US SEC qualitative "POW mining behavior": not a securities activity

Compilation | Wu Shuo Blockchain

introduction

As part of its efforts to clarify the application of federal securities laws in the crypto-asset field, [1] The Securities and Exchange Commission (SEC) Department of Corporate Finance is now making this statement on the “mining” activities of certain Proof-of-Work (hereinafter referred to as “PoW”) to elaborate its position. [2] Specifically, this statement involves participating in the network consensus mechanism through the programmatic functions built into the protocol itself and obtaining or using corresponding cryptographic assets in order to maintain the operation and security of the network technology in a public, license-free network. This statement calls such crypto assets "covered Crypto Assets" and [3] and calls their mining activities on the PoW network "Protocol Mining". [4]

Protocol mining

The network relies on cryptography and economic mechanism design, and can verify online transactions and provide settlement guarantees for users without a specially designated trusted intermediary. The operation of each network is controlled by a specific software protocol (computer code), which performs specific network rules, technical requirements and reward allocations in a programmatic manner. Each protocol contains a "consensus mechanism", that is, a method that enables computer nodes that are spread across the network and are unrelated to reach consensus on the state of the network. An open, license-free network allows anyone to participate in network operations, including verifying new transactions in accordance with the network consensus mechanism.

PoW is a consensus mechanism that incentivizes transaction verification by rewarding network participants known as “miners.” [5] PoW involves verifying transactions on the network and packaging them into blocks and adding them to distributed ledgers. "Work" in PoW is the computing resources miners use to verify transactions and add new blocks. Miners do not need to own covered crypto assets on the network, and they can also verify transactions.

Miners use computers to solve cryptography problems in the form of complex mathematical equations. Miners compete with each other. The first miner to solve the problem is responsible for accepting and verifying (or proposing) transaction blocks from other nodes and joining the network. Miners receive a “reward” for providing verification services, which are often newly minted or created covered crypto assets issued under the terms of the agreement. [6] Therefore, PoW incentivizes miners to invest necessary resources to add effective blocks to the network.

Miners can only receive rewards after other nodes in the network verify that their calculation results are correct and valid through protocols. When the miner finds the correct answer, it will broadcast it to other miners to verify that they have correctly answered the problem and received a reward. Once verified, all miners will add new blocks to their respective network replicas. PoW ensures network security by requiring miners to invest a lot of time and computing resources for transaction authentication. This verification method not only reduces the possibility of destroying the network, but also reduces the possibility of miners tampering with transactions (such as conducting double-spending attacks). [7]

In addition to Solo Mining, miners can also join the "Mining Pool" to combine computing resources with other miners to improve the chances of successfully verifying transactions and mining new blocks. Mining pools are divided into various types, each with different operating methods and reward distribution mechanisms. [8] Mining pool operators are usually responsible for coordinating miners' computing resources, maintaining the miner's software and hardware facilities, managing mining pool security precautions, and ensuring that miners receive rewards. In return, the mining pool operator deducts a certain fee from the rewards received by the miner as a commission. The reward payment mode of mining pools varies, but is usually allocated based on the proportion of computing resources contributed by miners to the mining pool. The miner has no obligation to continue to participate in a certain mining pool and can choose to leave at any time.

The position of the Ministry of Finance on agreement mining activities

The Ministry of Finance believes that in the circumstances described in this statement, the "mining activities" related to agreement mining (as defined below) do not belong to 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 Ministry of Finance believes that the subjects involved in mining activities do not need to register relevant transactions with the Commission in accordance with the Securities Act, nor do they need to apply any registration exemption provisions stipulated in the Securities Act.

Agreement mining activities covered by this statement

The above position of the Corporate Finance Department involves the following protocol mining activities and transactions (called "mining activities" and a single act is called "mining behavior"):

Mining covered crypto assets on the PoW network;

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

Mining activities involving the following protocols apply to this statement only:

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

•Mining Pool: Miners combine computing resources with other miners to increase the chance of successfully mining new blocks. Reward payments may be paid directly from the network to the miner or indirectly through the mining pool operator.

Specific analysis

Article 2(a)(1) of the Securities Act and Article 3(a)(10) of the Securities Exchange Act both define "securities" in an enumerated manner, including various financial instruments such as "stocks", "bills" and "bonds". Since the crypto assets covered are not explicitly listed in the definition, we analyze certain transactions in agreement mining based on the "Investment Contract" test (i.e., "Howey Test") proposed in the case of SEC v. WJ Howey. [10] The “Ouvian Test” is intended to analyze transaction arrangements or instruments that are not within the scope of the statutory definition based on economic reality. [11]

The key to economic reality analysis is whether the transaction involves investing funds in the business in order to reasonably make profits from other people's entrepreneurs or management efforts. [12] After the Howey case, the federal court further explained that this "other's efforts" need to be "an undeniably important, that is, management efforts that play a decisive role in the success or failure of a company." [13]

Solo Mining

Mining alone is not based on reasonable expectations of profits from other people's entrepreneurs or management efforts. Miners provide their own computing resources to maintain network security and receive rewards stipulated in the network protocol. The expectation of miners to receive rewards does not depend on any third party’s management efforts, but rather comes from their own performance of administrative or technical activities such as maintaining the network, verifying transactions, and joining new blocks. Therefore, rewards should be regarded as rewards for miners to provide services to the network, rather than profits from other entrepreneurs or management efforts.

Mining Pool

Similarly, when miners combine computing resources with other miners to increase mining success rates, they are not based on reasonable expectations of profits from other people's entrepreneurs or management efforts. The expected returns of miners mainly come from the computing resources they invest. The management activities provided by mining pool operators are mainly administrative or technical, and although they may be beneficial to miners, they are not sufficient to meet the standards of Howe’s testing of “others’ efforts”. Miners’ choice to join a mining pool is not intended to passively profit from the management activities of the mining pool operators.

For further information, please contact the Office of the Chief Advisor of the Company’s Finance Department:

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

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

[2] This statement only represents the views of staff of the Company’s Finance Department (hereinafter referred to as “Headquarters”). This statement is not a rule, regulations, guidance or formal statement made by the Securities and Exchange Commission (the “Committee”) and the Commission has not made a decision to approve or disapprove the contents of the statement. This statement, like other staff statements, is not legally binding or effective, will not change or amend applicable laws, nor will it bring new or additional obligations to any individual or entity.

[3] This statement only relates to certain specific "covered crypto assets" that do not have inherent economic attributes or rights, such as the right to generate passive income or grant holders the right to obtain future income, profits or assets of the company.

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

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

[6] The agreement determines the reward rules in advance. The miner cannot change the rewards he receives, and the reward structure is entirely determined in advance by the agreement itself.

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

[8] For example, in the Pay-per-share mode, the miner receives rewards based on each effective share or block contributed to the mining pool, regardless of whether the mining pool successfully mines the block; in the "Peer-to-peer" mode, the role of the mining pool operator is scattered among the mining pool members; in the "Proportional" mode, the miner receives rewards based on the proportion of the computing power he contributed in the successful mining of the block. In addition, there are some mixed-mode mining pools that combine different operating methods and reward payment methods.

[9] The view of the Company’s Finance Department cannot determine whether any particular mining activity (as defined in this statement) constitutes the issuance and sale of securities. The final judgment of a specific mining activity must be analyzed based on the facts of the activity. When facts differ from those described in this statement - such as how pool members are paid, how miners or other personnel participate in mining pools, activities actually engaged in by mining pool operators, etc. - The corporate finance department's view on whether a particular mining activity involves the issuance and sale of securities may be different.

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

[11] See the U.S. Supreme Court noted in Landreth Timber Co. v. Landreth, 471 US 681, 689 (1985) that the "economic reality" test established in the Howey case should be used to determine whether an instrument or an unusual instrument that is not explicitly included in the definition of "stock" in Article 2(a)(1) of the Securities Act. When analyzing whether an instrument is a securities, “the form should be ignored and the substance should be focused” (Tcherepnin v. Knight, 389 US 332, 336 (1967)) and “focus on the economic substance behind the transaction rather than the surface name of the instrument” (United Housing Found., Inc. v. Forman, 421 US 837, 849 (1975)).

[12] Forman case, 421 US case, page 852.

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