# Howey Test and Cryptocurrency: Understanding Investment Contracts

![Howey Test: Four criteria an asset must meet to qualify as an "investment contract."](https://www.investopedia.com/thmb/RZzIi4Yj0ZjvBtvsaSxp8FRyjSI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/howey-test.asp-final-01641efa5a174c6ab7fa7276cd831b31.png)

*— Investopedia / Ryan Oakley*

## What Is the Howey Test?

The Howey Test evaluates whether transactions qualify as "investment contracts" under U.S. securities laws, focusing on the expectation of profits from the efforts of others. Its application is crucial for blockchain and cryptocurrency projects, impacting how these digital assets are classified and regulated.

### Key Takeaways

*   The Howey Test uses four criteria to determine if an asset qualifies as an "investment contract" under U.S. securities laws.
*   To pass the Howey Test, an asset must involve an investment of money, in a common enterprise, with an expectation of profit derived from the efforts of others.
*   The Howey Test is crucial for evaluating the regulatory status of cryptocurrencies and digital currency projects.
*   Cryptocurrencies often fall under scrutiny because they can meet the criteria of an investment contract, thus subjecting them to SEC regulations.
*   The SEC has used the Howey Test to regulate, and at times prosecute, certain cryptocurrency transactions and offerings.

## Understanding the Howey Test

The Howey Test is based on a ruling from _SEC v. W.J. Howey Co._, which reached the Supreme Court in 1946. Howey Company sold tracts of citrus groves to buyers in Florida, who would then [lease back](https://www.investopedia.com/terms/l/leaseback.asp) the land to Howey. Company staff would tend to the groves and sell the fruit on behalf of the owners. Both parties shared in the revenue. Most buyers had no experience in agriculture and were not required to tend to the land themselves.

Howey had failed to register the transactions, and the [U.S. Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp) intervened. The court ruled that the leaseback arrangements were investment contracts.

The Supreme Court defined an investment contract as a deal where someone invests money in a common venture expecting profits mainly from someone else's efforts. This statement created the four criteria now used as the Howey Test:

1.  An investment of money
2.  In a common enterprise
3.  With the expectation of profit
4.  To be derived from the efforts of others

> **Fast Fact**
>
> In the case of Howey, the buyers of the Florida citrus groves saw the transactions as valuable primarily because the labor and expertise were provided by others. Buyers only needed to invest capital to access an income stream.

## Applying the Howey Test to Cryptocurrencies

Digital currencies such as Bitcoin are notoriously difficult to categorize. They are decentralized and, as such, elude regulation in many ways. Nonetheless, the SEC has taken an interest in digital assets and has sought to clarify [when their sale meets the definition of an investment contract](https://www.investopedia.com/terms/s/simple-agreement-future-tokens-saft.asp).

According to the SEC, the "investment of money" test is easily satisfied with the sale of digital assets because fiat money or other digital assets are exchanged with the expectation of profits or gains. Likewise, the "common enterprise" test is also easily met. The commission has repeatedly used the test to pursue legal action against cryptocurrency developers.

## Case Studies: Howey Test in Action with Cryptocurrencies

In July 2023, the Southern District of New York court released a summary judgment regarding the case _SEC v Ripple_, a blockchain developer with a popular cryptocurrency, XRP. The SEC had filed an action against Ripple in 2020 for an unlawful offer and sale of securities, while Ripple denied the accusations. Both parties petitioned for summary judgments regarding sales to institutional and retail investors.

The court ruled that Ripple and its coin, XRP, did not pass the Howey Test when the [cryptocurrency](https://www.investopedia.com/terms/c/cryptocurrency.asp) was sold in a secondary sale, such as through an exchange. At the same time, it found that the sale did pass the Howey Test when XRP was offered to or purchased by institutional investors.

The ruling is controversial; the crypto industry claimed success, but the SEC kept using the Howey Test to regulate.

On July 13, 2023, the SEC filed a complaint against Celsius Network Limited for issuing unregistered securities and selling crypto asset securities. It then filed a complaint against Digital World Exchange, BoostedPro, and D.W. Exchange on July 21, 2023, for promoting, offering, and selling exchange tokens and crypto asset securities. It is possible the entities committed these acts, but the SEC clearly hasn't backed down from applying the test to cryptocurrencies.

## How Do You Determine If Something Is a Security?

The U.S. Supreme Court uses the Howey Test to determine whether certain transactions qualify as "investment contracts." If transactions qualify as "investment contracts" under the Securities Act of 1933 and the Securities Exchange Act of 1934, those transactions are considered securities.

## Why Is Bitcoin Not a Security?

In June 2018, the former Chair of the SEC, Jay Clayton, [clarified that Bitcoin is not a security](https://www.investopedia.com/news/sec-chair-says-bitcoin-not-security/): "Cryptocurrencies: These are replacements for sovereign currencies, replace the dollar, the euro, the yen with Bitcoin. That type of currency is not a security," said Clayton.

Bitcoin, which has never sought public funds to develop its technology, does not pass the Howey Test used by the SEC to classify securities; however, by Clayton's definition, tokens used in an ICO are securities.

## How Does the SEC Define a Security?

Securities are fungible and tradable financial instruments used to raise capital in public and private markets. The public sales of securities are regulated by the SEC.

The definition of a security offering was established by the Supreme Court in a 1946 case called _SEC v. W.J. Howey Co._

## The Bottom Line

The Howey Test provides a clear framework for identifying investment contracts, subjecting them to U.S. securities regulations. This framework is particularly relevant as regulators focus on cryptocurrencies, applying the Howey Test to determine if digital assets like ICOs qualify as securities. Recent legal cases, including the SEC's actions against Ripple and Celsius Network, underscore the ongoing efforts to apply this test to digital currencies. Understanding the Howey Test is crucial for blockchain developers and investors to navigate the complex regulatory landscape.  

> **Article Sources**
>
> 1.  Mendelson, Michael. "[From Initial Coin Offerings to Security Tokens: A U.S. Federal Securities Law Analysis](https://law.stanford.edu/wp-content/uploads/2019/01/Mendelson_20180129.pdf)." _Stanford Technology Law Review,_ vol. 22, no. 1, Winter 2019, pp. 66.
>     
> 2.  Library of Congress. "[Securities & Exchange Commission v. W. J. Howey Co. et. al.](https://tile.loc.gov/storage-services/service/ll/usrep/usrep328/usrep328293/usrep328293.pdf)," Pages 298-299.
>     
> 3.  Fisher Hudson Shallat. "[Decentralized Cryptocurrencies Typically Fail the Howey Test](https://fisherhudson.com/decentralized-cryptocurrencies-typically-fail-the-howey-test/)."
>     
> 4.  U.S. Securities and Exchange Commission. "[Framework for 'Investment Contract' Analysis of Digital Assets](https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets)."
>     
> 5.  U.S. District Court, Southern District of New York. "[Securities and Exchange Commission vs. Ripple Labs, Inc., et. al](https://storage.courtlistener.com/recap/gov.uscourts.nysd.551082/gov.uscourts.nysd.551082.874.0_2.pdf)."
>     
> 6.  U.S. Securities and Exchange Commission. "[SEC Charges Ripple and Two Executives With Conducting $1.3 Billion Unregistered Securities Offering](https://www.sec.gov/news/press-release/2020-338)."
>     
> 7.  Norton Rose Fulbright. "[U.S. Federal Court Issues Mixed Ruling in Watershed SEC Action on Ripple's XRP](https://www.nortonrosefulbright.com/en-us/knowledge/publications/74133d3b/us-federal-court-issues-mixed-ruling-in-watershed-sec-action-on-ripples-xrp)."
>     
> 8.  U.S. Securities and Exchange Commission. "[SEC Charges North Carolina Resident for Conducting Fraudulent and Unregistered Offerings of Crypto Asset Securities](https://www.sec.gov/litigation/litreleases/2023/lr25785.htm)."
>     
> 9.  U.S. Securities and Exchange Commission. "[SEC Charges Digital World SPAC for Material Misrepresentations to Investors](https://www.sec.gov/news/press-release/2023-135)."
>     
> 10.  U.S. Securities and Exchange Commission. "[SEC Charges Celsius Network Limited and Founder Alex Mashinsky With Fraud and Unregistered Offer and Sale of Securities](https://www.sec.gov/news/press-release/2023-133)."
>      
> 11.  CNBC. "[SEC Chief Says Agency Won’t Change Securities Laws to Cater to Cryptocurrencies](https://www.cnbc.com/amp/2018/06/06/sec-chairman-clayton-says-agency-wont-change-definition-of-a-security.html?)."
>      
> 12.  Justia. U.S. Supreme Court. "[SEC v. W.J. Howey Co., 328 U.S. 293 (1946)](https://supreme.justia.com/cases/federal/us/328/293/)."