and financial capacity eluded them.

An investment with engagements from average people with minimal investment funds can be said to be a security.

Alternative Tests

There are other ways with court approval that can ascertain if a material is a security or not. The “Blue Sky” is in use by the U.S as their unique material for security registration. However, the risk capital test is unique to California. It generally covers reasons for and risk of investment. This is how it determines security.

With blockchain and digital assets, securities can be put to watch. It can aid the regulation of securities. Even the use of Initial Coin Offerings for funding by beginner institutions is still applicable. But this may be difficult.

In conclusion, Howey Test is the best and most applicable test for determining security. Even SEC makes use of it very often.

Regulation On Digital Assets

Due to the method digital assets operate, they haven’t really met the requirement of the SEC. The regulations of cryptocurrency increase its level of acceptance. Digital assets always find a way to override the SEC’s strict rules. This continues to make difficult their categorization. That is why in the past few years, SEC has still denied Bitcoin being security. It invests money in an enterprise but doesn’t involve a third party. Therefore, doesn’t pass the Howey test.

Some tokens suffer penalties from SEC for operating without registration. An example is the court case of the XRP token of Ripple Labs and SEC. A lot of irregularities and inconsistencies made the court suspend the case to further notice.

Understanding Initial Coin Offering (ICO) 

This is an indirect way of accumulating funds for a digital asset project. When many people purchase an asset, they generate money for it.

The white paper is the initial document the company generates. Here, it contains the company’s mode of operation and vital information. Subsequently, it demands crowd funding mostly using Bitcoin. On the other hand, it gives out the project’s token as a swap asset. With the asset, holders receive a lot of benefits relating to the project.

Once you have the knowledge of ICOs, you can set up your own. Due to its low regulation, it is prone to attack and crime. This is its major challenge. A report from the Wall Street Journal can complement this.

Sometime last year, the head of SEC made a claim that the Crypto space doesn’t have a good quantity of investor protection. That, it contains a lot of crimes, fraud, and so on.

ICOs As Securities

Clayton not so long ago said that most ICOs are securities. This is because it follows the rule of investment money in an enterprise. Then, receives a profit from the effort of a third party.

The fulfillment of the second aspect of the test comes from the prevalence of common enterprise. This is the aspect where there is an expectance of profit and if it’s from the effort of a third party. After scaling through the tests, the next is to adhere to SEC’s regulations.

In a situation of failing the test, then we regard it as a utility token. With this, one is sure of having goods or services that are yet to come. Examples of utility tokens are Filecoin and Sis coin.

Any asset similar to a utility token can still be secure. In one way a digital token passes the Howey test. On the other hand, it fails it. The situation is very dicey.

Conclusion

The idea of the Howey Test is good. But will it last long? However, it will continue to spearhead the SEC’s digital asset classification and regulation.

The more, there is evidence that cryptocurrency is a security, the more SEC is disproving it. However, what is important is to carry out proper research with diligence. Also, make sure you adhere to the rule and regulations of setting up digital assets. Lastly, do not take any step without involving the appropriate legal authority like SEC.

See the List of things to learn.

  1. Blockchain Technology
  2. Defi
  3. NFTs
  4. DAOs
  5. Crypto
  6. Web 3.0
  7. Altcoin Tokenomics
  8. Metaverse
  9. Smart Contracts

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