Howey's Cryptonite: A Deep Dive on Digital Asset Classification
Introduction
On 17 March 2026, the US Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission issued a joint interpretive release establishing a securities taxonomy for crypto-assets the (Taxonomy).1 The Taxonomy is the most significant step yet in fulfilling SEC Chair Paul Atkins’ promise to establish a clear securities law framework as applied to crypto and digital assets. The Taxonomy now serves to help market participants to discern what characteristics the SEC would attribute to a crypto-asset to consider it a security.
Since the widespread adoption of digital assets more than a decade ago, questions have often arisen as to whether certain tokens, cryptocurrencies, non-fungible tokens (NFTs), and other innovative blockchain-based assets are securities. With the exception of Bitcoin (and ambiguously Ether), the SEC has steadfastly refused to answer the question, “Is this token a security?” Instead, it has often been accused of using a strategy of ad hoc “regulation by enforcement” of crypto-assets or suggesting that token issuers “come on in and register.”
The Taxonomy flips the script and seeks to offer the crypto industry clarity. First, the Taxonomy classifies crypto-assets into five categories and analyzes each category under the Howey test.2 Most notably, it “names names” and unambiguously identifies a dozen crypto-assets, including Solana, Bitcoin, Ether, and Cardano, as “digital commodities” rather than “securities.” Second, the Taxonomy provides some guidance regarding when a crypto-asset is a “security” because it takes the form of an “investment contract” and, critically, how it can lose that status. Third, the Taxonomy provides guidance with respect to certain crypto transactions, such as airdrops, protocol mining, protocol staking, and “wrapping” a nonsecurity crypto-asset in a crypto-asset.
History
The first crypto-asset, Bitcoin, was created in 2009 and introduced the concept of a decentralized, blockchain-based alternative to traditional financial systems. These assets immediately raised questions because they challenged and crossed the boundaries of traditional definitions found in the securities laws: they had features, characteristics, and iterations that fit the definitions of “security,” “commodity,” and even “currency,” sometimes all at the same time. A crypto-asset’s classification carried significant implications for which regulatory regime applied to its issuance and trading.
The SEC first addressed crypto-assets in The DAO Report, in which it applied the Howey test to offers and sales of crypto-assets by an unincorporated virtual organization known as (The DAO). The Howey test is used to determine whether an asset constitutes an “investment contract” and therefore a “security” under the federal securities laws.3 Under the Howey test, an “investment contract” is a transaction that involves (i) an investment of money (or other value), (ii) a common enterprise, and (iii) with a reasonable expectation of profits derived from the managerial efforts of others.4
In The DAO Report, the SEC outlined its determination that the offers and sales of crypto-assets by The DAO constituted investment contracts and, therefore, securities under the federal securities laws.5 Specifically, the SEC noted that The DAO was a common enterprise in which people invested money with a reasonable expectation of profits from the efforts of the creators of The DAO.6 The DAO Report set the stage for the SEC’s analysis of future crypto-assets under the federal securities laws.
In the years that followed, the SEC brought enforcement cases involving a variety of crypto-assets being allegedly offered as unregistered securities. Sometimes, in cases where dealers were accused of dealing dozens of crypto-assets, the SEC would not identify which specific crypto-assets it claimed were securities.7 Sometimes, the SEC’s analysis of why a crypto-asset is a security was ambiguous.8 In critical responses to such orders, SEC Commissioners Hester Peirce, Elad Roisman, and Mark Uyeda argued that applying specific “clues” from some enforcement actions did not yield clear answers in others,9 and echoed industry participants’ calls for clarity in discerning which crypto-assets are securities.10
The SEC’s approach left crypto-assets in a regulatory morass. Crypto-industry participants were encouraged to register with the SEC as intermediaries dealing in securities and to register crypto-assets as securities;11 however, the framework of federal securities regulation was not designed for decentralized entities such as those involved in dealing in crypto-asset activities.12 For example, the federal securities laws assume that a securities issuer is a discrete entity, whereas many crypto-assets are associated with open-source protocols featuring diffuse governance structures, raising questions about who would be required to register as the issuer.
The SEC’s New Guidance
The new Taxonomy signals a retreat from the SEC’s ambiguous “regulation-by-enforcement” approach and seeks to provide greater clarity for participants in crypto-asset markets.
Crypto-Asset Classifications, Defined
The most significant change introduced by the Taxonomy is the SEC’s specific classification of crypto-assets. Recognizing that crypto-assets can be used to represent securities, goods, services, rights, or other interests in a digital format, the SEC has classified crypto-assets into five categories based on their characteristics, uses, and functions: (i) digital commodities; (ii) digital collectibles; (iii) digital tools; (iv) stablecoins; and (v) digital securities.13
Digital Commodities
A digital commodity is a crypto-asset that derives its value from (i) the programmatic operation of a “functional” crypto-system and (ii) supply-and-demand dynamics, rather than from a reasonable expectation of profits from the essential managerial efforts of others, as is required under the Howey test.14 A digital commodity lacks economic properties or rights and does not generate a passive yield or convey rights to future income, profits, or assets.15
As explained in the Taxonomy, digital commodities are not securities because their value is linked to the programmatic functioning of the associated functional crypto system, rather than another party’s essential managerial efforts.16
The value of a digital commodity, like that of a physical commodity, derives from the value of the goods and services produced using the commodity, as well as supply-and-demand dynamics.17 Users of a digital commodity are encouraged to participate in its functional crypto system, and developers are incentivized to build applications for functional crypto systems that attract users.18 Because a functional crypto system does not have a central party that oversees participation or distributes rewards, the value of a digital commodity is linked to the programmatic functioning of a crypto system. Accordingly, a purchaser of a digital commodity would not reasonably expect to profit based on the essential managerial efforts of others, and a digital commodity therefore cannot pass the Howey test.19
The Taxonomy specifies that the following crypto-assets are digital commodities: Aptos (APT), Avalanche (AVAX), Bitcoin (BTC), Bitcoin Cash (BCH), Cardano (ADA), Chainlink (LINK), Dogecoin (DOGE), Ether (ETH), Hedera (HBAR), Litecoin (LTC), Polkadot (DOT), Shiba Inu (SHIB), Solana (SOL), Stellar (XLM), Tezos (XTZ), and XRP (XRP).20 However, this is not an exclusive list, and it is expected that many other crypto-assets would also be digital commodities.
Digital Collectibles
Digital collectibles, such as NFTs and meme coins, are digital assets designed to be collected.21 They typically represent or convey rights to art, trading cards, in-game items, or digital representations or references to internet memes.22 Digital collectibles generally have limited or no functionality and do not provide holders with legal rights or an ownership interest in any business or entity associated with the creator of the digital enterprise.23
EtherRock provides a useful example. EtherRock is a collection of 100 NFTs that serve no functional purpose and are commonly described as “Pet Rocks on the Blockchain.”24 Nevertheless, one of these digital collectibles sold for approximately US$1.3 million in 2021.25
The Taxonomy, however, notes that a crypto-asset may begin as a digital collectible—such as a meme coin—with no functionality within an associated functional crypto system, and later become a digital commodity, if it becomes functional within that system.26 Although a digital collectible may have artistic value or utility, it is not an investment; its value is based on the supply and demand of the digital collectible, rather than on an expectation of profits derived from the essential managerial efforts of its creator.27
A though a digital collectible is not itself a security, the offer and sale of a digital collectible—if fractionalized or otherwise structured to involve reliance on essential managerial efforts from which a purchaser would reasonably expect to derive profits—can give rise to an investment contract.28
Digital Tools
A digital tool is a crypto-asset that performs a practical function in a crypto system.29 For example, digital tools can take the form of a membership, ticket, or identity badge.30 A digital tool derives its value from its practical function, and users acquire it for its utility.31 A digital tool does not confer rights or interests in a business enterprise; instead its price is determined by supply-and-demand dynamics associated with its, rather than by an expectation of profits derived from the managerial efforts of its developer.32
Digital tools may be paired with digital commodities in a single digital asset.33 For example, the “Bored Ape Yacht Club” (Bored Ape) consists of a series of 10,000 NFTs that entitle holders not only to ownership of a digital image—as would be typical of a digital collectible—but also to access to exclusive Bored Ape gatherings, merchandise, and online forums.34 At their peak. Bored Apes sold for hundreds of thousands of dollars, reflecting the value placed on membership in this exclusive club.35
Similarly, CoinDesk, Inc.’s (CoinDesk) “Microcosm” (Microcosm) is a digital asset that provides holders access to CoinDesk’s “Consensus” conference (Consensus) for three years, in addition to ownership of one of 1,000 unique works of digital art.36
The activities of the maker of a digital tool may affect the value of the digital tool, but the maker typically does not make representations or promises that would cause a purchaser to reasonably expect to derive profits from the digital tool.37 The founders of the Bored Ape, Yuga Labs LLC (Yuga Labs), granted buyers full ownership of their Bored Apes, allowing holders to license, market, or otherwise sell their Bored Apes however they saw fit.38 The value of a Bored Ape was not attributable to Yuga Labs’ managerial efforts, but rather the desire to participate in an exclusive club.39 Similarly, the value of a Microcosm is based on the desire to access the Consensus conference, not the ongoing managerial efforts of CoinDesk in operating the digital asset.40 Accordingly, a digital tool would not constitute a security under the Howey test.
Stablecoins
A stablecoin is a crypto-asset that is designed to maintain a stable value relative to a reference asset, such as the US dollar. The Taxonomy notes that, under the Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act), enacted in 2025, “payment stablecoins” issued by a permitted payment stablecoin issuer are statutorily excluded from the definition of a “security”.
However, the Taxonomy notes that, because the GENIUS Act is not yet effective, its interpretation of whether a stablecoin constitutes a “security” is based on the SEC’s Staff Statement on Stablecoins.41 Under that statement “covered stablecoins”—that is, crypto-assets “designed and marketed for use as a means of making payments, transmitting money, or storing value,”42—would not be considered securities.
The Taxonomy did not specifically address stablecoins other than “covered stablecoins,” such as algorithmic stablecoins, leaving a potential source of ambiguity going forward.
Digital Securities
A digital security (or “tokenized” security) is a financial instrument enumerated in the definition of a “security” that is formatted or represented as a crypto-asset and where the record of ownership is maintained, in whole or in part, on or through one or more crypto networks.43 The Taxonomy is clear: “A security is a security regardless of whether it is issued, or otherwise represented, off-chain or on-chain. All devices and instruments that have the economic characteristics of a security are securities regardless of format or label.”44
This guidance closely follows a recent statement issued by SEC staff regarding tokenized securities.45 In that statement, the staff explained that a single class of securities may be issued in multiple formats, including as a token on an issuer’s distributed ledger technology, and neither the format in which a security is issued nor the method by which ownership interests are recorded affect the application of the federal securities laws.46 Likewise, if a tokenized security represents a class of securities that is also offered in a traditional format and has substantially similar characteristics—conferring comparable rights and privileges—it may be considered the same class of security as the traditionally issued security.
Digital securities may include additional nonfinancial benefits that appear resemble those of a digital commodity, digital collectible, or digital tool. The provision of such nonfinancial benefits, however, does not remove a digital security from the definition of a “security.”47
Getting Specific: Applying the Howey Analysis to Crypto-Assets
When an Investment Contract Analysis Applies
The Taxonomy not only marks a significant shift in the SEC’s stance on digital assets, but also gives a modern flavor to jurisprudence that is over eight decades old.48 When Congress enacted the Securities Act to define the term security, it “enacted a definition of ‘security’ sufficiently broad to encompass virtually any instrument that might be sold as an investment.”49 Accordingly, in addition to conventional financial instruments such as notes, stocks, bonds, debentures—as well as instruments not traditionally viewed as securities, such as fractional undivided interests in oil, gas, or other mineral rights—Congress included the term “investment contract” to capture novel, uncommon, or irregular devices that are widely offered or dealt in under terms establishing “their character as investment contracts or as any interest or instrument commonly known as a security.”50
Against this backdrop, that the Supreme Court (Court) articulated the criteria for an investment contract in the seminal case of SEC v. W.J. Howey Co.51 The Court defined an investment contract as involving three elements: (i) an investment of money (or other value); (ii) in a common enterprise; and (iii) with a reasonable expectation of profits derived from the managerial efforts of others.52
A crypto-asset that meets the definition of “investment contract” under the Howey test would be considered a “security.” The Taxonomy specifies how the elements of the Howey test apply in determining whether an investment contract is offered or sold in connection with crypto-assets.53 While these elements historically have been applied to crypto-assets with limited specificity,54 the Taxonomy seeks to provide a more defined framework for analyzing whether an investor can reasonably expect to realize profits derived from the managerial efforts of a digital asset’s issuer.55 In particular, the Taxonomy states that a purchaser’s reasonable expectation of profits is contingent on the issuer’s representations or promises to engage in such essential managerial efforts.56 Although the Taxonomy recognizes that the reasonableness of a purchaser’s expectation of profits depends on facts and circumstances, it specifies that relevant factors include the timing and manner in which the representations or promises are made.57
Timing
The Taxonomy states that expectation-creating promises must be conveyed to a purchaser prior to, or contemporaneously with, the issuer’s offer or sale. Importantly, post-sale representations or promises will not retroactively convert a prior sale into an offer or sale of an investment contract because such post-sale statements cannot form the basis of a purchaser’s expectations at the time of purchase.58
Manner of Speaking
With respect to the manner in which representations or promises are made, the Taxonomy states that it is reasonable for a purchaser to expect profits based on representations or promises conveyed to purchasers in written or oral agreements. In addition, public communications through which the issuer has established a regular pattern of communicating—such as the issuer’s website or social media accounts—direct private communications between the issuer and purchasers, and regulatory filings or other documents, such as a whitepaper, would be clearly attributable to the issuer.59 Other channels of communication may also suffice to support the reasonableness of a purchaser’s expectations of profits; however, that determination depends on whether the representations or promises are widely disseminated, the specific means by which they are conveyed, and the issuer’s established communication practices.
Types of Representations
The Taxonomy also provides criteria and examples of representations or promises that are likely to create reasonable expectations of profit. The primary criteria noted in the Taxonomy are representations or promises that:
- Are explicit and unambiguous with respect to the essential managerial efforts to be undertaken by the issuer;
- Contain sufficient details to demonstrate the issuer’s ability to implement the proposed project; and
- Explain how the issuer’s efforts are expected to produce the profits that purchasers reasonably anticipate.60
Examples of representations or promises that are likely to create reasonable expectations of profit include a business plan containing detailed milestones, timelines, information about personnel, sources of funding and other resources needed to meet such milestones, as well as an explanation of how holders of the crypto-asset are expected to profit from efforts of the crypto network.61 The Taxonomy distinguishes these representations from those that are vague or contain “no semblance of an actionable business plan,” that such representations would not give rise to a reasonable expectation of profits.62 Moreover, the Taxonomy explains that it would not be reasonable for a purchaser to expect profits based on representations or promises made by third parties, or based on secondary-market transactions in which a purchaser would not reasonably expect to profit from the issuer’s managerial efforts.63
Loss of Investment Contract Status
The Taxonomy also reinforces and clarifies that an asset’s status as an investment contract is not always permanent. This guidance may have significant ramifications beyond the digital-asset context, as it is not limited to digital assets, and reflects the reasoning adopted by lower courts decisions in SEC v. Ripple Labs, Inc. and SEC v. Binance Holdings Limited.64
In the Ripple opinion, Judge Analisa Torres held that even if a virtual currency was originally offered and sold by a crypto enterprise as part of a securities transaction, it does not necessarily remain a security in downstream transactions.65 Judge Torres therefore concluded that Ripple Labs, Inc.’s (Ripple) native crypto-token XRP, when sold to purchasers on exchanges through “bid/ask” transactions—among other factors—did not constitute the offer and sale of investment contracts. Unlike institutional purchasers, buyers who acquired XRP on an exchange did not purchase the token directly from Ripple pursuant to a contract.66 Similarly, in the Binance litigation, Judge Amy Berman Jackson applied comparable reasoning, holding that secondary-market sales of the token BNB did not constitute the offer and sale of a security.67
Accordingly, the Taxonomy explains that a nonsecurity crypto-asset offered and sold subject pursuant to an investment contract does not necessarily remain subject to that investment contract in perpetuity.68 Once a purchaser can no longer reasonably expect the issuer to engage in essential managerial efforts originally represented or promised, the nonsecurity crypto-asset is no longer subject to an investment contract.69 The Taxonomy refers to this process as a “decoupling,” which occurs when one or more of the following nonexclusive indicia indicating a separation of a nonsecurity crypto-asset from an investment contract is present:
Fulfillment of the Issuer’s Representations or Promises
If, the issuer has fulfilled its representations or promises to engage in essential managerial efforts, the investment contract may be considered “complete” and therefore no longer applicable to the asset.70 This remains true even if the issuer continues to provide efforts that are not essential managerial efforts with respect to the nonsecurity crypto-asset or an associated crypto system or other software project.71
Failure to Satisfy the Issuer’s Representations or Promise
If a purchaser would no longer reasonably expect the issuer to be able to fulfill—or to continue engaging in—the essential managerial efforts it previously represented or promised to undertake, the investment contract may likewise cease to apply.72 This may occur where a sufficiently long period of time has passed since the issuer’s offer and sale of the investment contract and it has become clear to the investors that the issuer failed to perform the promised managerial efforts, or it has become clear to investors that the issuer failed to perform the promised essential managerial efforts, or where the issuer has publicly announced that it will no longer perform those efforts.73 Such abandonment demonstrates that the investment contract is functionally void, although it may raise separate questions regarding whether purchasers have other legal remedies available to enforce, or seek recovery under, the no-longer operative investment contract.
Defining Mining, Staking, Wrapping, and Airdrops
While the classification of assets and investment contract status issues discussed above represent the most significant aspects of the Taxonomy, it also discusses a variety of other digital-asset issues. Many of these topics have been addressed in prior staff statements, however the Taxonomy both expands on those discussions and elevates the guidance from the staff level to Commission-level guidance. In particular, the Taxonomy provides guidance on how activities frequently undertaken by crypto networks will be analyzed under the Howey test, including “mining,” “staking,” and “wrapping.” In addition, the Taxonomy provides insight into the SEC’s views on crypto platforms’ use of “airdrops” to disseminate tokens.
Mining
“Mining” is the process used by certain crypto networks and platforms to generate new coins and validate new transactions.74 “Miners” facilitate transaction validation in a cryptographic network by operating a crypto protocol’s “consensus mechanism”—that is, a method that enables a distributed network of unrelated computers called “nodes,” to reach agreement.75 These nodes maintain a peer-to-peer network to agrees on the authoritative record of account balances, transactions, smart contracts, and other network data (collectively referred to as the network’s “state”).76 Proof-of-work (PoW) is a type of consensus mechanism that rewards miners for operating network nodes and contributing computational resources to the PoW network.77
Typical mining arrangements involve self (or solo) mining and mining pools.78 Self-mining involves mining digital commodities using the miner’s own computational resources.79 The miner may work along or together with others to operate a node and mine digital commodities.80 A mining pool involves mines combining their computational resources with other miners to increase their chances of successfully validating transactions and mining new blocks on the PoW network.81
Prior to the release of the Taxonomy, the SEC’s Division of Corporation Finance staff issued a statement in 2025 explaining that activities like self-mining and mining pools do not involve the offer and sale of securities.82 The staff reasoned that mining is not undertaken with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.83 Instead, a miner contributes its own computational resources and thus engages in an administrative or ministerial activity.84
The Taxonomy mirrored the staff’s statement by only addressing self-mining and mining pools and positing that these specific mining activities are not considered the offer and sale of a security within the meaning of section 2(a)(1) of the Securities Act and section 3(a)(10) of the Exchange Act.85 This is because mining is not undertaken with a reasonable expectation of profits derived from the managerial efforts of others.86 Rather, a miner contributes its own computational resources to secure the PoW network and enable the miner to earn rewards issued by the PoW network in accordance with its software protocol.87 Simply put, a miner engages in an administrative or managerial activity to secure the PoW network, validate transactions by adding new blocks, and receive rewards.88 Thus, a miner’s expectation to receive rewards is not derived from any third-party’s essential managerial efforts.89 Similarly, a mining pool has no expectation of profits because a mining pool also engages in the same administrative or ministerial activities as self-mining actors.90
Staking
Overview of Staking and the SEC Staff’s Initial Stance on Staking
Proof of stake (PoS) is a consensus mechanism used to prove that Node Operators participating in a PoS Network have contributed to the PoS Network.91 Node Operators must stake the PoS Network’s digital asset to be selected by the PoS Network’s software protocol to validate new blocks of data to the PoS Network.92 This effectively updates the state of the network, in that the Node Operator checks and confirms transactions effected on the crypto-network.93 Therefore, when a Node Operator is selected by the network, it serves as a “Validator.”94 Validators earn rewards in exchange for providing validation services.95 These rewards are usually either generated digital assets distributed to the Validator by the PoS Network in accordance with its software protocol, or a percentage of the transaction fees paid in digital assets by parties seeking to add their transactions to the PoS Network.96 Node Operators must commit or “stake” digital assets to be eligible to validate and earn rewards.97 While staked, the digital assets are locked up and cannot be transferred.98 This therefore provides an incentive for participants to use their digital assets to secure the PoS Network.99
There are four main types of staking:100
- Self (or Solo) Staking: When self-staking, the digital asset owner maintains ownership and control of its digital assets and cryptographic private “keys” to unlock the staked assets if the owner so chooses.101
- Self-Custodial Staking With a Third Party: In this staking method, owners grant their validation rights to a third-party Node Operator. While the owner retains ownership and control of the staked digital assets, the owner and Node Operator split a portion of the rewards for the validating services.102
- Custodial Staking: A third party or “Custodian” takes custody of an owner’s digital assets and facilitates staking them on behalf of the owner.103 To effectuate this, the owner deposits the assets in a cryptographic wallet controlled by the Custodian.104 Although the Custodian may seem akin to a type of bank, the Custodian is not permitted to use the assets for operational or general business purposes. The Custodian also may not lend, pledge, or rehypothecate the assets for any reason, and the assets are held in a manner designed to not subject them to claims by third parties.105 Moreover, the Custodian also may not use the assets to engage in leverage, trading, speculation, or discretionary activities.106
- Liquid Staking: In this arrangement, depositors receive newly generated crypto-assets (or “staking receipt tokens”) evidencing the depositors’ ownership of the deposited digital assets.107 The staking receipt tokens are issued to depositors on a 1:1 basis to the amount of the deposited digital assets. This arrangement therefore allows holders to maintain liquidity without being obliged to withdraw deposited digital assets from staking. Depositors can redeem the staking receipt tokens for the deposited digital assets and any rewards that accrue during the period that the commodities were deposited.108 It is possible to participate in liquid staking using a third-party service provider or (Liquid Staking Provider), in which the Liquid Staking Provider holds the deposited digital commodities either in a cryptographic wallet controlled by the Liquid Staking Provider, or in a smart contract. The Liquid Staking Provider stakes the deposited digital assets on behalf of the depositor for an agreed-upon fee that reduces the amount of rewards that would otherwise accrue to the deposited assets.109
In 2025, the SEC’s Division of Corporation Finance staff released two statements addressing protocol staking and liquid staking respectively.110 The staff’s statements were clear that protocol staking and liquid staking do not involve the offer and sale of a security because they are administrative or ministerial activities and therefore do not meet the Howey standard of the managerial and entrepreneurial efforts of others.111
Protocol Staking Activities Covered by the Taxonomy
The Taxonomy differs from the staff’s statements on staking activities in that while the Taxonomy makes clear that protocol staking activities do not involve the offer and sale of a security under the Securities Act or the Exchange Act, this classification is only in relation to digital commodities.112 Accordingly, participants in protocol staking activities in connection with digital commodities are neither required to register such transactions with the SEC, nor fall within an exemption from registration.113 Generally, this is because a digital commodity does not constitute any of the financial instruments enumerated in the definition of a security.114 As such, the Taxonomy considers staking services to be administrative or ministerial to a crypto-network because the staking services are validating activities, which improve the operative and security capabilities of the network.115 Therefore, such activities do not suggest a reasonable expectation of profits to be derived from the essential managerial efforts of others under Howey.116
The Taxonomy is, however, less straightforward with regard to custodial arrangements. While the Taxonomy states that a custodian does not provide essential managerial efforts to depositors for whom custodians provide custodial services, the Taxonomy does note that a custodian acts as an agent in connection with staking the deposited digital commodities on behalf of the depositor.117 This is because the depositor decides whether, when, and how much of the depositor’s digital commodities to stake.118 While the Taxonomy states that such an arrangement does not constitute essential managerial efforts, the Taxonomy notes that a custodian who does select whether, when, or how much of a depositor’s digital commodities to stake is outside the scope of the Taxonomy.119 Therefore, it could be inferred that an arrangement in which the custodian has a more active role may be considered managerial efforts of others in the context of an investment contract analysis.
Additionally, the Taxonomy clarifies that a staking receipt token that is a receipt for a nonsecurity crypto-asset not subject to an investment contract does not fall within the definition of a security, because it does not have the economic characteristics of a security.120 This is because the staking receipt token evidences the deposited digital commodity held with the staking provider to which the depositor is the owner.121 Furthermore, a staking receipt token is not offered and sold subject to an investment contract because the parties involved in the process of generating, issuing, and redeeming the receipt token do not provide essential managerial efforts to holders of the receipt token, and any economic benefits realized by the holders of the receipt token are not derived from any such efforts.122 In other words, the receipt token is not a security because the receipt token’s value is derived from the value of the deposited digital commodity and not from the managerial efforts of the staking provider or any other third party.123 Nonetheless, the Taxonomy stresses that a staking receipt token for a digital security or nonsecurity crypto-asset subject to an investment contract is a security.124
Wrapping
“Wrapping” crypto-assets is a process in which a crypto-asset is deposited with a custodian or a cross-chain bridge (a self-executing code that programmatically generates and redeems wrapped tokens without the use of a custodian),125 and in return, the custodian or cross-chain bridge (in this capacity, both act as a “wrapped token provider”) generates an equivalent amount of redeemable wrapped tokens on a 1:1 basis.126 A redeemable wrapped token is a crypto-asset issued on a crypto-network representing either a crypto-asset native to a different crypto-network or a crypto-asset based on a different token standard and that is both backed by the deposited crypto-asset and can be redeemed on a 1:1 basis for the deposited crypto-asset.127 In the latter case, the redeemable wrapped token is “burned” (i.e., destroyed) and permanently removed from circulation.128 The wrapped token provider holds the deposited crypto-asset in a manner intended to ensure that there is an equivalent amount of the deposited crypto-asset being held.129 When the token holder wishes to redeem the redeemable wrapped token, the holder sends the tokens back to the wrapped token provider who burns the redeemable wrapped tokens, thereby releasing the equivalent amount of the deposited crypto-asset back to the holder on a 1:1 basis.130
The Taxonomy specifies that the offer or sale of a redeemable wrapped token that is a receipt for a nonsecurity crypto-asset not subject to an investment contract does not involve an offer or sale of a security under the Securities Act or the Exchange Act.131 This is because a redeemable wrapped token evidences the deposited crypto-asset held with the wrapped token provider.132 Furthermore, holders of a redeemable wrapped token are not making an investment in an enterprise because their funds are not pooled together to be deployed by promoters or other third parties, and their fortunes are therefore not tied to the efforts of a promoter.133 Additionally, any economic benefits realized by holders of such redeemable wrapped tokens are not derived from the essential managerial efforts of others because the value of the wrapped token is derived from the value of the deposited crypto-asset, rather than from the efforts of a third party. Therefore, there is no financial incentive derived from the wrapping process because a wrapped token is redeemable for the deposited crypto-asset on a fixed 1:1 basis without any additional financial incentive or benefit.134 However, an offer or sale of a redeemable wrapped token that is a receipt for a digital security or nonsecurity crypto-asset subject to an investment contract is an offer or sale of a security.135
Airdrops
The Taxonomy provides clarity on the SEC’s stance regarding a dissemination activity known as “airdrops.” An airdrop is a means for crypto-asset issuers to disseminate their crypto-assets in exchange for no or nominal consideration.136 An airdrop occurs when an issuer transfers the crypto-asset to specific cryptographic wallets or other addresses. This method is generally used to generate interest in use of crypto-assets and to expand the use and ownership of crypto-assets. Usually, airdrops are used to reward early or loyal users of a crypto-network. Issuers choose the recipients and all other terms of their airdrops, such as the timing and frequency of the airdrop, or the criteria for which recipients are eligible for an airdrop.
The Taxonomy specifies that it pertains only to airdrops of nonsecurity crypto-assets to recipients who did not provide the issuer with consideration in exchange for the airdropped nonsecurity crypto-asset.137 As such, the Taxonomy states that an airdrop of a nonsecurity crypto-asset does not become subject to an investment contract because an airdrop of a nonsecurity crypto-asset is not an investment of money under Howey.138 An airdrop does not constitute an investment of money under Howey because the recipients do not provide consideration in exchange for the airdropped nonsecurity crypto-asset.139
The Taxonomy also outlines types of scenarios in which it would be interpreted that the airdrop recipient does not provide consideration to the issuer in exchange for the airdropped nonsecurity crypto-asset. These scenarios include: (i) when an issuer airdrops a nonsecurity crypto-asset to persons who hold another specified crypto-asset in their digital wallets, and the issuer does not announce the airdrop before the asset is disseminated; (ii) when an issuer creates a new crypto-system and announces and issues an airdrop of nonsecurity crypto-assets to users who volunteered to use a test system of the new crypto-system (unless the issuer announced the airdrop during the testing phase to incentivize engagement); and (iii) when an issuer airdrops a nonsecurity crypto-asset free of charge to users satisfying a certain eligibility criteria based on usage of the application and the issuer does not announce the airdrop before dissemination.140
While the Taxonomy does not consider airdrops of nonsecurity digital assets to be subject to an investment contract, the Taxonomy states that airdrops of digital securities would constitute a “sale” under section 2(a)(3) of the Securities Act or section 3(a)(14) of the Exchange Act.141
Takeaways
While the Taxonomy is a useful step forward in providing clarity on the application of securities laws to crypto-assets, analysis of crypto-assets remains fact-specific. The clarity on specific digital assets as digital commodities and thus outside the securities laws may lead to a focus on these investment products going forward, given their unambiguous status. It may also lead to new digital assets seeking to resemble the essential characteristics of such named tokens to ensure that their status is not questioned. We will also likely see players in the crypto-industry realigning their operations and restructuring any token offerings in a way to avoid registering the tokens as digital securities and tailor their token offerings to offer nonsecurity crypto-assets.142
Chair Atkins recently noted in remarks that the Taxonomy is “a beginning, not an end” and that more action from the SEC is certain to come in the near term.143 To this end, Chair Atkins and Commissioner Peirce have alluded to a forthcoming “Crypto Innovation Exemption” that would allow crypto-firms to pilot onchain trading of tokenized securities and other blockchain-based products under defined limits and without prior SEC registration.144 This innovation exemption is expected imminently, along with other formal rulemaking procedures to follow.145
It is, however, important to note that the Taxonomy is purely guidance from the SEC and is neither statutory law nor binding jurisprudence. Indeed, following the Court’s consequential decision in Loper Bright Enterprises v. Raimondo,146 courts may exercise independent judgment and are no longer obligated to defer to an agency’s interpretation of the law simply because a statute is ambiguous.147 Therefore, a court would likely view the Taxonomy as at most persuasive evidence and perhaps give it Skidmore deference.148 That lesser deference still leaves the court in the position of having the final say, and courts will likely apply the Howey test according to the court’s best interpretation of the statute and precedent. Nonetheless, the Taxonomy is a significant step by the SEC and will help clarify the nebulous regulatory environment in which crypto exists. We expect that the Taxonomy will form the foundation of the assessment of the security status of digital assets unless and until there is further action from Congress or the Courts.
We acknowledge the contributions to this publication from our Washington, DC law clerk Stewart Atkins.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of the law firm's clients.
