Howey test: when a token can be treated as a security. Principles for blockchain tokens development and sale

A blockchain token is a digital asset created on blockchain, which has a certain value (most often economic, and in exceptional cases — reputational or other non-material value) and can be obtained in exchange for fiat money or cryptocurrency, for certain activity or free of charge — depending on the token purpose and its distribution terms.

A token can be used in exchange for a service or a product of a company that issued it. This is the so-called utility token. There are also cryptocurrency tokens (coin token), which serve as a means of payment, and tokens that have properties of securities (stock tokens and bond tokens). The latter give their holder a right to part of the profits of the company that issued them, or, less often, the right to vote in the company (more details on the types of tokens can be found in our previous issue).

However, whatever the token type is, the matter of its legalization inevitably arises after the digital asset release. For example, some tokens may be subject to federal or local legislation regulating the securities market, depending on their characteristics. Among other things, this means that they can only be sold to US citizens after the official registration or recognition of the project as an exception to the generally accepted practice. Similar rules apply in many other countries.

Specialists at Coinbase, Coin Center, Union Square Ventures and Consensys have developed a method that allows a better understanding of the extent the token corresponds to the definition of a security under the federal law on securities regulation, as well as verifies compliance with the key principles of developing and selling tokens. We decided to share this document with you, since we consider it very useful.

How to determine if a token is a security

The Howey Test

The US Supreme Court case of SEC v Howey established the test for whether an arrangement involves an investment contract. An investment contract is a type of security.

In the context of blockchain tokens, the Howey test can be expressed as three independent elements (the third element encompasses both the third and fourth prongs of the traditional Howey test). All three elements must be met in order for a token to be a security.

1. An investment of money
2. in a common enterprise
3. with an expectation of profits predominantly from the efforts of others.

Using the Framework

Click here to access the framework (google sheet). Save a copy in order to use it, or follow ​ the manual instructions below.

Step 1: ​Access the google sheet or refer to the copy of the framework in the Appendix.

Step 2: ​Review each characteristic and determine whether or not it applies to the token.

Step 3: ​You now have three point scores, one for each element. Your lowest point score represents your overall risk score​. Please remember that this methodology produces nothing more than an estimate. You should seek your own legal advice, tailored to your own specific situation and considerations.

To estimate how likely a particular blockchain token is be a security under US federal securities law refer to full legal analysis or read Russian translation.

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