The Howey test is a legal framework for defining investment contract securities. In the world of cryptocurrencies, the SEC must evaluate if crypto offerings meet the criteria outlined in the test based on the economic realities of the transaction. This article examines the key aspects of the Howey test and how it applies to cryptocurrencies, as well as recent examples of its application and the potential implications for investors.
What is the SEC’s Stance on Bitcoin and Ether?
The SEC does not view Bitcoin or Ether as securities. This is because they are highly decentralized networks without a third-party promoter that disclosure regulations would apply to. The SEC is comfortable viewing them as commodities outside securities laws.
Argument for Ethereum Being a Security
In a recent interview, Michael Saylor stated that Ethereum is plainly a security and should be labeled as such. He cites Ethereum’s shift from proof-of-work to proof-of-stake, enabled by centralized control, as evidence. Also, Ethereum held an ICO, which is commonly a characteristic of a security.
Ethereum has long been critiqued as an unregistered security issued by its founders to fund software development. The Ethereum Foundation held an ICO, similar to an IPO, to raise funds while evading securities laws by being overseas. This resembles a traditional securities offering.
Impacted if It’s a Security
If deemed a security, US Ethereum investors would need licensed brokers to buy, sell and manage ETH. They could not just directly buy and self-custody ETH like a commodity. The Ethereum Foundation would also likely owe millions in fines to the SEC, similar to Ripple Labs.
Ethereum would not disappear if deemed a security, as it still powers decentralized apps and services. But its circulation and access would be restricted, especially for US investors and entities. Much of DeFi may have to blocking US participants as well in that scenario.
If Ethereum is labeled a security while Bitcoin remains classified as a commodity, there could be a notable market rotation. Investors may shift away from perceived securities like ETH and towards decentralized cryptocurrencies clearly outside the SEC’s purview.
Does Heavy Regulation Really Protect Consumers?
The SEC needs to re-evaluate what consumer protection really means. Risk is inherent in markets, and eliminating it entirely goes too far. The goal should be informing consumers through disclosure, not blocking their access. Consumers should be able to decide what risks to take. Over-regulation can lead to disengagement.
