Source: U.S. SEC Division of Corporation Finance; Compiled by AIMan@Golden 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. These crypto assets are used to participate in the consensus mechanisms of such networks and/or are obtained as a result of participation in such mechanisms, or are used to maintain the technical operation and security of such networks and/or are obtained as a result of maintaining the technical operation and security of such networks. In this statement, we will 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 mechanisms designed to eliminate the need for a designated trusted intermediary 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 executes certain network rules, technical requirements, and reward distributions. Each protocol includes a "consensus mechanism" or method that enables a distributed network of unrelated computers (referred to as "nodes") maintaining a peer-to-peer network to reach an agreement on the "state" of the network or authoritative records of network address ownership balances, transactions, smart contract code, and other data. Public, permissionless networks allow anyone to participate in the operation of the network, including validating new transactions on the network according to the network's consensus mechanism.

Proof of Work ( "PoW" ) is a consensus mechanism that incentivizes network transaction verification by rewarding network participants (referred to as "miners") who operate nodes and contribute computational 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 computational resources contributed by miners to validate transactions and add new blocks to the network. Miners do not need to own the underlying cryptocurrency of the network to verify transactions.

Miners use computers to solve complex mathematical equations in the form of cryptographic puzzles. Miners compete with each other 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) a new block of transactions to the network. In exchange for providing validation services, miners receive "rewards" in the form of 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 effectively add blocks to the network.

Miners providing verification services can only receive rewards after other nodes in the network validate the solution's correctness and effectiveness through the protocol. To this end, once a miner finds the correct solution, it broadcasts this information to other miners, who can verify whether the miner has correctly solved the problem to receive the reward. Upon successful validation, all miners will add the new block to their own copies of the network. PoW aims to protect the network by requiring miners to spend considerable time and computational resources to validate transactions. When the verification process operates in this manner, it not only reduces the likelihood of someone attempting to compromise the network but also decreases the chances of miners including altered transactions (such as those allowing for "double spending" of regulated crypto assets).

In addition to mining on their own, miners can also join "mining pools". Mining pools allow miners to combine their computational 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 operational methods and reward distribution systems. Pool operators are typically responsible for coordinating the computational resources of miners, maintaining the mining hardware and software of the pool, overseeing security measures to prevent theft and cyber attacks, and ensuring that miners receive their rewards. In return, pool operators charge a fee, which is deducted from the share of rewards that miners receive from the pool. The reward payments from different pools vary, but rewards are usually distributed proportionally to the amount of computational resources each miner contributes to the pool. Miners are not obligated to stay in the pool and can choose to leave at any time.

The SEC's View on Protocol Mining Activities

The department believes that, under the circumstances described in this statement, the "mining activities" related to protocol mining (as defined in this statement) do not involve the issuance and sale of securities as defined in Section 2(a)(1) of the Securities Act of 1933 ("Securities Act") and Section 3(a)(10) of the Securities Exchange Act of 1934 ("Exchange Act"). Therefore, the department believes that participants in mining activities are not required to register transactions with the SEC under the Securities Act, nor do they need to comply with any of the exemptions from registration for these mining activities under the Securities Act.

The agreement mining activities covered by this statement

The department's viewpoint involves 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 mining pool operators in the protocol mining process, including their role in earning and distributing rewards. This statement only concerns mining activities related to the following types of protocol mining.

• Solo Mining refers to miners using their own computing resources to mine protected crypto assets. Miners can operate nodes and mine protected crypto assets either independently or in collaboration with others.
• Mining Pool, miners 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 indirectly routed to the miners through the mining pool operator.

Discussion

The Securities Law Article 2(a)(1) and the Trading Law Article 3(a)(10) define "securities" by listing various financial instruments (including "stocks," "notes," and "bonds"). Since the covered crypto assets do not constitute any financial instruments explicitly listed in the definition of "securities," we analyze certain transactions involving covered crypto assets in the context of protocol mining based on the "investment contract" test established in SEC v. WJ Howey Co. The "Howey Test" is employed to analyze arrangements or instruments not listed in these statutory terms based on their "economic reality."

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

Solo Mining

Mining by miners individually (or solo) is not to reasonably expect profits from the entrepreneurial or managerial efforts of others. Instead, miners contribute their computational resources, which can protect the network and enable miners to earn rewards issued by the network according to their software protocols. To earn rewards, the activities of miners must comply with the protocol rules. By adding their computational resources to the network, miners are merely engaging in organized or contributory activities to protect the network, validate transactions, and add new blocks in exchange for rewards. The expectation of miners to earn rewards does not stem from the management or entrepreneurial efforts of any third party upon which the network's success depends. Rather, the expected economic incentives of the protocol arise from the administrative or executive actions of miners executing protocol mining. Thus, rewards are compensation for the services miners provide to the network, not profits derived 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, they do not expect to profit from the entrepreneurial or managerial efforts of others. By adding their computing resources to a mining pool, miners are merely engaging in administrative or operational activities to secure the network, validate transactions, and add new blocks in exchange for rewards. Furthermore, any profit expectations of miners do not stem from the efforts of third parties, such as pool operators. Even when participating in a mining pool, individual miners still conduct actual mining activities by contributing their computational power to solve the cryptographic puzzles used for validating new blocks. Additionally, whether miners mine individually or as members of a mining pool does not alter the nature of protocol mining for the purpose of the Howey test. In either case, as stated, protocol mining remains an organizational or contributory activity. Moreover, the activities of pool operators that leverage the aggregated computational resources of participating miners to operate the mining pool primarily belong to an organizational or contributory nature. While certain activities of pool operators may benefit the miner community, any such efforts are insufficient to satisfy the Howey'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. Therefore, miners join pools not based on the ability to passively earn profits from the activities of pool operators.