Compilation | Wu Talks Blockchain

Introduction

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

Protocol Mining

Networks rely on cryptographic and economic mechanisms designed to verify network transactions and provide settlement assurances to users without the need for a specifically designated trusted intermediary. The operation of each network is governed by specific software protocols (computer code), which programmatically execute specific network rules, technical requirements, and reward distributions. Each protocol includes a "consensus mechanism," which is a method that allows distributed, unconnected computer nodes across the network to reach consensus on the state of the network. Public, permissionless networks allow anyone to participate in network operations, including verifying new transactions according to the network consensus mechanism.

PoW is a consensus mechanism that incentivizes transaction verification by rewarding network participants known as "miners." [5] PoW involves validating transactions on the network and packaging them into blocks to be added to a distributed ledger. The "work" in PoW refers to the computational 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 use computers to solve cryptographic puzzles in the form of complex mathematical equations, competing against each other; the first miner to solve the puzzle is responsible for accepting and validating (or proposing) transaction blocks from other nodes and adding them to the network. Miners receive "rewards" for providing validation services, which are typically newly minted or created Covered Crypto Assets distributed according to the terms of the protocol. [6] Thus, PoW incentivizes miners to invest the necessary resources to add valid blocks to the network.

Miners can only receive rewards after their computational results are verified as 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 for verification to confirm whether they have correctly solved the puzzle and earned the reward. Once verified, all miners will add the new block to their respective copies of the network. PoW secures the network by requiring miners to invest significant time and computational resources in transaction validation. This method of verification not only reduces the likelihood of disrupting the network but also decreases the chances of miners tampering with transactions (such as conducting double-spending attacks). [7]

In addition to solo mining, miners can also join "mining pools," combining their computational resources with other miners to increase the chances of successfully validating transactions and mining new blocks. Mining pools come in various types, each with different operational methods and reward distribution mechanisms. [8] Mining pool operators typically coordinate the computational resources of miners, maintain the hardware and software infrastructure of the pool, manage security measures, and ensure that miners receive rewards. In return, mining pool operators deduct a certain fee as a commission from the rewards earned by miners. The reward payment models of mining pools vary, but they are usually distributed based on the proportion of computational resources contributed by miners to the pool. Miners are not obligated to continue participating in a particular mining pool and can choose to leave at any time.

Division of Corporation Finance's Position on Protocol Mining Activities

The Division of Corporation Finance believes that, under the circumstances described in this statement, the "mining activities" (defined below) related to Protocol Mining do not constitute the issuance and 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 participants in mining activities are not required to register relevant transactions with the Commission under the Securities Act, nor are they subject to any registration exemption provisions of the Securities Act.

Protocol Mining Activities Covered by This Statement

The above position of the Division of Corporation Finance pertains to the following Protocol Mining activities and transactions (referred to as "mining activities," with a single action referred to as "mining behavior"):

Mining Covered Crypto Assets on PoW networks;

The role of mining pools and mining pool operators in the Protocol Mining process, including their roles in obtaining and distributing rewards.

Only mining activities involving the following types of Protocol Mining are applicable to this statement:

• Solo Mining: Miners use their own computational resources to mine Covered Crypto Assets. Miners can operate nodes independently or collaborate with others to operate nodes.

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

Specific Analysis

Sections 2(a)(1) of the Securities Act and 3(a)(10) of the Securities Exchange Act define "securities" in a non-exhaustive manner, including various financial instruments such as "stocks," "notes," and "bonds." Since Covered Crypto Assets are not explicitly listed in the definitions, we analyze certain transactions related to Protocol Mining using the "investment contract" test proposed in the SEC v. W.J. Howey Co. case (the "Howey Test"). [10] The Howey Test aims to analyze transactional arrangements or instruments that fall outside the statutory definitions based on economic realities. [11]

The key to the economic reality analysis is whether the transaction involves an investment of money in a common enterprise with the expectation of profits derived from the efforts of others. [12] Following the Howey case, federal courts further clarified that this "efforts of others" must be "undeniably significant, that is, management efforts that are critical to the success or failure of the enterprise." [13]

Solo Mining

Solo mining is not based on a reasonable expectation of profits derived from the entrepreneurial or managerial efforts of others. Miners provide their own computational resources to maintain network security and receive rewards as stipulated by the network protocol. The expectation of rewards for miners does not rely on the management efforts of any third party but rather stems from their own administrative or technical activities in maintaining the network, validating transactions, and adding new blocks. Therefore, rewards should be viewed as compensation for the services miners provide to the network, rather than profits derived from the entrepreneurial or managerial efforts of others.

Mining Pool

Similarly, when miners combine their computational resources with other miners to increase their chances of mining success, they are also not basing their reasonable expectation of profits on the entrepreneurial or managerial efforts of others. The expected returns for miners primarily stem from their own contributed computational resources. The management activities provided by mining pool operators are mainly administrative or technical in nature, which may benefit miners but do not meet the Howey Test's standard of "efforts of others." Miners choose to join mining pools not with the expectation of passively profiting from the management activities of the pool operators.

For further information, please contact the Chief Counsel's Office of the Division of Corporation Finance:

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

[1] The term "crypto asset" in this statement refers to assets generated, issued, and/or transferred through blockchain or similar distributed ledger technology networks (collectively referred to as "crypto networks"), including but not limited to assets referred to as "tokens," "digital assets," "virtual currencies," and "cryptocurrencies," which rely on cryptographic protocols. Additionally, in this statement, the term "network" refers to crypto networks.

[2] This statement represents the views of the staff of the Division of Corporation Finance (referred to as "the Division"). This statement is not a rule, regulation, guidance, or formal statement of the U.S. Securities and Exchange Commission (the "Commission"), and the Commission has not made any determination to approve or disapprove the content of this statement. Like other staff statements, this statement has no legal binding effect or authority, does not alter or amend applicable law, and does not create new or additional obligations for any individual or entity.

[3] This statement only addresses certain specific "Covered Crypto Assets," which do not possess inherent economic attributes or rights, such as generating passive income or granting holders rights to future income, profits, or assets of an enterprise.

[4] This statement only addresses transactions involving Covered Crypto Assets related to Protocol Mining and does not pertain to other types of Covered Crypto Asset transactions.

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

[6] The protocol pre-determines the reward rules. Miners cannot change the rewards they receive, and the reward structure is entirely determined in advance by the protocol itself.

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

[8] For example, in the "Pay-per-share" model, miners receive rewards based on each valid share or block contributed to the mining pool, regardless of whether the pool successfully mines a block; in the "Peer-to-peer" model, the role of the mining pool operator is decentralized among pool members; and in the "Proportional" model, miners receive rewards based on the proportion of computational power they contributed during the successful mining of a block. Additionally, there are some hybrid model pools that combine different operational methods and reward payment methods.

[9] The views of the Division of Corporation Finance do not determine whether any specific mining activity (as defined in this statement) constitutes the issuance and sale of securities. The final determination of specific mining activities must be based on an analysis of the facts of that activity. When the facts differ from those described in this statement—such as how pool members receive rewards, how miners or others participate in the pool, and the actual activities of the pool operators—the Division's views on whether specific mining activities involve the issuance and sale of securities may differ.

[10] U.S. Supreme Court case: 328 U.S. 293 (1946).

[11] See the U.S. Supreme Court's indication in Landreth Timber Co. v. Landreth, 471 U.S. 681, 689 (1985) that the appropriate standard for determining whether an instrument not explicitly included in the definition of "stock" in Section 2(a)(1) of the Securities Act is a security should be the "economic realities" test established in the Howey case. In analyzing whether an instrument is a security, "form should be disregarded and substance should be focused on" (Tcherepnin v. Knight, 389 U.S. 332, 336 (1967)), and "the economic substance behind the transaction, rather than the surface name of the instrument" should be considered (United Housing Found., Inc. v. Forman, 421 U.S. 837, 849 (1975)).

[12] Forman case, 421 U.S. at 852.

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

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