Crypto Mining Pools: Collective Investment Schemes?
The recent reports alleging that Nvidia, the computer hardware producer, underestimated its sales from crypto-asset and blockchain related hardware as $602 million (in the period April 2017 to July 2018) instead of the actual figure of $1.95 billion seem credible; the reports could offer an explanation to the obvious and logical linkage between the recent plummet of Nvidia’s stock by almost 50%, and the corresponding tumble of the crypto-asset market in the same time period.
Despite recent setbacks, cryptocurrency mining has rapidly become a huge business and has increased drastically in recent times. Industry bigwigs like Bitmain (the largest manufacturer of crypto-asset mining products) are trying to capitalise on this ever-expanding market — Bitmain has been, for sometime, considering going the IPO route after being valued at an impressive $15 billion in a pre-IPO funding round. Samsung has also outlined its intentions to start manufacturing crypto-asset mining equipment.
However, with the uncertainty surrounding the future of crypto-mining activities, we analyse a practical and effective alternative to dilute individual risk — crypto-mining pools, and comment on whether such crypto-mining pools can be regulated as collective investment schemes (CIS).
What is crypto-mining?
Crypto-assets or cryptocurrencies are brought into existence by ‘mining’ them — mining crypto-assets is the process of solving complex mathematical problems using specially designed computational machines in order to gain a ‘reward’. The reward for solving these problems (and thus ‘finding’ the latest ‘block’ of the crypto asset’s chain) before other computers in the network is a certain (constantly varying) amount of the crypto-asset. Apart from generating crypto-assets, mining also serves the purpose of validating and recording each transaction that takes place on a crypto-asset’s blockchain, essentially making the network functional. The more miners there are in a crypto-asset network, the more secure, decentralized, and tamper-proof the network becomes. The strength of the network of a crypto-asset is often judged by the computational power of the network.
Is it legal?
The question of legality of crypto-assets and their classification is hotly debated across legal jurisdictions. Countries like Japan have highly regulated the space, while others like China have an implicit ban in place. In India, the Reserve Bank of India (RBI) has placed a kind of ‘shadow ban’ on the crypto-asset industry — while dealing in these assets is not illegal, RBI-regulated entities have been restricted from using banking channels for crypto-related activities and the Registrar of Companies (RoC) has stopped accepting registration forms from cryptocurrency exchanges and other intermediaries.
Very few countries have sought to regulate the mining of cryptocurrency. Austria and Ukraine have classified mining as a ‘commercial activity’ and ‘economic activity’, respectively. Belarus has expressly permitted the mining of cryptocurrency. Australia, Denmark, Germany, and Slovakia have commented on the taxation treatment of mining, thereby implicitly recognizing the activity.
Lawmakers and regulators in India have been quick to voice their disapproval of decentralised crypto-assets but have not commented on mining. With the current lack of regulation, bitcoin mining is neither legal nor illegal in India.
Crypto-mining pools
Miners often combine their computational power together in an informal ‘pool’ in order to seek the block reward in a more organized and efficient manner. They are rewarded on the basis of processing power supplied by each miner in the efforts to find a block of the crypto-asset. Some of the popular mining pools include btc.com, Slush Pool, etc.
For a crypto-mining pool to organise itself as a collective investment scheme, it must have the following features:
(i) pooling of capital (in cash or in kind);
(ii) defined investment policy (crypto-mining resources to participate as a pool in blockchain-related crypto-mining activities);
(iii) generation of pooled returns (crypto-assets like Bitcoin or Ether); and
(iv) the absence of investor’s day-to-day discretion.
At the outset, it does appear that most crypto-mining pooling ventures possess the aforesaid requisite features of a collective investment scheme, but the law in India provides that a CIS can only be offered by a Collective Investment Management Company (CIMC), which must be a company registered under the (Indian) Companies Act. There is also a requirement that all transactions relating to purchase/subscription of the units of the CIS must be paid through cheque or demand draft or through any other banking channel, but not cash. In light of the restrictions imposed by the RoC and by the RBI, it appears that the majority of the requirements for setting up of a CIS, including the ones highlighted above, cannot be complied with.
Concluding Remarks
The second interdisciplinary committee set up by the Government of India (GOI) is touted to submit its report shortly, with murmurs of lifting the RBI and RoC related ban slowly dying down. Moreover, amidst recent reports that the GOI has invited certain other stakeholders to present their suggestions for cryptocurrency regulation in India, it is only a matter of time before the activity of crypto-mining will also sought to be regulated. Considering the inherent features of a CIS in any organized crypto-mining pooling venture, it only seems logical that the activity is brought under the aegis of the Securities Exchange Board of India (SEBI) and is regulated as a CIS.
Madhav Behl and Shivam Arora are lawyers with leading law firms in New Delhi and Mumbai, respectively. The views of the author(s) in this article are personal and do not constitute legal / professional advice of the law firms they represent. For any further queries or follow up, please contact us at shivamarora93@gmail.com / madhavbehl@gmail.com.
