This research report originates from a multi-part series titled Law and Ledger, which examines one of the most important and unsettled questions in digital-asset law: when, and under what circumstances, crypto falls within the reach of U.S. securities regulation.
Written by: Michael Handelsman and Alex Forehand for Kelman.Law
This research report contains five additional sections. Access the full report for free here and explore the rest of our research reports.
Is Crypto a Security?
As courts, regulators, and market participants continue to wrestle with applying decades-old legal doctrines to blockchain-based assets, this series breaks down the core principles shaping the modern landscape—from the Howey test and so-called utility tokens, to secondary-market transactions, DeFi, staking, NFTs, and the shifting regulatory posture of the SEC and CFTC.
The goal is to provide a practical, legally-grounded framework for understanding how U.S. law is adapting to crypto in real time.
Part I: The Howey Test
U.S. securities law does not contain a dedicated statute for digital assets. Instead, the SEC and courts continue to apply the “investment contract” doctrine from SEC v. W.J. Howey Co.—a 1946 Supreme Court case involving orange groves, not distributed ledgers. Despite that anachronism, Howey remains the primary analytical tool for determining whether a token sale, issuance, or distribution triggers federal securities laws in the United States.
It is important to note that the Howey definition of an investment contract is merely one of the dozens of assets that qualify as a security subject to SEC regulation. The SEC has made clear that tokenized securities—be that a tokenized bond, stock, or security-based swap—are still securities, and merely putting an asset on blockchain does not “transform the nature of the underlying asset.”
Because of its prominence within the securities analysis, however, this Part focuses on the four elements of the Howey test, how the SEC and courts adapt those elements to token ecosystems, and why the distinction between a token and an investment contract is now one of the most important developments in crypto jurisprudence.
The Four Elements of Howey
In August 2019, the SEC released a framework for how they analyze digital assets under the Howey test for investment contracts. To establish the existence of an investment contract, one must establish four elements:
(1) an investment of money
(2) in a common enterprise
(3) with a reasonable expectation of profits
(4) to be derived from the efforts of others.
1. Investment of Money
According to both courts and the SEC, an investment of money includes fiat, other digital assets, or anything else of value. Because time and labor are considered to be of value, this prong is often easily satisfied.
2. Common Enterprise
With respect to a common enterprise, courts have adopted multiple theories. Horizontal commonality focuses on the pooling of funds, and whether each investors’ fortunes rise and fall together, whereas vertical commonality is more closely tied to the efforts of the promoter, focusing on network growth, tokenomics, and treasury-managed development.
While the SEC originally stated in its 2019 guidance that they typically find this prong satisfied, actual case law suggests otherwise. In reality, this prong is often a hurdle for secondary transactions, particularly under horizontal commonality. For example, in the SEC’s case against Ripple, the court only found a common enterprise with respect to the original institutional sales, but not buyers on the secondary market.
3. Expectation of Profits
For a reasonable expectation of profits, this prong focuses on whether a typical purchaser—not a technical user, a speculative trader, or any specific user—was led to reasonably believe that the token could appreciate in value. Importantly, this analysis is objective. Even if some buyers intend to use the token for utility, the inquiry focuses on what the issuer’s conduct would lead a reasonable person to believe.
If promotional materials, such as a whitepaper, pitch deck, or social media campaign highlight price potential, burn mechanisms, future listings, or token scarcity, courts and the SEC view this as evidence of a profit motive. Relatedly, promises of partnerships, roadmap milestones, or integrations that would increase token value are routinely cited in enforcement actions.
4. Efforts of Others
This is the “managerial efforts” prong—and it is where crypto cases are won or lost. Here, courts ask whether purchasers depend on the entrepreneurial, technical, or managerial efforts of a core team for the token to succeed in the way it was marketed.
Courts evaluate whether the issuer made statements that the team will build, integrate, or deliver features essential to the token’s success at any point in the future. If the network requires substantial future coding, feature releases, upgrades, or integrations before reaching its intended functionality, courts view purchasers as reliant on the team.
Attempts to build the ecosystem, such as partnerships, listings, user-acquisition strategies, and market-making arrangements are all considered entrepreneurial efforts driving value. Further, retaining authority over treasury funds, token supply changes, validator sets, governance parameters, or upgrade mechanisms is heavily scrutinized.
It is important to note that this prong does not require total or permanent centralization. The inquiry is tied to the moment of the transaction: if purchasers are relying on the issuer’s managerial or technical efforts at that time, the prong is typically satisfied.
Importantly, ecosystems can—and often do—evolve. A network that begins in a centralized state may later decentralize to the point where purchasers are no longer depending on a core team. However, courts have not articulated a clear threshold for what constitutes sufficient decentralization. As a result, even projects that appear meaningfully decentralized may still face scrutiny if early purchasers reasonably relied on identifiable managerial efforts during the network’s formative stages.
How Courts Adapt Howey to Token Transactions
Because tokens do not fit neatly into Howey’s original fact pattern, courts evaluate the economic reality of each transaction rather than the technical mechanics of the blockchain. Courts have repeatedly emphasized that the focus is on the substance of the transaction, rather than its form.
This means that merely calling a token a utility token—or embedding features like staking, governance, or on-chain functionality—does not automatically insulate it from being part of an investment contract. Courts look past labels to the real-world incentives and expectations surrounding the transaction.
The Supreme Court emphasizes that Howey evaluates the entire scheme—the sale, the distribution plan, marketing, tokenomics, lockups, and the issuer’s conduct. The token’s code may be neutral, but the context of its sale is not.
When promotional materials emphasize token appreciation, trading liquidity, market listings, or growth potential, courts often find that purchasers have a reasonable expectation of profit. Statements in whitepapers, social media posts, investors decks, and public interviews frequently become key evidence.
Tokens sold before the network is usable or before meaningful functionality exists often satisfy Howey, because purchasers necessarily rely on the issuer’s future development work. This is where pre-launch SAFTs, early ICOs, and “beta” ecosystems are most vulnerable.
A functional network, however, is not the end of the analysis—ongoing entrepreneurial efforts tend to support Howey’s fourth prong as well. Thus, courts also scrutinize the issuer and founding team’s ongoing actions, including protocol development, incentives, ecosystem partnerships, treasury management, or public claims about future growth.
Relatedly, when a founding entity retains discretion over upgrades, treasury management, validator configuration, emissions schedules, or governance, courts generally find that purchasers depend on those managerial efforts.
Token v. Investment Contract
The most important doctrinal evolution in the last several years is the recognition—by multiple courts, and, recently, the SEC itself—that a token is not itself a security. Instead, the investment contract may arise from the way the token is offered or sold.
In SEC v. Ripple Labs, the court held that the token ( XRP) itself was not a security. The court differentiated between direct, institutional sales, which constituted investment contracts, and sales on the secondary-market, which did not satisfy Howey because the purchasers lacked any reasonable basis to expect profits from Ripple’s managerial efforts.
The SEC has now seemingly come to accept this view as well. In a recent speech by Atkins, the SEC Chair analogized tokens to the land in Howey, which now hosts golf courses and resorts instead of orange groves, to show that the underlying asset itself is not necessarily the security.
If the token itself is not a security, but certain methods of distribution are, then secondary transactions can be treated differently from primary sales. This means that exchanges may not be offering securities when the issuer’s ecosystem is decentralized or the issuer is no longer the source of value.
Key Takeaways
The Howey test remains the backbone of U.S. token analysis. Courts have adapted it to digital assets by examining context, incentives, and issuer behavior—not labels or technical features. Understanding this framework is essential for navigating issuance, exchange listings, secondary transactions, and risk management as the regulatory environment continues to evolve.
Staying informed and compliant in this evolving landscape is more critical than ever. Whether you are an investor, entrepreneur, or business involved in cryptocurrency, our team is here to help. Kelman PLLC provides the legal counsel needed to navigate these exciting developments. If you believe Kelman PLLC can assist, schedule a consultation here.
This research report contains five additional sections. Access the full report for free here and explore the rest of our research reports.
