“Hashlets, Hasktakers and Hashpoints” – The Weird Quantum World of Cryptocurrency Answers Howey’s Test


It has been a difficult year for the cryptocurrency industry. The Federal Trade Commission reported that cryptocurrency scammers have stolen more than $1 billion from 46,000 people since the start of 2021. In February 2022, the Department of Justice announced the arrest of a team husband and wife who allegedly stole approximately $4.5 billion in Bitcoin. And the industry has seen the crash of popular stablecoins, whose value is usually tied to underlying currencies, and therefore considered a relatively safe way to trade digital assets in the crypto-economy. Although the industry has launched a variety of legal claims in recent years that are litigated in many forums in the United States and elsewhere, the most commonly litigated claims remain federal securities fraud claims. , often as part of a class action. A recent class action case in the Connecticut Federal District Court shows how complicated the questions can be of whether and how cryptocurrencies and related crypto products are “securities” for the purposes of securities fraud claims. movables.

A short primer on when financial products are considered securities for the purposes of securities fraud claims is necessary. In order for the Securities Exchange Commission (SEC) or individuals to sustain claims of securities fraud under the Securities Act of 1933 (“the Act”), the financial transaction must qualify as “security” under the Howey Test, first formulated by the United States Supreme Court in a 1946 securities case called SEC vs. WJ Howey Co. 328 U.S.C. 293 (1946) joint venture and is bound to expect benefits solely from the efforts of the promoter or a third party”. 328 U.S.C. 293, 298-99. In deciding that a sale-leaseback agreement was an investment contract subject to registration requirements under the Act, the Howey the court held that a transaction is an investment contract subject to federal securities regulations if 1) the transaction involves a monetary investment; 2) there is an expected profit associated with the investment; and 3) the silver investment is a joint venture and the profit from the transaction comes from the efforts of a third party or the efforts of the promoter. Cherepnin c. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967) (summarizing the Howey The factors).

The SEC thus far has a short but generally successful history of court-imposed regulation of cryptocurrencies under federal securities laws. Prior to an SEC lawsuit against KIK Interactive, Inc., as the issuer of a cryptocurrency called “Kin,” few courts had squarely addressed the question of whether cryptocurrencies met the definition. investment contract under the Howey Test. On July 25, 2017, after Kik announced its intention to issue Kin but before its distribution, the SEC released its Investigative Report under Section 21(a) of the Securities Exchange Act of 1934: The DAO (the “DAO Report”). Press Release No. 81207, 117 SEC Docket 745, 2017 WL 7184670 (July 25, 2017); see also Former SEC. 88, ECF No. 60-100. In the DAO report, the SEC described its investigation into the sale of tokens by a German company to investors. The SEC has determined that the tokens are securities, but no enforcement proceedings have been initiated. 2017 WL 7184670, at *1, 8-12. The SEC “advises[d] those who would use … a distributed ledger or blockchain-enabled means to raise capital, to take appropriate steps to ensure compliance with U.S. federal securities laws.

In 2019, the SEC filed enforcement proceedings against Kik. After counter-motions for summary judgment, the trial court of Kik ruled that cryptocurrency tokens are “securities” under the Howey test, thereby triggering federal securities registration requirements. SEC v Kik Interactive Inc., 492 F. Supp. 3d 169 (SDNY 2020). The Kik The tribunal began its analysis by noting that in determining whether an investment contract could be a form of security, the form should be “disregarded for substance and the focus should be on the economic reality of the investment plan”. . Identifier. at 177. The Kik The court concluded that the sale of “Kin” satisfied the three factors of the Howey test. First, the Court concluded that the crypto tokens constituted an investment of money by the buyers of the tokens. The Court further concluded that a joint venture existed because there was a “horizontal community” between the investors – that is, the fortunes of each individual investor were linked to the fortunes of the other investors by the pooling of investment assets. Central to this finding was the Court’s observation that “Kin tokens are intended to be used for all transactions within a Kin ecosystem comprised of digital services that participate in the right and opportunity to innovate and compete for compensation in the form of Kin tokens”. Identifier. at 179. As to the third factor under Howey, the court found that the company’s issuance of the crypto tokens came with a reasonable expectation of profit from the management or business efforts of others. On this last point, the Kik The court pointed to the company’s marketing and promotional efforts that value would increase as demand increases due to the limited supply of the cryptocurrency.

Kik then settled the SEC case, preventing the court’s decision from being appealed. Nevertheless, the Kik The decision was seen as a blow to the crypto industry as it appeared to ensure that absent legislative action, cryptocurrencies would forever be subject to both SEC enforcement actions and potentially securities fraud claims, including class action lawsuits. Indeed, the courts after Kik came to the same conclusion that cryptocurrency schemes should be considered investment contracts for the purposes of federal securities law. See, for example, Securities and Exchange Commission v. NAC Foundation, LLC, 512 F. Supp. 3d 988, (ND Cal. 2021); Securities and Exchange Commission c. Ripple Labs, Inc. 2022 WL 748150 (SDNY). Perhaps unsurprisingly, SEC enforcement action increased after Kik. According to Cornerstone Research, in 2021 alone, the SEC filed a total of 20 lawsuits against cryptocurrency companies, with 80% of those lawsuits alleging that the defendants engaged in the sale of unregistered securities.

A recent class action lawsuit involving cryptocurrency in the United States District Court for the District of Connecticut, Audet et al. against Fraser 2022 WL 1912866, however, shows how a Howey analysis can be when the crypto industry creates new products from the currencies themselves. Applicants in Audet alleged fraud and securities-related claims under the Uniform Securities Law of Connecticut (“the Connecticut Law”) regarding four cryptocurrency coins or products – “Hashlets”, “Paycoin”, “Hashstakers” and “Hashpoints”. At trial, the court reserved its decision on the defendant’s motion for judgment, which included arguments that the cryptocurrencies were not securities subject to Connecticut law because the products did not comply with the Connecticut version. from Howey test. The case went to a jury, which returned a defense verdict on all counts. The jury specifically found that none of the crypto products at issue were securities under Howey. The plaintiffs filed post-trial motions, which in part requested a new jury trial. Howey analysis. The opinion of the court of first instance, which has just been delivered on June 3, 2022, is indicative of the complexity of a Howey analysis can be in the crypto world.

The Audet The trial court reviewed the evidence before the jury regarding the nature and purpose of each of the four products. According to conflicting testimony at trial, the hashlets were either a computer used for cryptocurrency mining, including Bitcoin, or a percentage of the mining power of the defendant’s crypto mining ‘farm’ . WL1912866*3. Hashlet buyers have either purchased a specific share of the mining energy at the farm or they have purchased a share of the profits generated from the mining activities. Identifier.Each Hashlet owner had the power to select different mining “pools”, and different payouts on Hashlet shares could be obtained based on the value of the different pools. WL1912866*4. Based on this evidence, the trial court found that a reasonable jury could have concluded that there was no horizontal commonality because Hashlet owners could make profits or suffer losses regardless of wealth. from other buyers. WL1912866*13. The court further concluded that a finding of no vertical commonalities did not undermine the weight of the evidence, as there was no evidence that the defendant had directly benefited from the exploration of data itself, and that the defendant earned fees only through the sale of Hashlets.

The lower court came to a different conclusion regarding Paycoin. According to the evidence presented at trial, Paycoin was a new cryptocurrency launched by the defendant and promoted and offered to investors as an investment program. The trial found that the weight of evidence did not support a jury finding that Paycoin was not an investment contract under the Howey The factors. At the heart of this finding was evidence that Paycoin was to be used within a crypto “ecosystem” created by the defendant in which coins could be exchanged and used to make purchases. WL1912866*15. This ecosystem linked the fortunes of Paycoin buyers to each other as the value of coins rose or fell within the ecosystem.

With respect to Hashpoints – which were described at trial as a form of “internal credit” that could be exchanged for Paycoin, and Hashstakers – which was a specialized electronic wallet in which Paycoins could be housed – the trial court found noted that the jury heard “very little evidence” about these products, and concluded that the mere fact that each could be used for the acquisition or holding of Paycoin was not sufficient to render these products investment contracts. under Howrey. WL1912866*18.

Although some states have enacted regulations for the sale and trade of cryptocurrency, there is no uniform set of federal regulations specifically dealing with this rapidly changing industry. While the decision of the court of first instance in Audet regarding Paycoin product squares with federal rulings in Kik and elsewhere, the complicated set of proceeds and facts described at trial in Audet suggest that the crypto industry may develop products and services that fall outside the judicial enforcement of current industry securities regulations.


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