The Howey Test - II
The Howey Test - II
In the first part of the Howey Test analysis, we touched the general framework of the Howey Test with its main components. In the second part, we analys its effect on the cryptocurrency market.
The Howey Test’s concerns whether the investment’s profit is largely or completely outside the control of investors. If yes, the investment can be considered as a security. But, if the investor has a critical influence on how the investment is managed, then it cannot be classified as a security. During the creation period, SEC (Security Exchange Commission – the regulatory body of U.S.A. security markets) built a test, which considers an investment’s substance instead of its form to determine if it is a security. Investments, which are not labeled as a “Bond” or “Stock” can be a security under the law if registration and disclosure requirements are applied. With the Howey Test creation, some promoters masqueraded securities to escape registration requirements. Therefore, the courts have started to view the economic realities associated with an investment scheme to eradicate such crimes.
Additionally, there are three main approaches in the Howey Test. These approaches are:
- Broad Vertical Commonality: Since the investor’s success is not tied to the promoter’s success, the second prong of the Howey Test is not likely to be satisfied under a broad vertical approach.
- Horizontal Commonality: The horizontal approach exclusively needs a link between the investors’ profits, who have mutually invested in the project. Therefore, the tokens are considered as securities in a common enterprise.
- Narrow Vertical Commonality: Under this approach, the investor’s profits and project organisers are linked inextricably. Also, the connection between the profit of the investor is not assumed. Since the token’s model in the vertical approach is decentralised, it cannot be recognised as existing within the common enterprise framework.
The Howey Test is an important determiner of regulatory oversight. So, it can be applied to tokens; security, and utility tokens; which serve as securities. For example, security tokens are built to offer ownership rights in the firm. The profit is to be expected from the investment of money based on the labor of others. As a result, the project becomes successful and the value of the tokens gets increased. The security tokens offer many benefits such as lower issuance fees, enhanced market efficiency, and fractionalisation of a larger asset.
Furthermore, utility tokens represent a unit of account. The utility would be added in the token as much as the network grows. The demand for the tokens increases as the network size grows along with the transaction volumes. There is an investment of money that fulfills Howey Test criteria. Though these tokens may not represent shares in a firm, it does not mean the token will not grow in value. The Token’s value increases based on the project’s ability to attract users and enhance the token over time. It is expected, that profit may be increased for token holders, which satisfies another Howey Test criteria. Also, the investment’s profit is based on the other’s efforts.
The Howey Test is crucial, particularly in above areas where the organizers of cryptocurrency assets project intend to raise funds from investors who belong to the U.S.A., or the project itself is planned to be implemented in the U.S.A. As it was developed by the SEC, the Howey Test enables building a link between a financial transaction and an investment contract as security type.
Last but not least, the Howey Test has a mission for sending shockwaves through the cryptocurrency world and it is taken as security for investment purposes. It has also crucial support during initial coin offerings. Please have a look on our detailed article about initial coin offerings.
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