How Is Howey Test Applied In ICO Regulation: Main Rules
The United States of America is the leader by the number of ICOs. At the same time, it is the country with the strict ICO regulation. In the previous article, we talked about the background of the Howey test. It was originally developed to evaluate transactions and identify the fact of securities purchase. The rise of blockchain technology and the increase in the number of the ICO campaigns have led to the adaptation of the test to the cryptocurrency market realities.
Digital assets must be legalized and have a certain status in the legal environment. Therefore, in 2016, a new version of the Howey test was developed specifically for ICO regulation in order to determine the nature of issued tokens. Unlike the original version, the test consists of three blocks, although its essence remains the same.
The blocks of the test define:
- Is there a confirmed fact of investing in cryptocurrency in the context of a project?
- Does the investment in a common enterprise occur with other investors?
- Do investors expect a profit, the amount of which depends on a third party?
The test consists of eight questions, and the majority of them is in the third block. The functions of a token, the time of its sale start and the power of investors are the emphasis. The automation of processes is also important: a token has much more chances to be considered as a security if its value depends on manual actions.
Each question must be answered with "yes" or "no". Answers are evaluated in points, and the sum of points allows to figure out if a token looks like a security paper. Anyone wishing to launch an ICO campaign in the United States can pass the Howey test online. However, the online test does not guarantee anything, because the SEC considers each case separately.
How the results of the Howey test look like
Everything related to the Howey test is exposed in a document developed by a joint team from Coinbase, Coin Center, Union Square Ventures, and Consensys. Also six basic principles are defined there. You can successfully launch an ICO campaign in the United States following these guidelines.
Principles of development and token sale organization
1. The official project description should be publicly available and contain all necessary information about the token and the project including:
- business model description;
- technical implementation data;
- blockchain specification.
An investor needs to understand the idea behind the digital token and how it will function. Ideally, the description should contain an independent expert assessment.
2. The designated project roadmap must include a clear time frame. The financing of each project stage is calculated separately. The composition and contribution of the team is important at each time stage. Investors will be interested in whether the team’s access to collected funds is restricted.
3. Maximum transparency is a must. It includes using a public blockchain, publishing a code on a public resource, creating tokens based on an existing standard. This allows customers seeing the influence individual team members have on the project. The lower the influence is, the more chances there are to successfully pass the Howey test.
4. A token price must be supported by the project's economy and understandable to an investor. The information on the number of tokens, their price and possible rate changes over time is to be disclosed. The total expected investment should be limited and not exceed the development cost. The quantity, the price of tokens and the term of sale are calculated in accordance with this amount.
5. The number of tokens for the team must be determined initially. It should not be too large to prevent the risk of centralization. At the same time, the number should be sufficient for their motivation.
6. A token should not be positioned as an investment. The main incentives to buy the token are its functionality and economic potential, not the price.
The startupers who intend to launch an ICO campaign in the US and potential investors should also be guided by these rules. However, you shouldn’t forget that these recommendations are aimed to help you successfully pass the Howey test, while the SEC always makes decisions in accordance with its own assessment.