The Debate Continues: The Controversy Surrounding the Howey Test in Crypto Trading

It’s Wednesday, August 7th and this is Markets Daily hosted by me Jen Sani. On this show, we navigate the currents shaping the crypto markets, providing insights against the broader financial landscape. So whether you’re actively trading or simply fascinated by the volatility of crypto markets, this show is your compass to understanding what’s happened, where we are, and where we’re going. Good morning, everyone, happy Wednesday and stay tuned.

Now, we’ve been talking a lot about crypto and the elections. It’s been a super hot topic here in the industry. Many folks who have come on this show have said that this needs to be a bipartisan issue if we expect to see any movement on legislation here in the United States. Now, Coinbase Chief Legal Officer Paul Grey Wall is getting in on the conversation. He said in an interview at the Asia Blockchain summit, “My number one concern is that crypto becomes politicized and becomes a partisan issue in ways that at the very least slow and perhaps even worse threaten its continued growth and development. There needs to be an understanding that the Howie Test was developed in the context of an orange grove real estate in Florida in the 1940s and 1950s.” He said arguing that applying the Howie test blindly and McKay to blockchains and crypto does not make practical sense. This sentiment has long been expressed by many in the crypto industry and yet Sec chair Gary Gensler stands by his stance that no new rules are needed for crypto.

Today, we’re going to talk all about the Howie Test, what it is, how it works, why it remains a contentious issue, and why it’s relevant to investors like you. The Howie test is a legal standard used in the United States to determine whether a transaction qualifies as an investment contract and thus would be considered a security under federal law. It originates from a 1946 Supreme court case, SEC versus WJ Howie Co involving a Florida Citrus Grove. Now, the court’s decision laid down a four-part test and it goes like this: an investment of money in a common enterprise with an expectation of profits solely from the efforts of others. If all of these elements are met, the transaction is deemed a security, meaning that it falls under the regulatory purview of the SEC.

So how does this apply to cryptocurrencies? Well, the application of the Howie test to the crypto world is where things get interesting, controversial, and kind of murky. Many projects have been scrutinized under this test. The SEC has argued that numerous tokens and coins are essentially offering securities without proper registration. Based on this Howie criteria, let’s break down how each part of the Howie test might apply to a Cryptocurrency or token offering: investment of money to participate in many coins or tokens, participants invest their money in exchange for a new Cryptocurrency or token, common enterprise, this is often satisfied in the crypto space as the success of the investment is usually linked to the success of the project as a whole, expectations of profits, investors typically expect to profit from their investment through the appreciation of the token’s value and efforts of others, this is where it gets a little heated if the success of the project relies heavily on the efforts of a centralized group or company, it leans towards security.

So why is the Howie Test so controversial when it comes to crypto? For starters, this industry is incredibly diverse. Tokens serve numerous functions beyond just investment, they can be used for accessing services governance or as a medium of exchange within a specific ecosystem. This multifunctionality makes it challenging to apply to a one-size-fits-all test like Howie. Moreover, the decentralized nature of many Blockchain projects further complicates things. This ambiguity has led to a lot of uncertainty and frustration in this industry. Crypto projects argue that the Howie test is a tool from the mid-20th century, ill-equipped to handle the nuances of modern decentralized technologies. On the other hand, regulators maintain that the Howie test is flexible enough to apply to various scenarios and essential for protecting investors from fraudulent schemes.

Now, why is this relevant to our crypto markets today? The classification of a crypto asset as a security has significant implications. If deemed a security, a cryptocurrency must comply with a host of regulatory requirements including registration with the SEC, disclosure obligations, and investor protection measures. This can impose substantial costs and operational hurdles for crypto projects. For investors, understanding what a token is classified as a security is crucial. It affects how you legally buy, sell, and trade these assets. This regulatory risk can create volatility and uncertainty in the crypto markets, impacting investor confidence and market stability. For now, the Howie test plays a crucial role in the regulatory landscape of cryptocurrencies.

Coinbase Paul Graal said at the summit precedents even from the Supreme Court have always been recognized as applying in particular contexts and needing to adapt to new technologies and issues that emerge in markets and in the economy more generally. He added it’s important to respect precedents and to use the wisdom garnered from decades of applying them in all sorts of other contexts without being beholden to them in a way that just doesn’t make practical sense. Alright, we’ll leave it there for today’s show. Thank you so much for listening and coming on this journey with me to better understand the crypto markets. If you enjoyed today’s show, subscribe to the CoinDesk Podcast Network that is available anywhere you find the podcast, give us a five-star rating. If you prefer to watch on video, subscribe to our YouTube channel and hit that like button. Your support means the world. We hope you have a fantastic day and we’ll see you tomorrow.

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