BlockFi, a leading cryptocurrency lender and exchange, filed for chapter 11 bankruptcy protection this past Monday. This comes two weeks after the crash of FTX token and FTX exchange. BlockFi works similarly to a regular bank. An individual or business will come and request a loan, except instead in of dollars, the loan funds are often in cryptocurrency. The company was backed by Fidelity, Akuna Capital, SoFi, Coinbase, and many other large companies. Its aim was to “redefine banking”. Some investors are learning a difficult lesson about investing in non-securities and the lack of regulation surrounding crypto. Following the catastrophic failure of FTX, it’s important for investors to know what a security is.
The Howey Test
The Howey test aims to test whether something is a security or not. It consists of four prongs, which must all be satisfied for a product to be considered a security:
1. There is an investment of money
Many courts have also moved to a broader ‘investment of wealth’ instead
2. The investment is made into a “common enterprise”
Broadly, this means that either the investor’s fortune (investment) is linked to the efficacy of the efforts and successes of the company seeking the investment.
3. The investors expect to make a profit
This portion of the test considers the investor’s intent for purchasing an asset. They could either be trying to profit, or they could be trying to store their wealth. If they are simply trying to store their wealth, the asset would likely be defined as a currency
4. Any expected profits are due to the actions of a third party or promoter
This portion separates the investor from the third party. “If the investor has a significant hand in the success of an investment, it’s most likely not an investment.”
There are three main types of securities: equity - which provides ownership rights, debt – which is typically a loan repaid with periodic payments; and hybrids – an instrument that combines some aspects of both debt and equity. Any public sale of securities is regulated by the SEC. According to the Howey Test, Cryptocurrencies do not qualify as a security. It’s important that in the future, investors should consider whether the instrument they are investing in has proper protections and is understandable. Hopefully, investors will be more cautious in the future.
Written by Jacob Patterson
Date: Tuesday, November 29th, 2022
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