howey testi

What Is the Howey Test?

The Howey Test is a judicially established standard used to determine whether a particular fundraising arrangement qualifies as an “investment contract” under securities law. Rather than a specific statute, it originates from the United States Supreme Court’s 1946 decision in SEC v. W.J. Howey Co. (Source: U.S. Supreme Court, 1946).

The case involved an orange grove company that sold land plots to tourists and managed the orchards on their behalf. Buyers contributed funds with the expectation that the company’s efforts would generate profits. The Court summarized four criteria based on this scenario to assess whether something constitutes an investment contract. In the crypto industry, the Howey Test is frequently used to evaluate the regulatory status of token offerings and token trading.

What Are the Four Elements of the Howey Test?

The Howey Test sets out four interrelated criteria: an investment of money, a common enterprise, an expectation of profits, and profits primarily from the efforts of others. If all four elements are met, it is more likely to be classified as an investment contract under securities law.

Step 1: Investment of Money. “Money” isn’t limited to cash—fiat currency, crypto assets, or even exchanging services for tokens may all count as investment.

Step 2: Common Enterprise. A “common enterprise” means your funds and profits are pooled or linked with those of others, with everyone’s results closely intertwined in the same business activity or pool.

Step 3: Expectation of Profits. If the issuer’s statements, whitepapers, or marketing highlight potential appreciation, dividends, or returns, buyers may be participating with profit expectations.

Step 4: Profits Primarily from the Efforts of Others. If investor profits mainly depend on the team’s development, operations, or marketing efforts rather than direct value creation by investors themselves, this element is likely met.

Why Does the Howey Test Matter in Crypto?

The Howey Test is widely used by the U.S. Securities and Exchange Commission (SEC) to determine whether a token qualifies as a security, impacting whether it can be publicly sold to U.S. users, traded on platforms, and whether projects must register or qualify for exemptions.

Since 2017, the SEC has cited the Howey Test in multiple crypto-related cases—for example, Telegram’s token offering (2020 decision and settlement), LBRY (2022 ruling), and Ripple (2023 partial ruling demonstrating that different sales structures can yield different legal outcomes). These cases show that fact-specific details can result in different conclusions (Source: SEC official enforcement and public filings as of 2024).

How Is the Howey Test Applied to Crypto Tokens?

When applying the Howey Test to tokens, the focus is on whether their design, sale, and marketing meet all four elements. Utility tokens primarily used for paying fees or accessing product features—without emphasizing investment returns—pose lower regulatory risk. In contrast, tokens that promote dividends, profit sharing, or returns generated by team management present higher risk.

Step 1: Examine if funds are raised from the public and if marketing emphasizes profits or price appreciation. If the whitepaper mentions “dividends” or “guaranteed returns,” proceed with caution.

Step 2: Analyze token use cases and rights. Rights such as pure utility or discounts are fundamentally different from participation in profit distribution—the latter is closer to securities characteristics.

Step 3: Determine the source of returns. If profits depend mainly on the issuer’s business operations, marketing, or technical updates (rather than users’ own activities), this fits the “efforts of others” criterion.

Step 4: Observe control and governance. If the core team can unilaterally affect profits (e.g., setting dividend rates or buyback programs), both “common enterprise” and “efforts of others” criteria are more likely satisfied.

In practice, exchanges also monitor these risks. For example, Gate's project reviews and risk disclosures often address questions like “does it promise returns or profit sharing”—both are signals for the Howey Test. Always exercise caution when making financial decisions and consult legal professionals when needed.

What Does “Common Enterprise” Mean Under the Howey Test?

A common enterprise can be understood as pooling everyone’s funds and outcomes together. If you and other purchasers put money into a shared fund, and your returns depend on a joint business activity or management team, this represents a classic common enterprise.

Typical indicators include: tokens representing shares of a revenue pool; projects aggregating funds for unified management and distributing returns using a standard formula; your profit closely tracking overall project performance. This differs from simply purchasing software access rights, where value depends primarily on your own use rather than collective management results.

How Do You Determine “Efforts of Others” Under the Howey Test?

“Efforts of others” refers to profits generated mainly by the issuer or a third party’s work—not by the investor themselves. To assess this, look at whether the project requires ongoing team operation, business development, compliance efforts, or technical upgrades that decisively affect returns.

For example, if a token promises to distribute platform profits proportionally to holders and those profits come mainly from team operations, that’s a strong signal for “efforts of others.” Conversely, if a token is just a product “ticket” or “fuel,” its value comes primarily from user utility rather than team performance—so it is less likely to be deemed an investment contract.

How Is the Howey Test Used for NFTs and DeFi?

NFTs (non-fungible tokens; digital collectibles) typically represent art or utility rather than investment. However, if issuers promise to share project profits with NFT holders or bundle NFTs into joint revenue schemes, this may trigger the Howey Test.

In DeFi (decentralized finance based on automated smart contracts), if tokens represent claims on a profit pool and participants expect returns generated by teams or protocol operators, there is an increased risk of being classified as investment contracts. By contrast, tokens used solely for paying fees or staking for feature access present lower risk.

What Is the Relationship Between the Howey Test and Compliant Offerings?

If a token is deemed a security under the Howey Test, public offerings to U.S. users typically require registration or qualifying for an exemption. Registration involves obtaining regulatory approval and ongoing disclosure; exemption means not registering but still meeting specific requirements—such as private placements for accredited investors or offshore sales (requirements are complex and require compliance advice).

Non-compliant offerings risk enforcement action, delisting from platforms, or restrictions on U.S. user participation. To reduce risk, projects should avoid promising dividends or guaranteed returns during design and promotion phases and ensure robust disclosure and suitability processes.

What Are the Risks of the Howey Test and How Can They Be Addressed?

For teams:

Step 1: Avoid terms like “guaranteed returns” or “dividend commitments” in whitepapers and marketing materials. Clearly emphasize token utility over investment features.

Step 2: Minimize centralized revenue pools that make tokens direct claims on profits. If fundraising is necessary, consider compliant paths (registration or exemption).

Step 3: Establish governance and disclosure mechanisms—even when using exemptions, ensure investor suitability standards and risk disclosures are met.

For users:

Step 1: Identify marketing signals—be wary when you see terms like “high yield,” “guaranteed,” or “dividends.”

Step 2: Verify the source of returns—if profits come mainly from team management or third-party activities rather than your own use, there is greater likelihood of triggering the Howey Test.

Step 3: Review platform risk disclosures—on Gate’s project pages or research content, check for warnings about potential securities status and make decisions based on your own risk tolerance.

What Is the Summary of the Howey Test?

The Howey Test is not a simple bright-line rule but a set of integrated principles focusing on “investment of money,” “common enterprise,” “expectation of profits,” and “efforts of others.” Crypto projects must consider these factors throughout design, sales, and marketing phases; users should use them as a framework for risk assessment. For offerings targeting U.S. markets, advance planning for registration or exemption—and cautious use of profit-related language—is critical for compliance. Any financial transaction involves uncertainty; seek professional legal and compliance advice when necessary.

FAQ

Will My Project’s Token Be Classified as a Security Under the Howey Test?

It depends on whether your token satisfies all four elements of the Howey Test. If holders expect profits primarily from others’ efforts, it will generally be deemed a security. Consult legal experts during token design to clarify its intended function (such as governance or utility) and avoid overemphasizing investment returns.

What Exactly Does “Efforts of Others” Mean in the Howey Test? How Can It Be Avoided?

“Efforts of others” refers to actions by project teams or third parties—such as management, operations, or marketing—that directly impact token value. Ways to avoid this include involving the community in decision-making, enhancing actual token utility, and reducing reliance on project team promises. Emphasize independent token value rather than profit expectations.

What Happens if My Project Is Classified as a Security?

If deemed a security, your project must comply with strict securities regulations—such as disclosure requirements and investor protection rules—or face penalties like fines, asset freezes, or even criminal charges. Many projects choose geographical arbitrage or redesign tokenomics to meet Howey compliance standards. Proactive compliance is recommended over reactive measures.

Is the Howey Test Only Used in the United States? Do Other Countries Recognize It?

The Howey Test is based on U.S. law; however, many other regulators (such as those in Singapore and Switzerland) use similar frameworks when assessing whether crypto assets are securities. Projects should monitor policy developments across major jurisdictions and adopt global compliance strategies rather than relying solely on one region’s standards.

Why Have Some Well-Known Projects’ Tokens Not Been Classified as Securities?

Such projects often have clear real-world utility and robust community governance mechanisms—users hold tokens for functional purposes rather than pure investment motives. They also tend to avoid excessive marketing promises and centralized control by project teams, so they do not fully meet all four Howey elements. However, this does not guarantee absolute safety; policies may change at any time.