The Howey Test, a regulatory framework for determining whether an arrangement constitutes an “investment contract” or security, may have made sense in the context of its orange grove origins in the mid-20th century. However, critics argue that this decades-old test seems out of place in the current digital age, especially when it comes to cryptocurrency.
From Orange Groves to Digital Assets
The Howey Test sprouted from a court case involving W.J. Howey Co., a company that sold parcels of its Florida citrus groves to buyers who then leased the land back to Howey for cultivation and profit-sharing. The U.S. Securities and Exchange Commission (SEC) deemed this arrangement as an investment that needed to be registered and regulated. The Supreme Court agreed and came up with the Howey Test as a three-part assessment to identify an “investment contract.”
The criteria are as follows:
- There is an investment of money.
- The investment is in a common enterprise.
- The investors anticipate profits predominantly from the efforts of others.
While these conditions might have effectively addressed orange grove land deals in the 1940s, some argue that they are ill-suited for the nuances of the cryptocurrency space.
Cryptocurrency: A New Frontier
Cryptocurrency is a digital or virtual asset that uses cryptography for security, operating independently of a central bank. This technology offers a revolutionary new way of transferring funds, making investments, and setting up contracts. However, it also raises complex questions about regulation and oversight.
When attempting to apply the Howey Test to cryptocurrency, several problems arise:
- Investment of money: Cryptocurrency does involve an exchange of value, but this value is often in the form of other cryptocurrencies, not traditional fiat money. This distinction challenges the conventional understanding of “money.”
- Common enterprise: Cryptocurrencies are typically decentralized, operating on a network of computers rather than being controlled by a single entity. This decentralization contrasts with the “common enterprise” model, which traditionally implies a centralized entity.
- Expectation of profits from the efforts of others: This is the trickiest part. While some people buy cryptocurrencies hoping that their value will rise, others use them as a medium of exchange or a store of value. These uses fall outside the expectation of profit solely from the efforts of others.
Given these challenges, critics contend that the Howey Test’s outdated framework fails to accommodate the unique characteristics of digital assets. They argue that attempting to fit the square peg of cryptocurrency into the round hole of a 1940s regulatory scheme simply doesn’t work.
While the Howey Test has served its purpose well over the past several decades, many believe that it’s high time for a new regulatory approach—one that takes into account the evolving landscape of investment in the digital age. And as we look ahead, the ongoing debate surrounding cryptocurrency regulation could be a catalyst for much-needed change in securities laws.
