The 'Efforts of Others' Prong is the legal mechanism that classifies an asset as a security. It triggers when a project's success depends on the managerial efforts of a centralized entity, not just its underlying code.
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Why the 'Efforts of Others' Test Captures Every Centralized Project
A technical analysis of why the SEC's 'efforts of others' prong is a legal sledgehammer that classifies any project with a core development team as a security, regardless of token utility.
introduction
THE HOWEY TEST'S BLIND SPOT
Introduction: The Legal Trap Door
The 'efforts of others' prong of the Howey Test is a legal trap door that captures every protocol with centralized operational dependencies.
Protocols are not exempt. A DAO's governance token fails this test if a core team controls critical infrastructure like the sequencer (e.g., Arbitrum's Offchain Labs) or the relayer network (e.g., LayerZero's Oracle/Relayer set). The legal risk is structural, not ideological.
Counter-intuitive Insight: A fully decentralized L1 like Bitcoin passes; a nominally decentralized L2 with a centralized sequencer fails. The test ignores marketing and examines operational control points.
Evidence: The SEC's case against Coinbase cited staking services, arguing user returns were derived from the company's efforts. This precedent directly implicates any protocol where a foundation runs validators or a company operates a canonical bridge.
key-trends
THE REGULATORY LITMUS TEST
Executive Summary: The Three Inescapable Truths
The SEC's 'Efforts of Others' test isn't a niche rule—it's a fundamental property check that exposes the inherent centralization of most crypto projects.
01
The Protocol/App Dichotomy
A true protocol is credibly neutral infrastructure; an application is a managed service. The test probes this boundary.\n- Key Insight: If a team's ongoing, essential efforts are required for the network's success or security, it's likely a security.\n- Example: A DeFi app with admin keys and upgradeable logic fails. A base layer like Bitcoin, where development is non-essential to its operation, passes.
>90%
Of 'DeFi' Fails
2
Networks Pass
02
The Founder's Dilemma
Active development and marketing—standard for startups—become legal liabilities. Decentralization is a binary state, not a future roadmap.\n- Key Insight: Promises of future decentralization ("We'll hand over keys later") are irrelevant to the current security analysis.\n- Consequence: Projects like Solana, Cardano, and major L2s with centralized sequencers or foundations are perpetually at risk, regardless of token distribution.
$100B+
Market Cap At Risk
0
Successful Appeals
03
The Infrastructure Exemption
Not all centralized projects are securities. The test carves a narrow path for genuine infrastructure providers.\n- Key Insight: If the token's value is derived solely from its utility within a closed system (e.g., paying for a service), not from the promoter's efforts, it may qualify as a utility token.\n- Survivors: This is the shaky ground where Filecoin (storage), Helium (connectivity), and oracle tokens like Chainlink attempt to stand. Their legal defense hinges on proving passive, non-profit-driven infrastructure.
~5
Plausible Cases
High
Legal Burden
deep-dive
THE SECURITY TEST
The Anatomy of a Legal Black Hole
The 'efforts of others' test from the Howey analysis is a legal trap that ensnares any project with centralized coordination.
The legal black hole is the 'efforts of others' prong of the Howey Test. It defines an investment contract based on the promoter's essential managerial efforts, not just token utility. This creates a permanent legal vulnerability for any project where a core team, foundation, or DAO with concentrated voting power drives development and marketing.
Every centralized project fails this test. A protocol like Solana or Avalanche relies on its core developers for critical upgrades and ecosystem growth. A foundation like the Ethereum Foundation funds core research and client teams. This centralized coordination, however beneficial, directly satisfies the 'efforts of others' criterion, creating a persistent SEC enforcement risk.
Decentralization is the only escape vector. The test targets reliance on a promoter. True exit requires dissolving this reliance, moving to a credibly neutral, permissionless protocol where no single entity's efforts are essential. This is the endgame for protocols like Bitcoin and Ethereum, but most 'DeFi' and L2 projects remain firmly inside the event horizon.
THE 'EFFORTS OF OTHERS' PRONG
Case Study Matrix: How the SEC Applies the Test
A comparative analysis of how the SEC's 'efforts of others' test from the Howey Test is applied to centralized crypto projects, demonstrating their inherent classification as investment contracts.
| Critical Factor / SEC Inquiry | Centralized Exchange Token (e.g., BNB, FTT) | Staking-as-a-Service (e.g., Kraken, Coinbase) | Centralized Lending Platform (e.g., Celsius, BlockFi) |
|---|---|---|---|
Promoter's Essential Managerial Efforts Required for Success | |||
Investor's Profit Relies on Promoter's Business Acumen | |||
Development & Marketing Funded by Token Sales |
| Primary funding mechanism | Primary funding mechanism |
Promoter Controls Core Protocol Upgrades & Roadmap | |||
Token Value Tied to Promoter's Operational Performance (e.g., burns, buybacks) | Direct correlation via treasury | Indirect via platform growth | Direct via interest payments |
Investor is a Passive Participant | |||
SEC Enforcement Action Filed (as of Q1 2024) | |||
Resulting Legal Classification | Investment Contract | Investment Contract | Investment Contract |
counter-argument
THE LEGAL LENS
The Decentralization Mirage (And How to Actually Achieve It)
The 'Efforts of Others' test from the Howey Test is the definitive legal framework that exposes centralized control in crypto projects.
The Howey Test's Core: The SEC's 'Efforts of Others' test defines an investment contract. Investors rely on a promoter's managerial efforts for profits, not their own. This legal standard captures every project with centralized development, marketing, or roadmap control.
Protocols vs. Promoters: A truly decentralized network like Bitcoin or Ethereum passes this test; its success no longer depends on a core team. Most Layer 2s, DAOs with core dev multisigs, and appchains like dYdX v3 fail because a defined group's efforts remain essential.
The Operational Reality: Centralized sequencer profits from Arbitrum and Optimism flow to founding entities. Upgrades for Uniswap or Aave require governance votes often steered by whales and the founding team. This ongoing reliance is the legal vulnerability.
Evidence of Centralization: The SEC's cases against Ripple (XRP) and Coinbase hinge on this principle. They argue buyers expected profits from Ripple Labs' business efforts, not from a decentralized network of peer-to-peer users.
takeaways
THE HOWEY TEST'S KILLER APP
Takeaways: Navigating the Legal Minefield
The 'Efforts of Others' prong is the SEC's most potent weapon; here's how it functionally defines any project with a core team as a security.
01
The Problem: The 'Active Participant' Trap
The SEC's framework doesn't require a formal corporation. Any ongoing, essential development work by a founding team or foundation creates legal dependency. This captures 99% of L1/L2 roadmaps and protocol upgrades, turning governance tokens into de facto investment contracts.
99%
Of Active Protocols
SEC v. Ripple
Key Precedent
02
The Solution: Irreversible Decentralization
The only defensible exit is to make the core protocol's development and operations truly permissionless and non-reliant on a specific entity. This means:\n- Burning admin keys and multi-sigs\n- Fully on-chain, immutable governance\n- Eliminating foundational treasury control
0
Admin Keys
Bitcoin, Ethereum
Canonical Examples
03
The Reality: Most 'DAOs' Fail the Test
Voting power concentration and foundation-controlled grants prove continued reliance. The legal analysis looks at practical reality, not marketing. A <10 entity multi-sig or a VC-heavy token distribution is a red flag, regardless of 'DAO' in the name.
<10
Multi-sig Signers
Uniswap, Aave
Case Studies
04
The Precedent: Howey Applied to Software
The test hinges on expectation of profit derived from managerial efforts. A core dev team posting a roadmap creates that expectation. Post-launch marketing and business development activities are explicitly cited by the SEC as evidence of others' essential efforts.
SEC v. Telegram
Defining Case
Roadmaps, BD
Key Evidence
05
The Escape Hatch: Functional vs. Promotional Decentralization
To pass, decentralization must be functional, not narrative. This requires:\n- Multiple independent client teams\n- A thriving, competitive developer ecosystem\n- No single point of failure for critical protocol functions
5+
Client Teams
Ethereum
Gold Standard
06
The Verdict: Code as Law vs. SEC as Law
The fundamental conflict: blockchain's 'code is law' ethos vs. the SEC's 'substance over form' doctrine. Until a protocol reaches Bitcoin/Ethereum-level ossification, it operates in a regulatory gray zone where every upgrade is a potential securities law event.
Constant
Regulatory Risk
Ossification
End State
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