Disclaimer: I’m not a lawyer, and I am not your attorney.
This is my current understanding, including several important questions I am still working on. I encourage any and all corrections to this visual frame. And I must note that this is a high-level framework: the nuanced details will be the subject of several enforcements, settlements, and litigations and will be exercised within a long-period of time to come.
First: the what constitutes a”safety” has been defined by the courts specifically as an”investment contract”, which is a trade with the following properties:
- An investment of cash
- With the anticipation of gains
- In a so-called”common enterprise” (roughly meaning: shareholders and the company rise and fall together)
- In the attempts of a promoter or third party (some dispute over whether that means”solely” from a promoter, but clear that it involves”significant managerial attempts” of one promoter)
This four-part evaluation was established as part of SEC vs. Howey, a 1946 supreme court case involving the sale of tracts in an orange grove, with an affiliated lease-back arrangement where buyers of the property leased the property back to the Howey business in exchange for gains generated from cultivation of orange crops. This so-called”Howey Test” has become the basis for determining whether such a transaction represents an”investment contract” and would therefore fall under securities legislation (together with related registration and disclosure requirements).
How the test works is that, if the contract suits all 4″prongs”, it”moves” that the Howey Test and is consequently a securities trade. If the contract doesn’t satisfy any one of the prongs, it fails the Howey Test and is consequently isn’t a securities transaction. The Four prongs of the Howey Test
Ok, with all that as background, here is how I see the Howey Test — 4 prongs that need to be fulfilled:
Thus, if you should begin to consider how to”knock out” prongs of this test, thereby eliminating a trade from securities status, you would start one-by-one.
2) Eliminate the”expectation of profit” and what you have resembles a merchandise (think: pre-buying a back pack or film on Kickstarter, buying arcade or laundry tokens, or purchasing Stacks Tokens to add documents in the Blockstack blockchain):Is a”safety” an advantage or a trade?
A vital question throughout all this is if the”safety” is the digital asset itself, or rather the transaction between the electronic asset.
To begin, we must frame the question differently and focus not on the electronic asset itself, but on the situation surrounding the electronic asset and the way it is sold. To this end, a greater line of inquiry is:”Can an electronic asset that was initially provided in a securities that ever be sold in a fashion that doesn’t constitute an offering of a security?” In situations where the digital asset represents a set of rights that provides the holder a financial interest in an enterprise, the solution is likely”no.” In these circumstances, calling the trade a first coin supplying, or”ICO,” or a sale of a”token,” won’t take it from the purview of the U.S. securities legislation.
But what about cases where there’s no longer any fundamental enterprise being spent in or where the electronic asset is sold only for use to obtain a good or service accessible through the network where it was created?
The Hinman speech described two things: 1) that by knocking out the”efforts of others” prong of the Howey Test (#4 above) that a crypto asset trade can be considered through the lens of commodities vs 2 and securities ) an early trade of the asset (in this case the pre-sale of ETH) could be examined under Howey distinctly from a subsequent sale, given different facts and circumstances at the moment.
This last part is truly important, and that I still have difficulty pinning down (very smart, expensive) attorneys on the topic. There’s an idea that a”safety” is a entity as opposed to a trade , which does seem at odds with both Howey and the Hinman speech. In the event of Howey, the oranges produced under the contract aren’t the same as the contract itself (like contracts for future tokens), and in the event of the Hinman address, it is the trade as opposed to the underlying token (BTC or ETH).
Finally taking all this together, it is important to consider that 1) there are lots of sorts of cryptoassets, and 2) they’re offered/sold/traded/moved under different conditions over time.
I hope that’s helpful. This is complex stuff, and new land.