The Howey Test is expanding. The first prong, 'investment of money', now captures any asset transfer, including staking ETH on Lido or providing liquidity on Uniswap V3. The SEC argues these are capital contributions, not protocol usage.
the-sec-vs-crypto-legal-battles-analysis
Blog
Why the 'Investment of Money' Prong is Eroding
A technical analysis of how modern crypto mechanisms like airdrops, liquidity provisioning, and proof-of-stake mining are dismantling the foundational 'investment of money' requirement of the Howey Test, complicating the SEC's enforcement strategy.
introduction
THE LEGAL FRONTIER
Introduction: The SEC's Slippery Slope
The SEC's expansive interpretation of 'investment of money' is creating a dangerously broad definition of a security.
This erodes the 'common enterprise' distinction. The SEC's case against Coinbase conflates staking services with traditional investment contracts. This logic could implicate any DeFi protocol where value accrues to token holders, like Aave or Compound.
The precedent is a regulatory black hole. If sending crypto to a smart contract is an 'investment', then cross-chain messaging via LayerZero or bridging via Across Protocol are securities transactions. This chills permissionless innovation.
key-trends
THE CAPITAL EFFICIENCY FRONTIER
Executive Summary: The Three-Pronged Attack
The 'investment of money' prong of the Howey Test is being systematically dismantled by protocols that minimize or eliminate upfront capital lock-up, shifting risk from the user to the network.
01
The Problem: Idle Capital is a Tax
Traditional DeFi requires users to lock capital as collateral or liquidity, creating opportunity cost and impermanent loss risk. This is a clear 'investment of money'.
- $10B+ TVL sits idle in lending pools and AMMs.
- Capital is non-fungible and trapped in siloed protocols.
$10B+
Idle TVL
100%
Capital At Risk
02
The Solution: Intent-Based Architectures
Protocols like UniswapX and CowSwap abstract capital deployment. Users sign intents (orders), and a network of solvers competes to fulfill them using their own capital.
- User capital never leaves the wallet until execution.
- Risk of execution shifts to professional solvers, not retail.
0%
User Capital Locked
~500ms
Intent to Fill
03
The Solution: Generalized Restaking & AVSs
EigenLayer and similar protocols allow re-hypothecation of staked ETH. A single capital stake can secure multiple Actively Validated Services (AVSs).
- Capital efficiency multiplier on staked assets.
- Transforms security from a cost center into a yield-generating base layer.
5-10x
Efficiency Gain
40+
AVSs Secured
04
The Solution: Universal Liquidity Layers
Cross-chain messaging protocols like LayerZero and Axelar enable composable debt. Borrow on Chain A against collateral on Chain B via a canonical bridge, without manual bridging.
- Unlocks stranded capital across fragmented L2s.
- Creates a unified, programmatic credit market.
50+
Chains Connected
-90%
Bridging Friction
05
The Problem: Regulatory Arbitrage is a Feature
The SEC's stance relies on identifiable capital risk. When the user's capital is never at risk—only their transaction fee or gas is—the 'investment' prong fails. This is a legal engineering breakthrough.
- Transforms securities law analysis from substance to form.
- Creates a defensible regulatory moat for new primitives.
$0
User Capital Risk
1
Legal Prong Nullified
06
The Meta-Solution: Risk Markets as a Primitive
The endgame is the securitization and pricing of execution risk itself. Protocols like Across with bonded relayers and Sherlock for audit coverage commoditize failure modes.
- Risk is priced and traded, not just borne.
- Creates a capital-efficient backbone for trustless systems.
$200M+
Coverage Locked
24/7
Risk Pricing
deep-dive
THE EROSION OF MONEY
Deconstructing 'Capital Investment' in a Digital Context
The legal requirement for an 'investment of money' is collapsing under the weight of digital contributions that hold economic value.
The definition of 'money' is obsolete. The Howey Test's first prong requires an 'investment of money,' but modern crypto contributions are non-monetary. Users invest time, computational power, or data, which protocols like Helium and Filecoin directly monetize.
Value is now programmatic and abstract. A user's stake is not cash but provable work or locked digital assets. Staking ETH on Lido or providing liquidity in Uniswap v3 constitutes capital investment without traditional fiat.
Regulatory arbitrage exploits this gap. Projects intentionally design systems where the initial contribution is 'free' labor or attention, creating a legal gray area that the SEC struggles to classify as a securities offering.
Evidence: The SEC's case against Ripple hinged on XRP sales, but it explicitly excluded 'programmatic sales' and distributions to developers, implicitly acknowledging that not all value transfers constitute an 'investment of money.'
THE HOWEY TEST UNDER PRESSURE
Case Study Matrix: How Crypto Activities Challenge 'Investment of Money'
Comparison of modern crypto user actions against the SEC's traditional 'investment of money' prong, highlighting the erosion of clear capital commitment.
| Activity / Metric | Traditional Capital Investment (Howey Standard) | Modern Crypto User Action | Erosion Mechanism |
|---|---|---|---|
Capital Outlay | Fiat currency transferred to a common enterprise | Gas paid in native token (e.g., ETH) for execution | Payment is for network service, not an investment principal |
Asset Control Post-Transaction | Investor cedes control to a promoter/third party | User retains self-custody in non-custodial wallet (e.g., MetaMask) | No common enterprise if user never relinquishes assets |
Primary Economic Purpose | Expectation of profits solely from efforts of others | Access to utility (e.g., governance voting, NFT PFP, in-game asset) | Profit motive is secondary or incidental to consumptive use |
Form of Contribution | Money | Provision of liquidity (LP tokens), compute (staking), or attention (points) | Capital is programmatic, ephemeral, or non-monetary |
Direct Fiat On-Ramp | Required | Optional; user may earn tokens via airdrop, play-to-earn, or liquidity mining | Investment can begin with $0 fiat, bypassing 'money' prong entirely |
Time Horizon of Commitment | Indefinite or long-term | Seconds (e.g., MEV arbitrage bot) or until reward claim | Capital is deployed tactically, not invested statically |
Legal Precedent Fit | SEC v. W.J. Howey Co. (1946) | SEC v. Ripple (2023) - Programmatic Sales ruling | Court acknowledges context of sale (exchange vs. OTC) can negate investment contract |
counter-argument
THE LEGAL FRONTIER
The SEC's Rebuttal: 'Effort' as a Substitute for Money
The SEC is expanding the Howey Test's 'investment of money' prong to include non-monetary contributions, fundamentally altering its application to crypto.
The 'Effort' Argument is the SEC's primary tool for applying securities law to decentralized networks. The agency argues that contributing computational work or providing liquidity constitutes an 'investment of value' equivalent to capital. This redefinition directly targets Proof-of-Work miners and liquidity providers on platforms like Uniswap.
Legal Precedent is Sparse, making this a novel and aggressive interpretation. The SEC's position, seen in cases against LBRY and Ripple, suggests any expenditure of resources that benefits a common enterprise qualifies. This creates a regulatory gray area for active network participants that traditional investors never faced.
The Counter-Argument hinges on the definition of 'investment'. Legal scholars contend Howey's 'money' requirement was intentional and distinct. Redefining it to include effort collapses the distinction between an investor and an employee or contractor, a precedent with far-reaching consequences beyond crypto.
Evidence: In the SEC v. LBRY case, the court accepted that LBRY credits were sold as a security, partly based on the promise of developer effort to build the ecosystem. This established that promised labor can satisfy the investment prong, a critical precedent for targeting token projects.
takeaways
THE HOWEY TEST IN FLUX
Key Takeaways for Builders and Investors
The 'investment of money' prong of the Howey Test is being systematically eroded by new token distribution models, shifting legal risk from capital formation to functional utility.
01
The Airdrop as a Service Economy
Projects like EigenLayer, Starknet, and zkSync have decoupled token issuance from fundraising. The new model: raise VC capital, build, then airdrop to users. The SEC's argument that an airdrop recipient 'invested' is weak when the only cost was attention and gas fees.\n- Key Risk: Shifts to 'expectation of profit' prong.\n- Key Benefit: Creates a ~$20B+ liquid user base from day one.\n- Key Tactic: Retroactive, points-based systems (e.g., EigenLayer, Blast) formalize this non-monetary contribution.
$20B+
Liquid Base
0$
User Cost
02
The Work Token Loophole
Frameworks like Livepeer and The Graph pioneered the 'work token' model, where tokens are required to perform network services (e.g., transcoding, indexing). Purchasing LPT or GRT isn't an investment; it's buying a software license to work. This directly attacks the 'investment of money' premise.\n- Key Risk: SEC may argue secondary market trading implies investment.\n- Key Benefit: Aligns tokenomics with actual utility, not speculation.\n- Key Tactic: Staking-as-a-Service providers abstract the 'work', blurring the line further.
Utility-First
Model
SaaS
Abstraction
03
DeFi's Contribution-Based Valuation
In Uniswap, Compound, and Aave, token value accrues from fee switches and governance over $10B+ TVL protocols. Users 'invest' liquidity, not money into the token itself. The token's value is a derivative of network usage, not capital raised. This reframes the asset as a governance utility, not a security.\n- Key Risk: Fee switch activation could be seen as profit distribution.\n- Key Benefit: Value is tied to protocol revenue, a defensible metric.\n- Key Tactic: veTokenomics (e.g., Curve, Balancer) further locks value to protocol utility.
$10B+
Protocol TVL
Revenue-Linked
Valuation
04
The Points & Engagement Precedent
Systems like EigenLayer restaking points and Blast points create a measurable, non-financial contribution metric. They are explicitly not tokens and cannot be traded, yet the market prices them via OTC desks and futures. This creates a legal firewall: the 'investment' is in a points system, which is later converted via a legally distinct airdrop.\n- Key Risk: SEC may view the entire scheme as an integrated whole.\n- Key Benefit: Builds community and measures utility before a token exists.\n- Key Tactic: Creates a secondary derivatives market (e.g., Whales Market) that exists outside the project's direct control.
Pre-Token
Valuation
OTC Market
Liquidity
ENQUIRY
Get In Touch
today.
Our experts will offer a free quote and a 30min call to discuss your project.
NDA Protected
Confidentiality24h Response
Time to ValueDirectly to Engineering Team
No Sales Fluff10+
Protocols Shipped
$20M+
TVL Overall