Economic Substance Prevails: Courts ignore marketing claims and analyze the token's actual function. If the primary purpose is fundraising and price speculation, it is a security. The SEC's actions against Ripple (XRP) and Telegram (TON) established this precedent.
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Blog
Why the 'Utility Token' Defense Is Failing in Court
An analysis of how courts are piercing the narrative of token utility to focus on economic reality, secondary market trading, and the enduring power of the Howey Test, rendering the defense legally ineffective.
introduction
THE LEGAL REALITY
Introduction
The 'utility token' defense is failing because courts now evaluate economic reality over technical promises.
Decentralization is a Spectrum: A project citing 'future utility' fails if a central entity controls development and token distribution. The Howey Test focuses on investor expectation of profits from others' efforts, which most ICOs and token sales demonstrably create.
Evidence: In the SEC v. Ripple case, the court ruled institutional sales were securities offerings, while programmatic sales were not, creating a critical distinction based on buyer expectation and seller conduct.
thesis-statement
THE HOWEY TEST
The Core Argument: Function Over Form
Regulators are winning by focusing on a token's actual use, not its marketing.
The 'sufficient decentralization' defense is failing. Courts and the SEC analyze the token's present-day utility, not its future roadmap. If a core team controls governance or the treasury, the token is a security regardless of its branding as a 'governance' token.
Protocols like Uniswap and MakerDAO are the exception. Their tokens, UNI and MKR, passed the test because their development and treasury control are genuinely decentralized. Most projects claiming this status, like Ripple (XRP) or Terra (LUNA), fail this functional analysis.
The 'investment contract' hinges on managerial efforts. The SEC's case against Coinbase argues that staking services constitute an investment contract because rewards depend on the platform's efforts. This directly implicates tokens like SOL, ADA, and MATIC offered through these programs.
Evidence: The Ripple ruling was a partial loss. While XRP sales to institutions were deemed securities, programmatic sales were not. This narrow win reinforces the rule: token distribution method dictates its legal status.
case-study
LEGAL PRECEDENTS
Case Studies: The Defense Crumbles
Recent landmark rulings have systematically dismantled the 'utility token' defense, exposing protocols to securities law liability.
01
SEC vs. Ripple Labs (XRP)
The Howey Test was applied transaction-by-transaction, creating a fatal distinction. Institutional sales were deemed securities, while programmatic sales were not, proving context is king.
- Key Precedent: The 'ecosystem utility' of XRP for cross-border payments was irrelevant for institutional investors.
- Impact: Established that marketing and sale structure can define an investment contract, regardless of underlying tech.
$1.3B
Institutional Sales
2023
Summary Judgment
02
SEC vs. Terraform Labs (LUNA/UST)
The court rejected the 'algorithmic stablecoin' and 'staking reward' utility arguments entirely. Anchor Protocol's 20% yield was cited as a clear profit promise.
- Key Precedent: A token's integration into a yield-bearing protocol can itself be evidence of an investment contract.
- Impact: Destroyed the defense that decentralized governance (via DAO) or algorithmic design immunizes a token from securities laws.
20% APY
Anchor Yield
$40B+
Collapse
03
The 'Sufficiently Decentralized' Myth
The SEC vs. Coinbase lawsuit targets tokens like SOL, ADA, and MATIC, arguing their initial sales and ongoing ecosystem development constitute a common enterprise. Post-launch decentralization is not a retroactive shield.
- Key Precedent: The Foundational Team's ongoing role in development and promotion is a primary factor, negating later decentralization claims.
- Impact: Protocols cannot 'grow into' utility; the legal analysis is anchored at the point of sale and initial investor expectations.
13 Tokens
Named in Suit
Pre-Launch
Critical Period
04
The Howey Test's Digital Evolution
Courts now apply a functional, not formalistic analysis. Token burns, buybacks, and staking rewards are interpreted as profit distributions. The 'efforts of others' prong is satisfied by active core dev teams or foundations.
- Key Precedent: Passive appreciation expectation, even if driven by ecosystem growth, meets the profit prong.
- Impact: Pure 'gas token' or 'governance token' designs are the only potentially viable models; all others face extreme scrutiny.
4 Prongs
Howey Test
Functional
Analysis Focus
THE 'UTILITY' FICTION
The Judicial Scorecard: Key Rulings & Rationale
A comparative analysis of landmark U.S. court rulings that dismantled the 'utility token' defense, establishing the Howey Test as the dominant framework for crypto securities analysis.
| Legal Precedent / Case | Key Holding on 'Utility' | Securities Ruling | Rationale & Market Reality Test |
|---|---|---|---|
SEC v. Telegram (2020) | Gram tokens had 'consumptive use' for TON blockchain. | Future promise of a network, funded by capital raised from public investors, constitutes an investment contract. | |
SEC v. Kik (2020) | Kin tokens were 'currency' for digital services. | Primary motivation for purchase was anticipated profit from Kik's entrepreneurial efforts, not immediate consumptive use. | |
SEC v. Ripple Labs (2023) - Institutional Sales | XRP's utility on RippleNet was irrelevant for institutional buyers. | Institutional buyers purchased with an expectation of profit derived from Ripple's efforts to build the ecosystem. | |
SEC v. Ripple Labs (2023) - Programmatic Sales | XRP's utility created ambiguity for exchange traders. | Blind bid/ask transactions on exchanges did not necessarily convey promises from Ripple, creating a 'genuine dispute' under Howey. | |
SEC v. Coinbase (2023 - Ongoing) | Staking-as-a-Service constitutes an investment contract. | Investors' profits are derived solely from Coinbase's entrepreneurial efforts, not their own. 'Utility' of underlying token is irrelevant. | |
SEC v. Terraform Labs (2023) | Algorithmic stablecoin (UST) and governance token (LUNA) were marketed as profit-generating. | Marketing focused on returns and ecosystem growth. 'Utility' as a means of exchange was secondary to the investment pitch. |
deep-dive
THE LEGAL REALITY
The Fatal Flaws in the Utility Narrative
The 'utility token' defense is failing in court because regulators and judges are analyzing on-chain function, not marketing promises.
Utility is a legal distraction. Courts focus on the economic reality of the transaction, not the technical wrapper. The SEC's case against Coinbase established that staking-as-a-service constitutes an investment contract, regardless of the underlying ETH token's utility.
Protocol governance fails as a shield. Granting voting rights via Uniswap's UNI or Compound's COMP does not negate an investment motive. The Howey Test evaluates the expectation of profit from the efforts of others, which governance tokenomics explicitly create.
On-chain data is the evidence. Regulators trace token flows to prove centralized promotion and initial distribution, as seen in the Ripple case. The existence of a decentralized use case like Curve's veCRV gauge voting does not erase the initial securities offering.
The precedent is set. The SEC v. Wahi insider trading ruling treated tokens as securities based on their promotional context and pooled enterprise. This legal framework renders abstract claims of future utility legally irrelevant at the point of sale.
counter-argument
THE LEGAL REALITY
Steelman: What About True Utility?
The 'utility token' defense is failing because courts now judge tokens by their economic reality, not their technical features.
Courts apply the Howey Test, which assesses investment contracts based on profit expectation from a common enterprise. A token's technical function is irrelevant if its primary purpose is speculative appreciation. The SEC's cases against Coinbase and Ripple established this precedent, focusing on the token's marketing and initial sale structure.
True utility is operationally critical. A token like Ethereum's ETH for gas or Maker's MKR for governance is inseparable from its protocol's function. The legal distinction hinges on whether the token's value is derived from its use or from promoter efforts. Most 'utility' tokens fail this test at launch.
The 'sufficient decentralization' defense is narrow. Courts ruled that once a token is sufficiently decentralized, it is no longer a security. This creates a perilous transition period where projects must survive regulatory scrutiny before achieving this legal safe harbor, a timeline most cannot meet.
Evidence: The SEC's 2023 case against Terraform Labs explicitly rejected the utility defense for LUNA and UST, stating the ecosystem's design was a 'house of cards' built to generate returns, not provide a service.
takeaways
LEGAL REALITY CHECK
Key Takeaways for Builders & Investors
Recent SEC actions against Solana, Algorand, and others demonstrate that the 'utility token' defense is a legal fiction. The Howey Test's 'investment of money in a common enterprise with an expectation of profits derived from the efforts of others' is the only framework that matters.
01
The 'Sufficiently Decentralized' Myth
The SEC's case against Solana (SOL) proves that decentralization is a spectrum, not a binary switch. A core development team, foundation control of the treasury, and a token distribution favoring insiders create a clear common enterprise.
- Key Precedent: The Ripple (XRP) ruling distinguished institutional sales from public exchanges, but the SEC is aggressively appealing.
- Actionable Insight: True decentralization requires irreversible protocol governance and no identifiable, essential third party. Most L1s fail this test.
>90%
Of Top 20 Tokens Under SEC Scrutiny
02
The 'Burn & Buyback' Trap
Tokenomics designed to create artificial scarcity and price appreciation are a direct admission of an 'expectation of profit'. The SEC's case against Terraform Labs highlighted algorithmic stablecoin mechanisms as a core part of the investment contract.
- Key Precedent: The Howey Test's 'efforts of others' prong is triggered by active development, marketing, and ecosystem growth funded by the foundation.
- Actionable Insight: Avoid any economic model that explicitly or implicitly promises returns. Focus on protocol fee capture for validators/stakers, not token buybacks.
$40B
Terra (LUNA) Collapse Cited in Charges
03
The 'Future Utility' Fallacy
Promising future network functionality (e.g., 'gas for L2s', 'governance for DAOs') does not negate the investment contract at the time of sale. The Algorand (ALGO) case shows the SEC views the entire initial offering under the investment lens.
- Key Precedent: Marketing materials, founder statements, and exchange listings as 'investment assets' are entered as evidence.
- Actionable Insight: Build first, tokenize later. A token launched for a fully functional, revenue-generating protocol with a clear, immediate use-case (e.g., paying for API calls) is the only defensible model.
0
Successful 'Utility' Defenses in 2023-24
04
The Path Forward: Regulated On-Ramps & Real Products
Compliance is not optional. The future is in structuring token distributions as regulated securities offerings (Reg D, Reg A+) or building products so compelling that the token is a pure consumptive asset.
- Key Model: Look to Filecoin's (FIL) Reg D raise or the emerging trend of Real-World Asset (RWA) tokenization with clear legal wrappers.
- Actionable Insight: Engage counsel pre-launch. Design for product-market fit first, speculation last. The era of the 'vaporware token' is legally over.
$1B+
Raised via Compliant Crypto Securities (2023)
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