U.S. SEC: PoW Mining Does Not Constitute Securities Issuance and Does Not Require Registration?

Participants in mining activities are not required to register transactions with the U.S. SEC under the Securities Act, nor do they need to comply with any of the registration exemption provisions of the Securities Act regarding these mining activities.

Written by: U.S. SEC Division of Corporation Finance

Compiled by: AIMan @ Jinse Finance

Introduction

To clarify the applicability of federal securities laws to crypto assets, the SEC's Division of Corporation Finance is issuing guidance on certain activities on proof-of-work networks, referred to as "Mining."

Specifically, this statement addresses the mining of crypto assets that are intrinsically linked to the programmatic operation of public, permissionless networks, which are used to participate in the consensus mechanisms of such networks and/or obtained as a result of participating in such mechanisms, or used to maintain the technical operation and security of such networks and/or obtained as a result of maintaining the technical operation and security of such networks. In this statement, we refer to these crypto assets as "Covered Crypto Assets" and the mining of them on proof-of-work networks as "Protocol Mining."

Protocol Mining

The network relies on cryptographic technology and economic mechanism design to eliminate the need for designated trusted intermediaries to verify network transactions and provide settlement guarantees to users. The operation of each network is controlled by an underlying software protocol, which consists of computer code that programmatically enforces certain network rules, technical requirements, and reward distributions. Each protocol contains a "consensus mechanism" or method that enables a distributed network of unrelated computers (called "nodes") that maintain a peer-to-peer network to agree on the "state" of the network or an authoritative record of network address ownership balances, transactions, smart contract code, and other data. Public, permissionless networks allow anyone to participate in the running of the network, including validating new transactions of the network according to the network's consensus mechanism.

Proof of Work ( "PoW" ) is a consensus mechanism that incentivizes network transaction validation by rewarding network participants (referred to as "miners") who operate nodes and add computing resources to the network. PoW involves validating transactions on the network and adding them to the distributed ledger in the form of blocks. The "work" in PoW refers to the computing resources that miners contribute to validate transactions and add new blocks to the network. Miners do not need to own the covered crypto assets of the network to validate transactions.

Miners use computers to solve complex mathematical equations in the form of cryptographic puzzles. Miners compete with their peers to solve these puzzles, and the first miner to solve a puzzle is tasked with accepting bulk transactions from other nodes and validating (or proposing) new blocks of transactions to the network. In exchange for providing verification services, miners are rewarded with newly "minted" or created protected cryptographic assets, which are delivered according to the terms of the protocol. In this way, PoW incentivizes miners to invest the necessary resources to add valid blocks to the network.

Miners who provide validation services will only be rewarded if other nodes in the network have validated the solution correctly and effectively through the protocol. To do this, once a miner finds the right solution, it broadcasts this information to other miners who can verify that the miner has correctly solved the puzzle to earn a reward. Once verified, all miners add the new block to their own copy of the network. PoW aims to secure the network by requiring miners to spend a significant amount of time and computing resources validating transactions. When the verification process is run in this way, it not only reduces the likelihood that someone will attempt to compromise the network, but also reduces the likelihood that miners will include altered transactions, such as those that allow "double spending" on regulated crypto assets.

In addition to mining on their own, miners can also join a "mining pool". Mining pools allow miners to combine their computing resources to increase the chances of successfully validating transactions and mining new blocks on the network. Mining pools have developed into various types, each with different operating methods and reward distribution mechanisms. Pool operators are typically responsible for coordinating the computing resources of miners, maintaining the mining hardware and software of the pool, overseeing the security measures of the pool to prevent theft and cyber attacks, and ensuring that miners receive their rewards. In return, pool operators charge a fee that is deducted from the share of rewards that miners earn in the pool. The reward payments from different pools vary, but rewards are usually distributed proportionally to the entire pool based on the amount of computing resources each miner contributes to the pool. Miners are not obligated to remain in the pool and can choose to leave at any time.

SEC Division of Corporation Finance's View on Protocol Mining Activities

The Department believes that, under the circumstances described in this Statement, "Mining Activities" (as defined in this Statement) in connection with Protocol Mining do not involve Section 2(a)(1) of the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). Offering and sale of securities as defined in Section 3(a)(10). As a result, the Department believes that participants in mining activities are not required to register their transactions with the SEC under the Securities Act and are not required to qualify for one of the registration exemptions under the Securities Act for these mining activities.

The mining activities covered by this statement

The views of this department relate to the following protocol mining activities and transactions ("mining activities" and each "mining activity"): (1) mining protected crypto assets on a PoW network; (2) the role of mining pools and pool operators involved in the protocol mining process, including their roles in earning and distributing rewards. This statement only pertains to mining activities related to the following types of protocol mining.

Solo mining, where miners use their own computing resources to mine protected cryptocurrency assets. Miners can operate nodes and mine protected cryptocurrency assets either individually or in collaboration with others.

Mining pools allow miners to combine their computing resources with other miners to increase the chances of successfully validating transactions and mining new blocks on the network. Reward payments may flow directly from the network to the miners or may be distributed indirectly to the miners through pool operators.

Discussion

Section 2(a)(1) of the Securities Act and Section of the Exchange Act Article 3(a)(10) defines "securities" by listing various financial instruments, including "stocks", "notes" and "bonds". Because the covered cryptoassets do not constitute any of the financial instruments expressly listed in the definition of "securities," we analyze certain covered cryptoasset transactions in the context of protocol mining under the "investment contract" test set forth in SEC v. WJ Howey Co. The "OmniVision Test" is used to analyse arrangements or instruments not listed in these statutory provisions in light of their "economic realities".

When assessing the economic reality of a transaction, the standard to be examined is whether there is an investment of funds in the enterprise, and whether that investment is based on a reasonable expectation of profits generated by the entrepreneurial or managerial efforts of others. Since the Howey case, federal courts have explained that the condition for "efforts of others" in the Howey case is that "the efforts made by persons other than the investor are undoubtedly significant and constitute the necessary managerial efforts that affect the success or failure of the enterprise."

Solo Mining

Miners do not mine on their own (or alone) with a reasonable expectation of profit from the entrepreneurial or managerial efforts of others. Instead, miners contribute their own computing resources that secure the network and enable miners to receive rewards issued by the network in accordance with their software protocols. To receive rewards, miners' activities must comply with the rules of the protocol. By adding their computing resources to the network, miners are simply engaging in organizational or contributing activities to secure the network, validate transactions, and add new blocks and earn rewards. The expectation that miners will be rewarded does not come from the managerial or entrepreneurial efforts of any third party on which the network's success depends. Instead, the expected economic incentive of the protocol comes from the administrative or administrative act of protocol mining performed by the miner. Therefore, the reward is the remuneration that miners receive for the services they provide to the network, rather than the profits they receive from the entrepreneurial or managerial efforts of others.

Mining Pool

Similarly, when miners combine their computing resources with other miners to increase their chances of successfully mining new blocks on the network, miners do not expect to make a profit from other people's entrepreneurial or managerial efforts. By adding their own computing resources to a mining pool, miners are simply engaging in administrative or administrative activities to secure the network, validate transactions, and add new blocks and earn rewards. In addition, any profit expectations of miners are not from the efforts of third parties, such as mining pool operators. Even participating in mining pools, individual miners still perform actual mining activities by contributing their computing power to solve cryptographic puzzles used to validate new blocks. In addition, neither mining by the miners themselves (or individually) or as members of the mining pool does not change the nature of protocol mining for the purposes of the Howey test. In either case, protocol mining remains an organizational or contributing activity, as described in this statement. In addition, the activities of the mining pool operator to operate the mining pool using the combined computing resources of the participating miners are mainly of an organizational or contributing nature. While some of the activities of the pool operator may benefit the miner community, any such effort will not be sufficient to satisfy OmniVision's "efforts of others" requirement, as miners primarily rely on the computing resources they provide to the pool together with other members to earn profits. For this reason, miners do not join the pool based on the ability to passively earn profits from the activities of the pool operator.