US SEC defines "POW mining" as not a securities activity

Compiled by Wu Talks about Blockchain

introduction

As part of its efforts to clarify the application of the federal securities laws to crypto assets,[1] the U.S. Securities and Exchange Commission’s (SEC) Division of Corporation Finance is issuing this statement to clarify its position regarding “mining” activities on certain Proof-of-Work (PoW) networks.[2] Specifically, this statement covers activities that involve participating in the consensus mechanism of a public, permissionless network through programmatic functionality built into the protocol itself and obtaining or using corresponding crypto assets to maintain the operation and security of the network technology. This statement refers to such crypto assets as “Covered Crypto Assets,”[3] and their mining activities on PoW networks as “Protocol Mining.”[4]

Protocol Mining

The network relies on cryptography and economic mechanism design to verify network transactions and provide settlement guarantees to users without the need for a specially designated trusted intermediary. The operation of each network is governed by a specific software protocol (computer code) that programmatically enforces specific network rules, technical requirements, and reward distribution. Each protocol includes a "consensus mechanism," which is a method for unconnected computer nodes across the network to reach a consensus on the state of the network. Public, permissionless networks allow anyone to participate in the operation of the network, including verifying new transactions according to the network consensus mechanism.

PoW is a consensus mechanism that incentivizes transaction validation by rewarding network participants, called “miners.” [5] PoW involves validating transactions on the network and packaging them into blocks that are included in the distributed ledger. The “work” in PoW refers to the computing resources that miners use to validate transactions and add new blocks. Miners do not need to own the covered crypto assets on the network to validate transactions.

Miners compete by using computers to solve cryptographic puzzles in the form of complex mathematical equations, and the first miner to solve the puzzle is responsible for accepting and validating (or proposing) a block of transactions from other nodes and joining the network. Miners are rewarded for their validation services, which are typically newly minted or created covered crypto assets issued in accordance with the terms of the protocol. [6] PoW therefore incentivizes miners to invest the necessary resources to add valid blocks to the network.

Miners are only rewarded if their calculations are verified to be correct and valid by other nodes in the network through the protocol. When a miner finds the correct solution, they broadcast it to other miners so that they can verify that they have solved the problem correctly and receive the reward. Once verified, all miners add the new block to their own copies of the network. PoW ensures network security by requiring miners to invest a lot of time and computing resources to verify transactions. This verification method not only reduces the possibility of damaging the network, but also reduces the possibility of miners tampering with transactions (such as double-spending attacks). [7]

In addition to solo mining, miners can also join a "mining pool" to combine their computing resources with other miners to increase their chances of successfully verifying transactions and mining new blocks. There are many types of mining pools, each with different operating methods and reward distribution mechanisms. [8] Mining pool operators are usually responsible for coordinating miners' computing resources, maintaining the mining pool's hardware and software facilities, managing the mining pool's safety precautions, and ensuring that miners receive rewards. In return, the mining pool operator deducts a certain fee from the miner's rewards as a commission. Mining pool reward payment models vary, but are generally distributed based on the proportion of computing resources contributed by miners to the mining pool. Miners are not obligated to continue to participate in a mining pool and may choose to leave at any time.

Corporate Finance’s stance on protocol mining activities

The Division of Corporation Finance believes that, under the circumstances described in this statement, “mining activities” (defined below) related to protocol mining do not constitute an offer or sale of securities under Section 2(a)(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities Exchange Act of 1934. [9] Therefore, the Division of Corporation Finance believes that entities engaged in mining activities are not required to register the related transactions with the Commission under the Securities Act, nor are they required to apply any registration exemptions provided under the Securities Act.

Protocol Mining Activities Covered by This Statement

The Department of Corporation Finance’s position above relates to the following protocol mining activities and transactions (referred to as “mining activities” and a single act as a “mining action”):

Mining covered crypto assets on PoW networks;

The role of mining pools and pool operators in the protocol mining process, including their role in earning and distributing rewards.

Only mining activities involving the following types of protocol mining are subject to this statement:

•Solo Mining: Miners use their own computing resources to mine covered crypto assets. Miners can operate nodes independently or in collaboration with others.

• Mining Pool: Miners combine their computing resources with other miners to increase the chances of successfully mining a new block. Reward payments may be paid directly to miners from the network or indirectly through mining pool operators.

Specific analysis

Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Securities Exchange Act both define “security” enumerably to include a variety of financial instruments, including “stocks,” “notes,” and “bonds.” Because the crypto assets covered are not explicitly enumerated in the definitions, we analyze certain transactions in protocol mining under the “investment contract” test set forth in SEC v. W. J. Howey & Co. (the “Howey Test”). [10] The Howey Test seeks to analyze trading arrangements or instruments that fall outside the statutory definitions based on economic reality. [11]

The key to the economic reality analysis is whether the transaction involves investing money in an enterprise with the reasonable expectation of profiting from the entrepreneurial or managerial efforts of others. [12] Federal courts have further explained after Howe that such “others’ efforts” must be “undeniably significant, i.e., managerial efforts that are decisive to the success or failure of the enterprise.” [13]

Solo Mining

Solo mining is not based on a reasonable expectation of profit from the entrepreneurial or managerial efforts of others. Miners provide their own computing resources to maintain network security and receive rewards as specified in the network protocol. Miners' expectations of receiving rewards do not rely on the managerial efforts of any third party, but rather on their own administrative or technical activities such as maintaining the network, verifying transactions, and adding new blocks. Therefore, rewards should be considered as compensation for miners' services to the network, rather than profits from the entrepreneurial or managerial efforts of others.

Mining Pool

Similarly, when miners combine computing resources with other miners to increase their mining success rate, they are not doing so based on a reasonable expectation of profit from the entrepreneurial or managerial efforts of others. Miners’ expected returns are primarily derived from the computing resources they invest. The management activities provided by mining pool operators are primarily administrative or technical in nature, which may benefit miners but are not sufficient to meet the “efforts of others” standard of the Howey test. Miners do not choose to join a mining pool with the expectation of passively profiting from the management activities of the mining pool operator.

For further information, please contact the Office of the Chief Counsel, Corporate Finance:

https://www.sec.gov/forms/corp_fin_interpretive

[1] “Crypto assets” as used in this Statement refer to assets generated, issued and/or transferred through a blockchain or similar distributed ledger technology network (collectively, a “cryptonetwork”), including but not limited to assets referred to as “tokens,” “digital assets,” “virtual currencies” and “cryptocurrencies,” which rely on cryptographic protocols. In addition, in this Statement, the term “network” refers to a cryptonetwork.

[2] This statement represents only the views of the staff of the Division of Corporation Finance (the “Division”). This statement is not a rule, regulation, guidance, or official statement of the U.S. Securities and Exchange Commission (the “Commission”), and the Commission has not approved or disapproved the contents of this statement. This statement, like other staff statements, is not legally binding or has the force or effect of law, does not modify or amend applicable law, and does not create new or additional obligations for any person or entity.

[3] This statement relates only to certain “covered cryptoassets” that do not have inherent economic properties or rights, such as those that produce passive income or confer rights on the holder to future revenues, profits, or assets of a business.

[4] This statement only relates to covered crypto asset transactions related to Protocol Mining and does not relate to other types of covered crypto asset transactions.

[5] This statement discusses the Proof of Work (PoW) mechanism in general and does not address all specific PoW variants or specific PoW protocols.

[6] The protocol predetermines the reward rules. Miners cannot change the rewards they receive, and the reward structure is completely predetermined by the protocol itself.

[7] Double spending refers to the situation where the same crypto asset is sent to two recipients at the same time, which may occur when the ledger records are tampered with.

[8] For example, in the “pay-per-share” model, miners are paid for each valid share or block they contribute to the pool, regardless of whether the pool successfully mines a block; in the “peer-to-peer” model, the role of pool operator is distributed among the pool members; and in the “proportional” model, miners are rewarded in proportion to the computing power they contribute to the successful mining of a block. In addition, there are some hybrid model mining pools that combine different operating methods and reward payment methods.

[9] The Division’s opinion does not determine whether any particular mining activity (as defined in this statement) constitutes an offer and sale of securities. The ultimate determination of a specific mining activity must be made based on an analysis of the facts surrounding that activity. When the facts differ from those described in this statement—such as how mining pool members are compensated, how miners or other persons participate in the mining pool, or the actual activities performed by the mining pool operator—the Division’s opinion on whether a particular mining activity involves an offer and sale of securities may differ.

[10] United States Supreme Court decision: 328 U.S. 293 (1946).

[11] See the United States Supreme Court in Landreth Timber Co. v. Landreth, 471 US 681, 689 (1985), which held that the proper standard for determining whether an instrument that is not specifically included in the definition of “stock” in Section 2(a)(1) of the Securities Act or an unusual instrument is a security is the “economic realities” test established in Howey. In analyzing whether an instrument is a security, “form should be ignored and substance should be considered” (Tcherepnin v. Knight, 389 US 332, 336 (1967)), and “the economic substance of the transaction, not the name of the instrument, should be the focus” (United Housing Found., Inc. v. Forman, 421 US 837, 849 (1975)).

[12] Forman, 421 USC at 852.

[13] See, e.g., SEC v. Glenn W. Turner Enterprises, Inc., 474 F.2d 476, 482 (9th Cir. 1973).