failing the Howey Test

golf scoring applies

(NOTE: “nothing in this article constitutes advice or guidance for either individual collectors/investors, or for web3 projects looking to define their offerings from the perspective of SEC governance and/or compliance.” are you happy, Saul? i copy pasted the thing)

there aren’t too many tests that i’m determined to get negative results on. think the shortlist is: COVID tests, and the Howey Test.

in the world of web3, there are endless opportunities to spend money, some to make money, and even some to invest money. if you’re spinning up a project and decide to offer up a true investment opportunity, you’ll need to file with and be governed by the SEC. If you don’t, and are offering something that passes the Howey Test, the SEC will come calling – just ask Bored Ape Yacht Club or Ripple.

the Howey Test is used to determine if an offering meets criteria which constitutes qualification as a “security.” failing on any of these four components means the offering in question does not meet the textbook definition of a security, which is a good starting point (but not foolproof protection from SEC oversight). The test reads: “…an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” let’s break this down into its four core components and interpret them for web3:

an investment of money (or “wealth”)
- despite crypto being decentralized currency, Bitcoin and Ethereum are currently regulated as commodities. especially factoring in alternative interpretations that categorize this piece as “wealth,” any project that is not 100% free will pass this component of the test
in a common enterprise
- lots of ways to interpret this, but will be difficult for any web3 project to make a case as to why it does not qualify as a common enterprise. TLDR – common enterprise = a thing where a person or group of people offer up stuff to the public, and the public is relying on their expertise or efforts for potential returns
with expectations of profit
- THIS IS THE KICKER: utility is king, and where many projects might get into trouble. Take note whoomp founders: these tokens have perks (like ongoing residual revenue sharing from all future whoomp collections), BUT at the end of the day, they are an exclusive set of mixed emoji emotes that will help us fundraise to build all of the cool shit we’re working on
to be derived from the efforts of others
- unless you are actively involved in running the project (and therefore your efforts, not the efforts of others, are being utilized), the project will pass this component

so, project founders, if you’re planning any sort of derivative coins or other incentives for holding your tokens, make sure they have built in utility and set proper expectations at time of mint. otherwise, it’s going to be very difficult to explain how/why this incentive exists in any other context other than “expectations of profit.” here’s to failing at some things frends!