Why the Howey Test's 'Expectation of Profit' Is Dangerously Broad

The core flaw is the test's inability to distinguish between a passive investment and a functional access key. Tokens like UNI or AAVE are governance and utility instruments, not equity. The SEC's application treats all token appreciation as a 'profit expectation', ignoring their operational necessity in decentralized networks.

This misclassification creates systemic risk by forcing protocols to centralize or abandon US users. Projects like Lido and MakerDAO face existential legal threats despite providing non-financial infrastructure. The alternative, a functional utility test, would assess a token's actual use within its native ecosystem, not its market price.

Evidence: The SEC's case against Ripple hinged on this ambiguity, creating a multi-year legal battle that chilled development. Contrast this with the CFTC's approach to Bitcoin and Ethereum as commodities, which recognizes their use as decentralized computing resources.

Expectation of profit is universal. Every token holder, from an Uniswap LP to a Lido staker, expects the asset's value to appreciate. This includes governance tokens like UNI and AAVE, where utility and profit are inseparable.

The test fails its own logic. If buying a token for its utility inherently creates a profit expectation, then the test's third prong is always satisfied. This makes the 'common enterprise' analysis the only meaningful legal gate, not investor intent.

Evidence from enforcement. The SEC's cases against Coinbase and Ripple hinge on arguing that staking, trading, and even simple listings constitute investment contracts, proving the 'profit' prong offers no protection.

Profit is a byproduct of utility. The Howey Test's core flaw is its inability to separate a passive investment from an active tool. In crypto, token value accrues from network usage, not corporate dividends. A user pays ETH for gas on Arbitrum; the resulting fee burn and staking yield are secondary effects of the primary act of transacting.

The distinction between user and investor collapses. Under the current framework, a Uniswap liquidity provider is legally indistinguishable from a stockholder, despite providing the core function of a decentralized exchange. This misclassification ignores that their 'profit' is a dynamic fee for a service, akin to an AWS credit earning usage-based revenue.

Protocols are penalized for efficiency. A system like EigenLayer, which re-stakes ETH for cryptoeconomic security, creates a 'profit' expectation by design. This functional utility—securing new chains—is the primary purpose, but the regulatory lens sees only the yield. The test fails to weigh the operational necessity of the token against its financial attributes.

Evidence: The staking crackdown precedent. The SEC's enforcement against Kraken and Coinbase for their staking-as-a-service programs demonstrates this overreach. The agency treated a core protocol function (consensus participation) as an unregistered security offering, setting a dangerous precedent for any token with a staking or fee-sharing mechanism.

The 'Expectation of Profit' is the legal trigger for securities classification. The SEC's application ignores the functional reality of protocol tokens like Ethereum's ETH, which is a consumable gas resource, not a corporate equity share.

This overbroad definition captures any digital asset whose value might appreciate, including non-financial utility tokens for services like Filecoin storage or Helium network access. The test conflates secondary market speculation with primary utility function.

The regulatory consequence is a chilling effect on protocol design. Developers must contort tokenomics to avoid profit signals, harming functional efficiency to satisfy a 1940s legal framework ill-suited for decentralized software.

Evidence: The SEC's case against Ripple's XRP hinged on this ambiguity, creating a multi-year legal battle over a token with a clear utility in cross-border payments, demonstrating the test's failure to distinguish between investment contracts and operational tools.

The 'Expectation of Profit' Trap is the core vulnerability. The SEC's application focuses on passive appreciation from a common enterprise, a definition that captures token staking, governance participation, and even protocol fee accrual. This directly implicates systems like Lido's stETH and Compound's COMP distribution.

Protocols Are Not Passive Investments. The counter-argument is that active network participation—providing liquidity on Uniswap V3, validating on Solana, or securing a rollup—is a utility service, not a passive security. The legal distinction between work and investment is the critical, unresolved battleground.

Evidence: The Ripple Ruling. The 2023 summary judgment found XRP was not a security when sold on exchanges to retail, but was when sold to institutional investors. This bifurcated outcome demonstrates the test's inherent ambiguity and creates operational chaos for protocols with diverse user bases.