How the Third Circuit's Common Enterprise Analysis Could Reshape Crypto

The Howey Test's Common Enterprise is the new battleground. The Third Circuit Court ruled that horizontal commonality—investor funds pooled in a common enterprise—defines an investment contract. This bypasses the need for a central promoter, directly targeting decentralized finance (DeFi) protocols like Uniswap and Aave where user liquidity is pooled.

Protocols are now securities issuers. The court's logic frames the pooled liquidity in an Aave lending pool or a Uniswap v3 liquidity position as the 'common enterprise.' Token value derived from this collective asset pool implicates the token itself as a security, regardless of developer promises.

This invalidates the decentralization defense. Teams like those behind Lido (stETH) or MakerDAO (DAI) historically argued that sufficient decentralization removes the 'central promoter' from Howey. The Third Circuit's analysis makes that argument legally irrelevant if the protocol's token economics rely on a shared pool of assets.

Evidence: The SEC's enforcement roadmap is now clear. Following this ruling, expect immediate action against protocols with significant Total Value Locked (TVL). The SEC will argue that protocols like Curve (CRV) or Compound (COMP), where token rewards are tied to pooled user deposits, are unregistered securities offerings.

Common Enterprise Doctrine redefines decentralization. The SEC's Howey test traditionally focused on investor reliance on a promoter's efforts. The Third Circuit's ruling in SEC v. Coinbase expands this, finding a common enterprise exists when an ecosystem's success is interdependent. This makes the technical design of a protocol, not just a central team, the target for securities law.

Protocols are now defendants. This analysis directly implicates core infrastructure like Uniswap's AMM pools or Lido's staking network. The legal theory argues that the collective success of liquidity providers, node operators, and token holders creates an inseparable financial relationship. The protocol's code is the promoter.

Vertical integration is the vulnerability. The court scrutinized Coinbase's control over wallet, exchange, and staking services. For DeFi, this means composability is a liability. A protocol like Aave, whose aTokens are integral to yield strategies across Compound and Yearn, creates a web of interdependent success that fits the 'common enterprise' definition.

Evidence: The ruling cited the interdependence of Coinbase's services as key. In DeFi, this mirrors the interdependence of Curve's gauge votes, CRV emissions, and convex's vote-locking. This technical symbiosis, designed for efficiency, is now a legal vulnerability.

The SEC's Howey Test defines an investment contract by three prongs: investment of money, in a common enterprise, with an expectation of profits from others' efforts. The agency's enforcement actions against projects like Coinbase and Ripple treat most token sales as securities by default, ignoring technical decentralization.

The Common Enterprise Problem is the test's weakest link for crypto. The SEC argues that token price correlation across exchanges creates a 'horizontal commonality.' This logic fails for functionally decentralized networks like Ethereum or Solana, where no central promoter controls the asset's fate.

The Third Circuit's Ruling in SEC v. Coinbase introduced a stricter standard. It requires the SEC to prove a contractual undertaking between issuer and buyer, not just speculative trading. This dismantles the argument that secondary market trading alone satisfies Howey.

Evidence: The ruling's dissent warned this creates a 'regulatory vacuum.' This vacuum is where protocols with clear utility, like Uniswap's UNI or Maker's MKR, can operate outside securities law, forcing the SEC to litigate specific promises, not asset classes.

Vertical common enterprise prevails in most Layer 1 and Layer 2 networks. The success of token holders is inextricably linked to the managerial efforts of a core development team, like Optimism's OP Labs or Arbitrum's Offchain Labs, which control protocol upgrades and treasury funds.

Horizontal common enterprise is absent. Unlike a traditional partnership, token holders lack mutual agency; an Aave holder cannot legally bind the protocol or other holders. This structural disconnect is a legal fiction that regulatory scrutiny dismantles.

Foundation control is the critical flaw. The Swiss Foundation model used by Ethereum, Cardano, and others centralizes decision-making power over grants and core development. This creates a clear 'managerial effort' that benefits token value, satisfying the Howey Test's third prong.

Evidence: The SEC's case against Terraform Labs established that algorithmic stability constituted managerial effort. This precedent directly implicates DAOs with active treasury management, like MakerDAO, and delegative governance systems where whales control votes.

The Howey Test's Core is the expectation of profits from a common enterprise. The Third Circuit's 2022 ruling in SEC v. Telegram established that a common enterprise requires horizontal pooling, not just vertical reliance on a promoter.

This legal precedent dismantles the SEC's broad application of Howey to tokens like ETH or SOL. Most decentralized networks lack the contractual profit-sharing or pooled assets that define a horizontal common enterprise under this analysis.

The SEC's pivot is blocked by stare decisis. To reclassify major assets, the Commission must overturn binding circuit court precedent, a highly improbable legal battle it is unlikely to win given the clarity of the ruling.

Evidence of Impact is seen in the SEC's retreat from suing major exchanges over ETH trading post-Merge, a tacit acknowledgment that its Howey argument collapses under the common enterprise analysis for sufficiently decentralized networks.