Crypto FAQ: What is the Howey test for cryptocurrencies?

Derived from the 1946 U.S. Supreme Court Case SEC vs. W. J. Howey, the Howey Test broadly determines whether a transaction should be considered a security, and therefore subject to USA security laws and regulations, depending on whether it qualifies as an "investment contract". In order to be considered an investment contract, a transaction must be: 1) an investment of money; 2) in a common enterprise; 3) with the expectation of profit; 4) to be derived from the effort of others.

In the context of cryptocurrencies, the SEC has suggested that the Howey Test should be used to determine whether a cryptocurrency qualifies as a security as opposed to a commodity, so that it can potentially regulate its sale and usage. It has been legally argued that Bitcoin (BTC) would fail the Howey Test because at its inception, there was no BTC common enterprise with an expectation of profit. Similary, it has been argued that Ethereum (ETH) would fail the Howey Test because at its inception Ethereum was an informal open-source project (cf. business enterprise) with no clear expectation of profit. In contrast, the vast majority of other cryptocurrencies will potentially pass the Howey Test, because most of their Initial Coin Offerings (ICOs; cf. IPOs) were issued by businesses enterprises that had a clear expectation of profit.

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