Request for No-Action Letter: TNTcoin Classification Under the Howey Test
September 5, 2024
The Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), established the "Howey Test" to determine whether an investment qualifies as a security under the Securities Act of 1933. According to the Court, an investment contract—and thus a security—exists if the following conditions are met:
An investment of money;
In a common enterprise;
With an expectation of profits;
Derived solely from the efforts of others.
Central to this analysis is the phrase "solely from the efforts of others," which distinguishes situations where investors rely on external parties to generate profits from those where they manage the investments themselves, such as renting out a property through Airbnb. This reliance on third-party agents introduces what economists Jensen and Meckling termed "agency costs" in their Theory of the Firm. Agency costs refer to the losses borne by principals (investors and beneficial owners of the firm) when agents, acting on behalf of investors, engage in misconduct or fail to meet their fiduciary duties, such as through mismanagement. These risks justify regulatory frameworks like the SEC’s oversight, aimed at mitigating fraud and maintaining market integrity.
The SEC’s regulatory role is cruical in preventing market failures and promoting economic efficiency by addressing agency risks. These risks arise when external agents—such as management teams or promoters—control investor assets, increasing the potential for unethical practices like insider trading, financial misreporting, or corruption. High-profile cases of fraud, such as the Theranos scandal, illustrate the need for regulatory oversight to investigate and prosecute such misconduct.
Given the U.S. founding fathers’ strong emphasis on protecting the innocent in a jury trial, what entitles the U.S. government to imprison individuals for crimes like insider trading under the same legal doctrine? The answer lies in the harmful effects of unearned wealth extraction by fraudsters, as demonstrated by insider traders who profit from trading on non-public information. This unearned gain, akin to finding $100 on the street, allows the perpetrator to consume goods and services produced by others without contributing to their production. This aligns with the concept of "economic rents" in public choice theory, which have been shown to reduce Pareto efficiency, both theoretically and practically. Since the U.S. Constitution tasks the government with promoting the general welfare, and Pareto efficiency maximizes welfare, insider trading and similar market inefficiencies undermine overall welfare. Consequently, actions such as breaking up monopolies and imposing long-term prison sentences for insider trading are fully justified under existing U.S. law, as outlined by the U.S. Constitution.
However, when profits are not dependent on "the efforts of others," as defined by the Howey Test, the risk of agency-related fraud is eliminated, as no agents are involved. Investments where individuals retain direct control over their assets—such as owning and managing property—do not present the same agency risks as those managed by agents, making SEC regulation unnecessary.
For example, fractional ownership of a building in the form of a condominium is not considered a security because profits (e.g., property appreciation or rental income) are not derived from the efforts of external agents. The owner directly manages the asset, eliminating the need for SEC oversight. In contrast, fractional ownership of the same building through a Real Estate Investment Trust (REIT) is classified as a security because it depends on a management company’s efforts to generate profits, necessitating SEC regulation to protect investors from potential misconduct by agents.
This principle, used to classify all investments under the Howey Test, equally applies to cryptocurrencies like Bitcoin. The classification of a digital asset as a security hinges on the level of reliance on third-party efforts. Cryptocurrencies like Bitcoin and Ethereum are generally considered utility tokens, not securities, because they are designed for transactional use or as platforms for decentralized applications. Their value is derived from their utility within a decentralized network rather than from the efforts of a specific management team or promoter.
Bitcoin’s value stems from its adoption as a decentralized digital currency, independent of the efforts of miners or developers. While contributors like Satoshi Nakamoto and miners support the network’s functionality, their efforts do not satisfy the Howey Test’s requirement that profits be "derived solely from the efforts of others." Bitcoin’s value arises from its use as a currency, similar to commodities like gold, rather than from the actions of a specific entity. This decentralized nature explains why Bitcoin is not classified as a security and why entities like BlackRock can legally offer Bitcoin-backed ETFs, even though the underlying asset is unregistered.
Similarly, TNTcoin operates as a decentralized digital currency and smart contract facilitator, much like Bitcoin and Ethereum. Its value is not dependent on the efforts of a centralized management team but is instead driven by its utility within the blockchain network. TNTcoin’s decentralized structure and utility-driven value align with the classification of Bitcoin and Ethereum as utility tokens. Additionally, TNTcoin offers unique advantages, including enhanced security features, lower operational costs, and faster transaction processing, with significantly less reliance on "the efforts of others" compared to competing platforms. For instance, TNTcoin does not require miners.
TNTcoin’s decentralized nature and independence from any specific entity’s efforts reinforce the argument that it should be classified as a utility token, not a security. The SEC has previously recognized that cryptocurrencies like Bitcoin and Ethereum are not securities due to their decentralized frameworks and transactional functionality. TNTcoin shares these characteristics and, in many respects, offers greater utility than existing cryptocurrencies. For example, TNTcoin supports Anti-Money Laundering (AML) compliance and is backed by patent-pending technology, further distinguishing it from other cryptocurrencies as a valuable utility token with functional use as a currency. These factors strengthen the case for issuing a no-action letter, confirming that the SEC will not treat TNTcoin as a security. Unlike Dogecoin, which is based on the same software as Bitcoin but offers no additional utility beyond what Bitcoin provides, TNT-Bank software offers significant functionality that is not available in competing cryptocurrencies.
The reason TNTcoin’s application is fundamentally different from yet another proof-of-work Bitcoin copy lies in its software, which provides substantial advantages. Denying this request for a no-action letter would effectively create a regulatory monopoly favoring inferior but established cryptocurrencies like Bitcoin and Ethereum, which have already been exempted from securities regulation. Given that TNTcoin’s value is driven by its decentralized nature and innovative technology—not by the efforts of any specific group—there is no legitimate basis for denying this request. TNTcoin's ability to facilitate regulatory compliance, particularly with potential AML regulations, further justifies its classification as a utility token. This is especially relevant to our intended use case: tracking fractional ownership of commodities such as carbon credits using “green coins.”
Carbon Credits as Commodities
Carbon credits represent CO2 captured in trees or other carbon sinks. Their value is not tied to the efforts of any individual but rather to a property owner's commitment to preserve the carbon sink by signing an easement, which requires no additional effort from the seller. This is similar to the structure of mineral rights. Carbon credits can be traded on existing exchanges or privately, as they are widely accepted as emissions offsets and valued in the marketplace, especially due to regulatory requirements for net-zero emissions—much like commodities such as oil, lithium, coal, ethanol, and clean water.
Regulation of Fractional Ownership of Commodities
Issue:
Whether fractional ownership of a commodity, such as mineral rights or carbon credits, is subject to regulation by the Commodity Futures Trading Commission (CFTC) or the Securities and Exchange Commission (SEC), particularly when no future obligations or efforts by others are involved.
Facts:
Fractional ownership of commodities involves dividing ownership interests in a physical commodity. These transactions do not involve future obligations (i.e., no delivery at a later date) or expectations of profits generated by others, as ownership is direct and immediate.
Applicable Law:
Howey Test for Securities: As previously discussed in detail.
CFTC Jurisdiction: The Commodity Futures Trading Commission regulates futures contracts, options on futures, and swaps under the Commodity Exchange Act (CEA).
Analysis:
Under the Howey Test, fractional ownership of a commodity does not meet the definition of a security if profits are not derived from the efforts of others. This is why mineral rights are not regulated by the SEC. Direct ownership of a commodity, without the need for management or pooling of resources to generate profits, does not satisfy the "efforts of others" criterion. Therefore, such ownership is not classified as a security and does not require SEC regulation. This is similar to direct fractional ownership of a building, such as a condominium, or mineral rights—neither of which are regulated by the SEC, as there is no legal basis for such regulation under the U.S. Constitution. In these cases, the value of fractional ownership shares is not influenced by the efforts of others, as there are no third-party agents involved. Consequently, there is no risk of the type of fraud the SEC is designed to prevent, and thus, no legal basis for regulatory oversight.
The CFTC’s regulatory authority extends to futures contracts and derivatives. If fractional ownership does not involve future delivery obligations or speculation on future prices, it falls outside the CFTC’s jurisdiction. Therefore, fractional ownership of commodities, such as carbon credits or mineral deposits, would not be subject to regulation by either the SEC or the CFTC. Even in a hypothetical scenario where regulation might apply, it would fall under CFTC oversight as long as the underlying assets are commodities—such as mineral rights or carbon credits—that do not require any maintenance and therefore do not rely on the efforts of others to maintain their value.
Conclusion:
Fractional ownership of a commodity, such as mineral rights, raw land, or carbon credits, without future delivery obligations or profits derived from the efforts of others, does not meet the definition of a security under the Howey Test. Additionally, because no futures contracts or derivatives are involved, the Commodity Futures Trading Commission (CFTC) would not have jurisdiction. Therefore, these transactions are not subject to regulation by either the SEC or the CFTC.
TNTcoin as a Utility Token
TNTcoin should be classified as a utility token under the Howey Test, similar to Bitcoin and Ethereum. As a decentralized and efficient alternative to Bitcoin, TNTcoin avoids the excessive energy consumption associated with proof-of-work mining. Its specific use cases, such as "green coin" applications, further enhance its utility by accurately tracking fractional ownership of commodities like mineral rights, which are not classified as securities. Using a proof-of-work cryptocurrency to represent carbon credits would be counterproductive to environmental goals, making TNTcoin’s super-efficient blockchain a perfect fit for these applications.
TNTcoin’s decentralized structure, functional value, and independence from third-party efforts to generate profits clearly distinguish it from traditional securities. Moreover, TNTcoin addresses significant environmental concerns by eliminating the energy waste associated with proof-of-work mining, which, in the past year, consumed as much electricity as entire countries. In contrast, TNTcoin’s energy-efficient design aligns with global initiatives to reduce unnecessary energy consumption.
It would be unfortunate if the SEC impeded this innovative technology from reaching the market, especially given its clear environmental benefits and the fact that it falls outside the SEC's regulatory scope. Refusing to issue a no-action letter in this case would, in effect, establish a regulatory monopoly that favors less efficient and environmentally harmful competitors like Bitcoin, thereby perpetuating significant environmental damage and resource waste.
Accordingly, we respectfully request that the SEC issue a no-action letter confirming that TNTcoin will not be subject to securities regulation under the Securities Act of 1933.