Reimagining the Howey Test for the digital age of cryptocurrencies

Reimagining the Howey Test for the digital age of cryptocurrencies

In the case of the stablecoin, BUSD, which is issued by the cryptocurrency exchange, Binance. In February 2021, Binance was reportedly under investigation by the CFTC (Commodity Futures Trading Commission) to determine whether it had violated U.S. rules by allowing Americans to buy and sell derivatives that are linked to digital tokens. Shortly after, it was reported that the SEC was also investigating Binance, specifically with regard to the issuance of the BUSD stablecoin.

This conversation started again this week. According to a press release on Monday, Paxos, the issuer of the stablecoin Binance USD (BUSD), has acknowledged receiving a Wells Notice from the U.S. Securities and Exchange Commission (SEC), indicating a possible enforcement action. The SEC’s charge is that BUSD constitutes an unregistered security, despite Paxos claiming it is not. BUSD is a stablecoin pegged to the U.S. dollar, and Paxos has stated that it is always backed 1:1 with U.S. dollar-denominated reserves, held in segregated accounts, and bankruptcy remote. Paxos also emphasized that the Wells Notice only pertains to BUSD and not any other part of its business. It is mentioned that they are prepared to litigate if necessary. Paxos also announced earlier that it would stop issuing new BUSD tokens at the direction of the New York Department of Financial Services (NYDFS), which CoinDesk reported on. The NYDFS is currently investigating Paxos.

Stablecoins are a type of cryptocurrency that is designed to maintain a stable value relative to another asset, such as the U.S. dollar. They are often used to facilitate transactions on cryptocurrency exchanges or to provide a stable store of value for users of cryptocurrency wallets. In the case of BUSD, the SEC is reportedly investigating whether the stablecoin qualifies as a security under U.S. law. If the SEC determines that BUSD is a security, the issuer could be subject to regulatory requirements under federal securities laws.

The BUSD case highlights U.S. authorities’ continued regulatory scrutiny of the cryptocurrency industry, as well as the potential for stablecoins to be considered securities under the Howey test. I honestly think that BUSD is not a security. This should be a firm stand from all parties as nobody would expect a profit from having BUSD. I will walk you through my thoughts.

Howey Test in 1946

The Howey Test is a legal test used in the United States to determine whether a transaction qualifies as an “investment contract,” which is a type of security that is subject to regulation under federal securities laws. The test is named after the 1946 U.S. Supreme Court case SEC v. W.J. Howey Co., which established the framework for evaluating whether an investment contract exists.

Under the Howey Test, a transaction is considered an investment contract if it involves:

1. An investment of money

2. In a common enterprise

3. With an expectation of profits

4. That are derived solely from the efforts of others

If a transaction satisfies all four prongs of the Howey Test, it is considered an investment contract and subject to federal securities laws, including registration requirements and antifraud provisions.

It’s worth noting that the “common enterprise” prong of the Howey Test has been broadly interpreted by courts to include various arrangements, including cryptocurrency and other digital asset offerings. In recent years, the SEC has applied the Howey Test in several high-profile cases involving digital assets, including initial coin offerings (ICOs) and various types of token sales.

The Howey Test is an important tool for determining whether a transaction qualifies as a security and is used by regulators, investors, and businesses alike to navigate the complex and evolving world of securities laws.

Debate on cryptocurrencies are securities

The question of whether cryptocurrencies are securities under U.S. law has been a topic of much debate and uncertainty. The Securities and Exchange Commission (SEC) has taken the position that some cryptocurrencies may be considered securities if they meet the criteria established by the Howey Test.

In 2017, the SEC issued a report stating that the offering of certain cryptocurrencies and initial coin offerings (ICOs) may be subject to federal securities laws. The report emphasized that whether a particular investment transaction involves the offer or sale of a security depends on the facts and circumstances of that transaction, and the application of the Howey Test.

The SEC has also brought enforcement actions against certain cryptocurrencies and ICOs that it considers to be securities. Another example, in 2018, the SEC charged two cryptocurrency companies with conducting unregistered securities offerings. The companies had offered and sold digital tokens that were deemed to be securities because they met the Howey Test’s criteria.

Despite this, the application of the Howey Test to cryptocurrencies is still a matter of debate, with many in the cryptocurrency industry arguing that it is not applicable to digital assets. Some have argued that cryptocurrencies should be considered a new asset class that does not fit within the traditional definitions of securities, commodities, or currencies.

In response to the uncertainty, some countries have sought to establish clearer regulatory frameworks for cryptocurrencies. In 2019, the Swiss Financial Market Supervisory Authority (FINMA) published guidelines that outlined the regulatory framework for digital assets in Switzerland. The guidelines aimed to provide clarity on the classification and treatment of digital assets for financial institutions and other market participants in the country.

According to the FINMA guidelines, digital assets are divided into three categories: payment tokens, utility tokens, and asset tokens. Payment tokens are defined as digital assets that are primarily used as a means of payment, such as Bitcoin or Litecoin. Utility tokens, on the other hand, are digital assets that provide access to a specific product or service, such as a digital ticket or a token that grants access to a particular platform. Finally, asset tokens are digital assets that represent assets such as real estate, company shares, or other physical or financial assets.

Each of these three categories of digital assets is subject to different regulatory requirements in Switzerland. Payment tokens, for example, are not considered to be securities under Swiss law, and as such, they are not subject to the same regulatory requirements as securities. However, financial institutions that provide payment services with payment tokens must comply with the country’s anti-money laundering regulations.

Utility tokens are not considered to be securities if they meet certain conditions, such as being redeemable for services or products on a platform, but not tradable on secondary markets. If these conditions are not met, utility tokens may be considered securities and subject to Swiss securities regulations.

Asset tokens are generally considered to be securities under Swiss law, and as such, they are subject to the country’s securities regulations. This includes complying with rules around prospectus requirements, disclosure obligations, and registration with the authorities.

The guidelines provided by FINMA have helped to clarify the regulatory treatment of digital assets in Switzerland. By defining clear categories of digital assets and outlining the corresponding regulatory requirements, the guidelines have provided greater certainty and stability for market participants in the country’s digital asset industry.

Such clarify is essential. To me, the application of the Howey Test to cryptocurrencies is still a matter of debate, it is clear that the SEC has taken the position that some cryptocurrencies may be considered securities if they meet the criteria established by the Howey Test. As such, cryptocurrency issuers and investors must be aware of the potential implications of the Howey Test and ensure that their transactions are compliant with applicable securities laws.

Modern-day application of Howey Test on Cryptocurrencies

As the cryptocurrency industry has evolved, questions have arisen as to whether the Howey Test is still applicable in the modern-day context of cryptocurrencies. To address this issue, some experts have proposed a modern-day version of the Howey Test that takes into account the unique characteristics of digital assets.

The proposed modern-day version of the Howey Test for cryptocurrencies would include several factors. The first factor would be whether there is an investment of money. If a digital asset issuer has not sold any assets issued to build its project, it is unlikely to be considered a security.

The second factor would be whether there is an expectation of profits from the investment. If the digital asset is utility-based, such as being used for voting purposes, it is unlikely to be considered a security.

The third factor would be whether the investment of money is in a common enterprise. If the project is decentralized and not controlled and operated by a centralized entity, it is unlikely to be considered a security.

Finally, the fourth factor would be whether any profit comes from the efforts of a promoter or third party. If the profit primarily comes from the community, which has nothing to do with the issuance of the digital asset, it is unlikely to be considered a security.

Adapting Howey Test to better fit Cryptocurrencies

Adapting the Howey Test to fit the unique characteristics of cryptocurrencies better is a complex issue, and there is an ongoing debate among legal experts and regulators on how to do so. However, some potential ways to improve the test’s application to cryptocurrency include:

Examining the underlying technology: One potential approach is to look at the underlying technology of a cryptocurrency and evaluate whether it is sufficiently decentralized and functional to qualify as a utility token rather than a security. For example, suppose a token is used primarily to access a particular blockchain network or platform, and its value is tied to its utility rather than speculation. In that case, it may be less likely to be considered a security.

Considering the role of promoters and third parties: Another potential approach is to examine the extent to which promoters or third parties play a role in the development and promotion of a cryptocurrency. If a token’s value is primarily driven by the efforts of a centralized entity or individual, rather than the broader community of users, it may be more likely to be considered a security.

Focusing on the economic reality of the transaction: Rather than relying on a strict application of the four-pronged Howey Test, some legal experts have suggested that a more flexible approach may be needed to assess whether a particular cryptocurrency is a security. This could involve looking at the economic reality of the transaction and considering a range of factors, including the nature of the token, the purpose of the transaction, and the expectations of the parties involved.

In conclusion, while the Howey Test has been a useful reference point for determining whether an investment qualifies as a security, it is not a perfect fit for the unique characteristics of cryptocurrencies. Cryptocurrencies, especially those that are decentralized, often have features that do not align with traditional securities, and thus may not meet the criteria outlined in the Howey Test. As the cryptocurrency industry continues to evolve, there is a growing need for regulatory frameworks that are tailored specifically to the unique nature of digital assets. While the Howey Test can serve as a starting point, it is important to adapt and refine the rules to better reflect the realities of the cryptocurrency market. It is clear that cryptocurrency is a new and rapidly developing asset class that requires careful consideration when applying traditional securities laws. A more nuanced and flexible approach is needed to ensure that innovation is not stifled while at the same time protecting investors from fraudulent activities.

Coming back to my first point- BUSD is not a security. BUSD is primarily used as a means of payment, rather than as an investment vehicle, and it is not designed to generate profits for investors in the same way that traditional securities do. The price of BUSD is intended to be stable and is tied to the value of the US dollar, rather than being subject to the speculative forces that often drive the prices of other cryptocurrencies. Let’s stick to this.

 

Source: https://www.financialexpress.com/blockchain/reimagining-the-howey-test-for-the-digital-age-of-cryptocurrencies/2992092/

Anndy Lian is an early blockchain adopter and experienced serial entrepreneur who is known for his work in the government sector. He is a best selling book author- “NFT: From Zero to Hero” and “Blockchain Revolution 2030”.

Currently, he is appointed as the Chief Digital Advisor at Mongolia Productivity Organization, championing national digitization. Prior to his current appointments, he was the Chairman of BigONE Exchange, a global top 30 ranked crypto spot exchange and was also the Advisory Board Member for Hyundai DAC, the blockchain arm of South Korea’s largest car manufacturer Hyundai Motor Group. Lian played a pivotal role as the Blockchain Advisor for Asian Productivity Organisation (APO), an intergovernmental organization committed to improving productivity in the Asia-Pacific region.

An avid supporter of incubating start-ups, Anndy has also been a private investor for the past eight years. With a growth investment mindset, Anndy strategically demonstrates this in the companies he chooses to be involved with. He believes that what he is doing through blockchain technology currently will revolutionise and redefine traditional businesses. He also believes that the blockchain industry has to be “redecentralised”.

j j j

Modern-Day Version of Howey Test For Cryptocurrencies- How Does It Look Like?

Modern-Day Version of Howey Test For Cryptocurrencies- How Does It Look Like?

Howey test, which the Securities and Exchange Commission uses to decide whether a digital asset should be classed as a security, has certain limitations, according to SEC Commissioner Hester Peirce. I can relate to this statement very much. I felt the same way too, especially when they used the same framework for cryptocurrencies. I will walk you through my thoughts on what should the modern-day version look like.

What is Howey Test?

The Howey test is used by the U.S. Securities and Exchange Commission (SEC) to determine whether a particular financial product or transaction qualifies as an “investment contract.” If a product or transaction is deemed to be an investment contract, it is subject to certain regulatory requirements under federal securities laws.

The test is named after the 1946 Supreme Court case SEC v. W.J. Howey Co., in which the Court established a four-part test to determine whether a transaction qualifies as an investment contract:

1.         It involves an investment of money

2.         There is an expectation of profits from the investment

3.         The investment of money is in a common enterprise

4.         Any profit comes from the efforts of a promoter or third party

If all four of these criteria are met, the transaction is considered an investment contract and is subject to regulation as a security.

What is a Security?

Before we look further, let’s look at what is a security. A security is a financial instrument representing an ownership position in a publicly traded corporation (stock), a creditor relationship with a governmental body or a corporation (bond), or rights to ownership as represented by an option.

There are several types of securities, including:

1.         Stocks: Stocks represent ownership in a company and entitle the holder to a share of the company’s profits.

2.         Bonds: Bonds are a type of debt security that involves borrowing money from an investor for a set period of time at a fixed interest rate.

3.         Options: Options are a type of derivative security that gives the holder the right, but not the obligation, to buy or sell a specific asset at a predetermined price within a specific time frame.

4.         Mutual funds: Mutual funds are investment vehicles that pool money from multiple investors and use that money to buy a diversified portfolio of stocks, bonds, or other securities.

5.         Exchange-traded funds (ETFs): ETFs are investment funds that are traded on stock exchanges, much like stocks. They typically track an index, such as the S&P 500, or a specific sector or theme.

6.         Derivatives: Derivatives are financial instruments that are derived from other assets, such as stocks, bonds, commodities, or currencies. They are used to hedge risk or speculate on the price movements of the underlying asset. Examples of derivatives include futures, options, and swaps.

Howey Test Applied to Cryptocurrencies

The Howey test is a well-established legal test used for decades to determine whether a financial product or transaction qualifies as an investment contract and is subject to regulation as a security. While the test was originally developed in the context of traditional securities, it has also been applied to cryptocurrency and initial coin offerings (ICOs).

The four-part test established by the Howey case has generally been applied to cryptocurrency in the same way as it has been used to traditional securities. However, there may be some nuances or specific considerations that apply specifically to cryptocurrency when applying the Howey test.

For example, the first prong of the test, which requires an investment of money, may be satisfied by the purchase of a cryptocurrency using fiat currency (such as U.S. dollars) or by the exchange of one cryptocurrency for another.

The second prong, which requires an expectation of profits, may be satisfied by the potential appreciation of the cryptocurrency’s value or by the ability to earn returns through the use of the cryptocurrency in a particular platform or network.

The third prong, which requires the investment of money to be in a common enterprise, may be satisfied by the pooling of resources or the use of a shared infrastructure or platform.

The fourth prong, which requires any profits to come from the efforts of a promoter or third party, may be satisfied by the involvement of a central authority or the use of a decentralized autonomous organization (DAO) to manage the cryptocurrency or ICO.

Modern-Day Version of Howey Test for Cryptocurrencies

The above pointers may sound familiar to you. You are a project owner and have spoken to a lawyer before; this is the same advice they gave you. My question now is, since the state of play in cryptocurrencies are changing rapidly, should there be an adapted version for the modern day?

The modern-day version might look something like this:

1.         Is there an investment of money?

If the crypto digital asset issuer has not sold any assets issued to build its project. It is most likely not considered a security.

2.         Is there an expectation of profits from the investment?

If the crypto asset is utility-based, for example, it is used for voting purposes. It is most likely not considered a security.

3.         Is the investment of money in a common enterprise?

If the project is decentralized, it is not controlled and operated by a centralized entity. It is most likely not considered a security.

4.         Are any profit comes from the efforts of a promoter or third party?

If the profit primarily comes from the community which has nothing to do with the issuance of the crypto asset. It is most likely not considered a security.

Reminding all again, when all four criteria are met, the investment is considered a security and is subject to regulatory requirements of the Securities Act of 1933. The application of the Howey test to cryptocurrency may involve considering the specific characteristics and features of the particular cryptocurrency or ICO in question, as well as the broader market and regulatory context in which it operates.

Take some time to do a self-evaluation based on the above thoughts shared. If you have time, you can ask yourself these questions about the tokens you invested. This is a good exercise for self-reference. I am not a lawyer, and none of the written content is formal advice.

“If you are a retail crypto investor- Do your crypto research. Learning about the regulation side of things can help you with your investment decision, avoiding unnecessary issues down the road.

If you are a project and you claim to be decentralized. Please stay decentralized. This will also avoid getting into any regulatory problems.” – Anndy Lian

 

 

Source: https://www.benzinga.com/22/12/30205466/modern-day-version-of-howey-test-for-cryptocurrencies-how-does-it-look-like

Anndy Lian is an early blockchain adopter and experienced serial entrepreneur who is known for his work in the government sector. He is a best selling book author- “NFT: From Zero to Hero” and “Blockchain Revolution 2030”.

Currently, he is appointed as the Chief Digital Advisor at Mongolia Productivity Organization, championing national digitization. Prior to his current appointments, he was the Chairman of BigONE Exchange, a global top 30 ranked crypto spot exchange and was also the Advisory Board Member for Hyundai DAC, the blockchain arm of South Korea’s largest car manufacturer Hyundai Motor Group. Lian played a pivotal role as the Blockchain Advisor for Asian Productivity Organisation (APO), an intergovernmental organization committed to improving productivity in the Asia-Pacific region.

An avid supporter of incubating start-ups, Anndy has also been a private investor for the past eight years. With a growth investment mindset, Anndy strategically demonstrates this in the companies he chooses to be involved with. He believes that what he is doing through blockchain technology currently will revolutionise and redefine traditional businesses. He also believes that the blockchain industry has to be “redecentralised”.

j j j

Regulating Cryptocurrencies: Are you Investing in Securities?

Regulating Cryptocurrencies: Are you Investing in Securities?

There is an ongoing legal case between SEC and Ripple Labs. In December 2020, the San Francisco-based corporation and its current and former senior executives were sued by the SEC on charges that they had been selling unregistered securities worth $1.3 billion since the token’s inception. The commission declared XRP as a security. You should have heard of this case if you are in the crypto industry. Many questioned how this happened and will this have any affect on the rest of the cryptocurrencies. What is a security? How SEC determine what is a security? I will try to break it down in this article.

What is Howey Test?

The Howey test is used by the U.S. Securities and Exchange Commission (SEC) to determine whether a particular financial product or transaction qualifies as an “investment contract.” If a product or transaction is deemed to be an investment contract, it is subject to certain regulatory requirements under federal securities laws.

The test is named after the 1946 Supreme Court case SEC v. W.J. Howey Co., in which the Court established a four-part test to determine whether a transaction qualifies as an investment contract:

  1. It involves an investment of money
  2. There is an expectation of profits from the investment
  3. The investment of money is in a common enterprise
  4. Any profit comes from the efforts of a promoter or third party

If all four of these criteria are met, the transaction is considered an investment contract and is subject to regulation as a security.

What is a Security?

Before we look further, let’s look at what is a security. A security is a financial instrument representing an ownership position in a publicly traded corporation (stock), a creditor relationship with a governmental body or a corporation (bond), or rights to ownership as represented by an option.

There are several types of securities, including:

  1. Stocks: Stocks represent ownership in a company and entitle the holder to a share of the company’s profits.
  2. Bonds: Bonds are a type of debt security that involves borrowing money from an investor for a set period of time at a fixed interest rate.
  3. Options: Options are a type of derivative security that gives the holder the right, but not the obligation, to buy or sell a specific asset at a predetermined price within a specific time frame.
  4. Mutual funds: Mutual funds are investment vehicles that pool money from multiple investors and use that money to buy a diversified portfolio of stocks, bonds, or other securities.
  5. Exchange-traded funds (ETFs): ETFs are investment funds that are traded on stock exchanges, much like stocks. They typically track an index, such as the S&P 500, or a specific sector or theme.
  6. Derivatives: Derivatives are financial instruments that are derived from other assets, such as stocks, bonds, commodities, or currencies. They are used to hedge risk or speculate on the price movements of the underlying asset. Examples of derivatives include futures, options, and swaps.

Howey Test Applied to Cryptocurrencies

The Howey test is a well-established legal test used for decades to determine whether a financial product or transaction qualifies as an investment contract and is subject to regulation as a security. While the test was originally developed in the context of traditional securities, it has also been applied to cryptocurrency and initial coin offerings (ICOs).

The four-part test established by the Howey case has generally been applied to cryptocurrency in the same way as it has been used to traditional securities. However, there may be some nuances or specific considerations that apply specifically to cryptocurrency when applying the Howey test.

For example, the first prong of the test, which requires an investment of money, may be satisfied by the purchase of a cryptocurrency using fiat currency (such as U.S. dollars) or by the exchange of one cryptocurrency for another.

The second prong, which requires an expectation of profits, may be satisfied by the potential appreciation of the cryptocurrency’s value or by the ability to earn returns through the use of the cryptocurrency in a particular platform or network.

The third prong, which requires the investment of money to be in a common enterprise, may be satisfied by the pooling of resources or the use of a shared infrastructure or platform.

The fourth prong, which requires any profits to come from the efforts of a promoter or third party, may be satisfied by the involvement of a central authority or the use of a decentralized autonomous organization (DAO) to manage the cryptocurrency or ICO.

Modern-Day Version of Howey Test for Cryptocurrencies

The above pointers may sound familiar to you. You are a project owner and have spoken to a lawyer before; this is the same advice they gave you. My question now is, since the state of play in cryptocurrencies are changing rapidly, should there be an adapted version for the modern day?

The modern-day version might look something like this:

  1. Is there an investment of money?

If the crypto digital asset issuer has not sold any assets issued to build its project. It is most likely not considered a security.

  1. Is there an expectation of profits from the investment?

If the crypto asset is utility-based, for example, it is used for voting purposes. It is most likely not considered a security.

  1. Is the investment of money in a common enterprise?

If the project is decentralized, it is not controlled and operated by a centralized entity. It is most likely not considered a security.

  1. Are any profit comes from the efforts of a promoter or third party?

If the profit primarily comes from the community which has nothing to do with the issuance of the crypto asset. It is most likely not considered a security.

Reminding all again, when all four criteria are met, the investment is considered a security and is subject to regulatory requirements of the Securities Act of 1933. The application of the Howey test to cryptocurrency may involve considering the specific characteristics and features of the particular cryptocurrency or ICO in question, as well as the broader market and regulatory context in which it operates.

Take some time to do a self-evaluation based on the above thoughts shared. If you have time, you can ask yourself these questions about the tokens you invested. This is a good exercise for self-reference. I am not a lawyer, and none of the written content is formal advice.

“If you are a retail crypto investor- Do your crypto research. Learning about the regulation side of things can help you with your investment decision, avoiding unnecessary issues down the road.

If you are a project and you claim to be decentralized. Please stay decentralized. This will also avoid getting into any regulatory problems.” – Anndy Lian

 

Source: https://www.securities.io/regulating-cryptocurrencies-are-you-investing-in-securities/

Anndy Lian is an early blockchain adopter and experienced serial entrepreneur who is known for his work in the government sector. He is a best selling book author- “NFT: From Zero to Hero” and “Blockchain Revolution 2030”.

Currently, he is appointed as the Chief Digital Advisor at Mongolia Productivity Organization, championing national digitization. Prior to his current appointments, he was the Chairman of BigONE Exchange, a global top 30 ranked crypto spot exchange and was also the Advisory Board Member for Hyundai DAC, the blockchain arm of South Korea’s largest car manufacturer Hyundai Motor Group. Lian played a pivotal role as the Blockchain Advisor for Asian Productivity Organisation (APO), an intergovernmental organization committed to improving productivity in the Asia-Pacific region.

An avid supporter of incubating start-ups, Anndy has also been a private investor for the past eight years. With a growth investment mindset, Anndy strategically demonstrates this in the companies he chooses to be involved with. He believes that what he is doing through blockchain technology currently will revolutionise and redefine traditional businesses. He also believes that the blockchain industry has to be “redecentralised”.

j j j