Phillipines’ SEC Says Cloud Mining Contracts Are Securities
On Tuesday, the Philippines’ Securities and Exchange Commission (SEC) issued a statement claiming that cryptocurrency cloud mining contracts are securities under the Howey Test. Cloud mining contracts are agreements between entities which own cryptocurrency mining equipment and individuals. The mining facilities utilize investments from individuals to fund purchases of large-scale cryptocurrency mining equipment in a remote datacenter. The agreements require an initial investment of fiat currency from the individual, in return for a share of mining profits generated at the remote datacenter.
The Philippines is now treating these contracts as unregistered issuances of securities after applying the Howey Test for securities classification. The Howey Test is a 71-year old test which originated from a court case disputing whether a leaseback agreement for real estate was legally an investment contract. The test consists of four requirements which must be met to classify a contract as a security:
- There must be an investment of money
- The investment is in a ‘common enterprise’ – some centralized entity or company
- There is an expectation of profits on the behalf of the investor
- The profits are generated from the efforts of a third party, other than the investor
Cloud mining contracts clearly meet all of these requirements, and therefore the entities issuing these contracts should be authorized securities brokers or dealers. However, this new distinction begs the question of whether cryptocurrency assets themselves should be classified as securities. This question has been hotly debated, and other regulatory forces such as the United States SEC are leaning towards classifying cryptos as securities. Obviously, this distinction depends on the features of the individual cryptocurrency in question. A white paper created by Coinbase in collaboration with Coin Center, Union Square Ventures and Consensys proposed a framework for classifying individual cryptocurrencies as securities based on their features.
There is a widely held belief that cryptocurrencies designed simply to facilitate a transfer of value, such as bitcoin, should not be securities. While bitcoin uses a proof-of-work system in which participants invest money (in mining equipment) and expect profits (via block rewards), those investments are not in a ‘common enterprise’ – the network is decentralized and not owned or operated by any single entity. On the other hand, utility tokens issued via token sales or initial coin offerings (ICOs) will likely be subject to securities regulations in the future, as they are frequently marketed by common enterprises who promise returns to investors. The method of distribution is an important aspect which plays into whether or not a cryptocurrency will be classified as a security.
United States SEC Chairman Jay Clayton commented on this issue at a Senate Banking Committee hearing in February:
“. . . I’M VERY UNHAPPY THAT PEOPLE ARE CONDUCTING ICOS LIKE PUBLIC OFFERINGS OF STOCK WHEN THEY SHOULD KNOW THAT THEY SHOULD BE FOLLOWING THE PRIVATE PLACEMENT RULES UNLESS THEY’RE REGISTERING WITH US.”
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