SMART CONTRACTS, DEFI & WEB3 SECURITY - Chapter 9, Exercise 2 Solution ========================================================== Applying the Howey Test to a Hypothetical Token PROBLEM ------- Apply the real, four-part Howey Test to a hypothetical new token sold with the pitch "buy this token now, and our development team will build products that make it valuable later." Explain which of the four prongs this pitch appears to satisfy, and why. SOLUTION -------- The Howey Test asks whether there is (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profit, (4) derived primarily from the efforts of others. Each prong needs to be checked against the specific pitch given. INVESTMENT OF MONEY: satisfied. A purchaser is buying the token with real money (or another asset of value), which is exactly what this prong requires. COMMON ENTERPRISE: appears satisfied. Every buyer's own outcome is tied to the same underlying development team and the same set of future products - buyers are not independently pursuing separate, unrelated ventures, but are pooled together in dependence on the same team's own success. EXPECTATION OF PROFIT: satisfied directly by the pitch's own wording. "Make it valuable later" is explicitly an expectation that the token's worth will increase over time - precisely the kind of profit expectation this prong is checking for. PROFIT DERIVED FROM THE EFFORTS OF OTHERS: satisfied, and this is the most clearly implicated prong given the specific pitch. The stated reason to expect profit is not anything the buyer will do themselves - it is "our development team will build products," meaning any future value is explicitly attributed to the team's own labor, not the purchaser's. WHY THIS MATTERS Because the pitch as given appears to satisfy all four real prongs, a token sold this way would be a strong real candidate for classification as an investment contract, and therefore a regulated security, under the actual 1946 legal test still used today. This does not mean a court would necessarily reach that exact conclusion, since real cases often involve additional facts and nuance - but the pitch as stated maps onto all four prongs about as cleanly as a hypothetical example reasonably can. ANSWER: The pitch appears to satisfy all four Howey Test prongs - money is invested, buyers are pooled together in dependence on the same team (common enterprise), the pitch explicitly promises the token will "make it valuable later" (expectation of profit), and that expected profit is explicitly attributed to the development team's own future work rather than anything the buyer does ("efforts of others"). A token marketed this way would be a strong real candidate for classification as a security under this test. ---- WHY THIS WORKS AS AN ANSWER It checks the hypothetical pitch against each of the four real prongs individually rather than reaching a conclusion without justification, and correctly identifies that the pitch's own specific wording ("our development team will build") is what most directly satisfies the fourth, often-decisive prong.