The Howey Test's Third Prong is the SEC's primary weapon. The agency argues that token buyers anticipate profits from the entrepreneurial or managerial efforts of others, a definition that captures most token-based ecosystems where a core team drives development and marketing.
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Why The 'Efforts of Others' Test Is the Core of the SEC's Argument
A technical dissection of the SEC's primary legal weapon against staking services, analyzing why the 'efforts of others' prong of the Howey Test is the decisive battleground for protocols like Lido, Coinbase, and Kraken.
introduction
THE LEGAL BATTLEGROUND
Introduction
The SEC's case against crypto protocols hinges on a single, archaic legal doctrine that determines what constitutes an investment contract.
Protocols are not passive assets. Unlike a share of stock, a token's utility often depends on a decentralized network's growth, which the SEC contends is orchestrated by a central team. This creates a legal dependency on developer efforts that satisfies the Howey test's critical criterion.
The decentralization defense is a spectrum. The SEC targets protocols like Solana (SOL) and Algorand (ALGO) where foundational entities clearly drove early development. True decentralization, as argued in the Ethereum 2.0 case, requires a network to operate independently of its creators, a state few projects achieve.
Evidence: In its case against Ripple, the SEC highlighted how XRP purchasers relied on Ripple Labs' efforts to build use cases and market the token, a pattern it replicates in suits against Coinbase and Binance for listing similar assets.
thesis-statement
THE LEGAL BATTLEGROUND
The Core Thesis
The SEC's case against Uniswap hinges on applying the 'efforts of others' test to decentralized protocol governance.
The Howey Test's 'Efforts of Others' is the SEC's primary weapon. They argue that UNI token holders rely on the managerial efforts of the Uniswap Labs team and the Uniswap Foundation for the protocol's success and fee generation, which would classify UNI as a security.
Decentralization is the Defense. Uniswap's counter is that the protocol is a self-executing, autonomous software stack. Governance votes are executed by code, not by a central promoter, severing the legal link between token value and a specific group's efforts.
Precedent vs. Protocol. The SEC cites cases like Telegram's TON and LBRY, where centralized development teams were deemed essential. Uniswap points to the Bitcoin and Ethereum precedents, arguing its governance is more akin to a public utility than a corporate enterprise.
Evidence: The SEC's Wells Notice specifically highlights the Uniswap Foundation's role in protocol upgrades and treasury management as evidence of central managerial efforts, a direct challenge to claims of full decentralization.
deep-dive
THE CORE CONFLICT
Deconstructing the Legal vs. Technical Reality
The SEC's case hinges on a legal abstraction that fundamentally misrepresents how decentralized protocols operate.
The 'Efforts of Others' test is the SEC's primary legal tool for classifying an asset as a security. It asks whether investors profit from the managerial efforts of a third party. For the SEC, any protocol with a foundation, core developers, or a DAO treasury is that 'third party'.
This legal framework is incompatible with the technical reality of decentralized systems. A protocol like Uniswap or Lido operates via immutable smart contracts. The 'effort' is codified, not managerial. The SEC's argument conflates protocol development with security issuance.
The precedent is dangerous because it criminalizes open-source development. Under this logic, the Ethereum Foundation's ongoing work on the protocol could retroactively deem ETH a security, creating regulatory uncertainty for the entire ecosystem.
Evidence: The SEC's case against Ripple (XRP) established that a token's status can change. Secondary market sales of XRP were not deemed securities transactions, highlighting the inconsistency of applying a static 'efforts of others' test to dynamic, decentralized networks.
THE HOWEY TEST'S CRITICAL PRONG
The Legal Battleground: Key Cases & Arguments
Comparing how the SEC's 'Efforts of Others' argument has been applied in landmark crypto enforcement cases.
| Legal Test / Case Factor | SEC v. Ripple (XRP) - 2020 | SEC v. Terraform Labs (LUNA/UST) - 2023 | SEC v. Coinbase - 2023 |
|---|---|---|---|
Core Allegation | XRP is an unregistered security | LUNA, MIR, UST are unregistered securities | Staking-as-a-Service is an unregistered security |
'Efforts of Others' Argument | Ripple's active ecosystem development and promotion created reasonable profit expectation from others' work | Terraform's algorithmic peg maintenance and promotion were essential, managerial efforts driving value | Coinbase's staking program involves managerial efforts in node operation, creating profit expectation |
Defendant's Counter-Argument | XRP is a currency/virtual good; sales were to sophisticated entities; ecosystem is decentralized | Tokens are commodities; stablecoin is a currency; algorithm, not managerial effort, maintains peg | Staking is a service, not an investment contract; customers retain ownership and control |
Court Ruling on 'Efforts' (Initial) | Summary Judgment (2023): Institutional sales = security. Programmatic sales & other distributions ≠security. | Summary Judgment (2024): LUNA & MIR are securities. UST stablecoin is also a security under Howey. | Motion to Dismiss Denied (2024): Court found SEC's claim that staking is a security 'plausible'. |
Key Precedent Set | Created distinction based on buyer expectation and seller's actions. Fragmented the 'common enterprise' analysis. | Applied Howey to algorithmic stablecoins, rejecting the 'currency' defense. Broad view of 'enterprise'. | Extended 'efforts of others' to a service wrapping a native protocol (ETH staking), a novel application. |
Impact on 'Decentralization' Defense | Partial win: Court acknowledged later sales lacked 'efforts' as ecosystem decentralized. | Loss: Court rejected decentralization defense due to Terraform's central, essential role. | Pending: Tests if a centralized service provider's efforts can taint an underlying decentralized protocol. |
Current Status (as of Q2 2024) | Remedy phase ongoing. SEC seeks $2B penalty. | Post-trial; awaiting final judgment and penalties. | Proceeding to discovery; trial not yet scheduled. |
case-study
DECENTRALIZATION VS. SECURITY
Protocol Spotlight: How Different Staking Models Fare
The SEC's 'efforts of others' test is the legal fulcrum for determining if a token is a security, making staking model architecture a primary battleground.
01
The Problem: Centralized Staking Services (e.g., Coinbase, Kraken)
These services act as a single, critical intermediary, concentrating the 'efforts of others' and painting a target for the SEC.
- Legal Risk: Directly implicated in SEC lawsuits (e.g., Coinbase, Kraken Earn).
- Single Point of Failure: User funds and validation control are custodial.
- Regulatory Surface Area: Clear, centralized entity to regulate and sue.
High
SEC Risk
Custodial
Model
02
The Solution: Liquid Staking Tokens (Lido, Rocket Pool)
Decentralizes the staking provider layer but centralizes the protocol layer, creating a nuanced legal argument.
- Protocol-Level Centralization: Lido's ~30%+ Ethereum stake creates a dominant 'effort'.
- User-Level Decentralization: Users hold non-custodial LSTs (stETH, rETH).
- Legal Gray Zone: The SEC's target shifts from a company to a DAO, a more complex legal entity.
$30B+
Collective TVL
Medium
SEC Risk
03
The Solution: Solo Staking & DVT (Obol, SSV Network)
Minimizes the 'efforts of others' by enabling permissionless, distributed node operation. This is the architectural endgame for regulatory defense.
- True Decentralization: No essential managerial or entrepreneurial effort from a third party.
- Fault Tolerance: Distributed Validator Technology (DVT) eliminates single-node failure.
- Strongest Legal Defense: Aligns with the Howey Test's emphasis on independent effort.
~100%
Self-Custody
Low
SEC Risk
04
The Problem: Delegated Proof-of-Stake (Early EOS, TRON)
Explicitly designed around voting for a small set of block producers, making the 'efforts of others' dependency blatant and legally vulnerable.
- Managerial Dependency: Token holders rely entirely on elected delegates' performance.
- Historical Precedent: The SEC's case against EOS established this model as a security.
- Centralization by Design: Typically results in <30 entities controlling the chain.
~21-30
Active Validators
High
SEC Precedent
05
The Solution: Re-Staking & AVSs (EigenLayer)
Creates a new legal vector: stakers now also secure third-party services (AVSs), potentially increasing 'efforts of others' complexity.
- Compounded Dependency: Stakers rely on EigenLayer operators and AVS developers.
- Novel Legal Question: Does securing external protocols create a new common enterprise?
- Systemic Risk: Correlated slashing across the ecosystem amplifies 'effort' reliance.
$15B+
TVL
Evolving
Risk Profile
06
The Verdict: Native Staking (Ethereum, Solana)
The baseline. Staking directly to the protocol's consensus mechanism presents the cleanest case for a non-security, but only if done solo.
- Pure Protocol Effort: Rewards are for securing the native chain, not a third-party business.
- The Solo Staking Ideal: A user running their own validator is performing the critical effort.
- The Pooling Loophole: Using a staking pool reintroduces the 'efforts of others' dependency.
~900k
Ethereum Validators
Baseline
Legal Case
counter-argument
THE HOWEY MISAPPLICATION
The Fatal Flaw in the SEC's Logic
The SEC's core argument hinges on a misapplication of the 'efforts of others' prong from the Howey Test to decentralized protocols.
The 'Efforts of Others' Test is the SEC's primary weapon. It argues that token purchasers rely on the managerial efforts of a core development team for profit, creating an investment contract. This logic collapses when applied to sufficiently decentralized networks like Ethereum or Uniswap, where no single entity controls protocol upgrades or operations.
Protocols Are Not Corporations. The SEC's framework treats a decentralized development community like a corporate board. In reality, the code is the manager. Profit derives from the protocol's automated, permissionless function, not from a promoter's promises. This is the critical distinction between a security and a commodity.
Evidence: The SEC's own inconsistent enforcement proves the flaw. It declared Ethereum not a security in 2018, acknowledging its decentralized state, yet now pursues similar protocols. This creates a regulatory Catch-22 where decentralization is the goal but also the trigger for enforcement, chilling innovation in projects like Lido and Aave.
takeaways
THE REGULATORY FRONTIER
Key Takeaways for Builders & Investors
The SEC's 'Efforts of Others' test is the legal fulcrum for determining if a token is a security. Understanding its mechanics is non-negotiable for protocol design and investment.
01
The Problem: Decentralization is a Spectrum, Not a Switch
The SEC's Howey Test hinges on a reasonable expectation of profits from the efforts of others. A project is not 'decentralized' simply because it's on-chain. The core question is: who controls the essential managerial efforts that drive value?\n- Key Risk: Founders retaining control over treasury, roadmap, or core protocol upgrades.\n- Key Risk: Active marketing that creates an expectation of future appreciation.
>90%
Of Tokens at Risk
02
The Solution: Engineer for Irrelevance
The goal is to architect a system where the founding team's ongoing efforts are provably non-essential. This is a technical and governance design challenge, not just a legal one.\n- Key Action: Implement immutable, on-chain governance with broad, dispersed voter participation.\n- Key Action: Decouple treasury control via multi-sigs with community-elected signers or progressive decentralization roadmaps.
Irreversible
Goal State
03
The Precedent: Ethereum's Successful Transition
Ethereum's 2018 shift from a pre-mined ICO to a Proof-of-Stake network is the canonical case study. The SEC's 2023 closure of its investigation signaled that sufficient decentralization had been achieved.\n- Key Lesson: The transition of core development from a foundation to a broad, independent client team was critical.\n- Key Lesson: Usage utility (gas, staking) began to outweigh pure speculative profit expectation.
2018 -> 2023
Regulatory Path
04
The Investor Lens: Scrutinize the 'Others'
VCs and token buyers must perform deep due diligence on centralization vectors. A slick whitepaper is meaningless if control is concentrated.\n- Key Check: Who controls the upgrade keys (e.g., proxy admin)? Is there a timelock?\n- Key Check: Is the token's primary utility speculative or functional within the protocol's economy?
Centralization
Top Risk Factor
05
The Builder's Dilemma: Launch Liquidity vs. Long-Term Safety
Early-stage projects need liquidity and guidance, which often requires centralized efforts (CEX listings, market making, development). The path to decentralization is a high-stakes balancing act.\n- Key Tactic: Use vesting schedules and lock-ups to align team incentives with long-term decentralization.\n- Key Tactic: Design protocol-native revenue mechanisms that don't rely on team-driven token burns or buybacks.
3-5 Years
Typical Timeline
06
The Regulatory Arbitrage: A Global Game
The SEC's stance is not global law. Projects like Solana (SOL) and Cardano (ADA) faced similar scrutiny but operate in a different enforcement context. Builders must navigate a patchwork of global regulators (e.g., MiCA in EU, progressive stance in Singapore/UK).\n- Key Consideration: Entity structuring and geographic operations are as important as code.\n- Key Consideration: Legal opinions on token status are a critical, non-technical deliverable.
Multi-Jurisdiction
Strategy Required
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