On March 20, the SEC released a Statement on Certain Proof-of-Work Mining Activities. In the statement, the Division of Corporation Finance (Corp Fin) provides its view that many proof-of-work mining activities are not securities transactions as defined by federal law. Corp Fin notes that the statement is “part of an effort to provide greater clarity on the application of the federal securities laws to crypto assets.”
The statement focuses on “the mining of crypto assets that are intrinsically linked to the programmatic functioning of a public, permissionless network, and are used to participate in and/or earned for participating in such network’s consensus mechanism or otherwise used to maintain and/or earned for maintaining the technological operation and security of such network.” In other words, the statement directly addresses mining activities with an intrinsic proof-of-work (PoW) consensus and may not apply to other types of mining.
Within PoW systems, the statement considers two types of mining, “self (or solo) mining” and “mining pools.” Self-mining is defined as “a miner mining Covered Crypto Assets using its own computational resources” either “alone or together with others.” Mining pools are “miners combining their computational resources with other miners to increase their chances of successfully validating transactions and mining new blocks on the network,” with rewards from “the network directly to the miners or indirectly to them through the pool operator.”
In Corp Fin’s view, self-mining and mining pools, as defined in the statement, do not comprise securities transactions, and “participants . . . do not need to register transactions with the Commission under the Securities Act or fall within one of the Securities Act’s exemptions from registration.”
Federal securities laws define a “security” by providing a long list of financial instruments.1 Crypto assets are not on this list. Therefore, courts and the SEC generally consider whether transactions involving crypto assets qualify as “investment contracts.”
In SEC v. W.J. Howey Co., 328 U.S. 293 (1946), the Supreme Court articulated the test for whether a transaction comprises an “investment contract” (and therefore a securities transaction). Under Howey, the following elements constitute an investment contract:
The Corp Fin statement applies this test to both self-mining and mining pools—and concludes that in both cases the third Howey element is not met. Therefore, neither self-mining nor mining pools comprise securities transactions.
Corp Fin reasons that self-mining “is not undertaken with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others” because “the expected financial incentive” arises from mining activities “performed by the miner,” not “the entrepreneurial or managerial efforts of others.” In other words, the miner puts his or her own computational resources to work to secure the network, and it is those efforts—not the efforts of any other party—that result in any financial reward to the miner. Therefore, the third Howey element is not met.
Corp Fin reaches a similar conclusion with respect to mining pools, noting that individual efforts predominate even when participating in a pool: “Even when participating in a mining pool, individual miners still perform the actual mining activity by contributing their computational power to solve the cryptographic puzzles for validation of new blocks.” Like self-miners, miners in a mining pool “are relying on the computational resources that they provide in conjunction with other members to the mining pool to earn profits.”
The pool operator’s activities do not alert the analysis as long as “a pool operator’s activities . . . primarily are administrative or ministerial in nature.” Case law has long limited Howey’s third element to managerial or entrepreneurial efforts, finding that administrative or ministerial efforts do not suffice. 2 While “some of the pool operator’s activities may benefit the group of miners,” Corp Fin concludes that these activities are not sufficiently entrepreneurial or managerial to satisfy the third Howey element.
Finally, the statement also takes aim at the second Howey element, positing that “a miner does not join a mining pool based on the ability to earn profits passively from the activities of the pool operator."
As Corp Fin disclaims, its statement “is not a rule, regulation, guidance, or statement” of the SEC; the SEC has not approved or disapproved the statement; and “like all staff statements,” it “has no legal force or effect.” However, as with other recent SEC guidance, the statement suggests a shift in focus away from pursuing enforcement actions against proof-of-work mining activities for failure to register securities.
On the other hand, because the guidance is non-binding, the SEC’s stance is subject to change, especially in a future presidential administration. Affected industry participants should closely monitor for continued SEC guidance, enforcement actions, and potential judicial interpretation following this latest release by Corp Fin.
For the latest cryptocurrency news and regulatory developments, visit our Fenwick Crypto Review.
Footnotes
1 Defining “security” as “any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.” 15 U.S.C. § 77b(a)(1) (Securities Act of 1933); see also 15 U.S.C. § 78c(a)(10) (nearly identical definition in the Securities Exchange Act of 1934).
2 E.g., SEC v. Glenn W. Turner Enterprises, 474 F.2d 476, 482 (9th Cir. 1973), holding “the efforts made by those other than the investor” must be the “undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise”.