The iconic 1946 SCOTUS case of SEC vs Howey established a few simple criteria for what, exactly, constitutes a security.
Quoting Findlaw verbatim:
Per the Howey Test, an asset is a security if:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
Cloud mining investing is the practice of buying mining contracts from large mining operations.
Large mining operations must keep a positive cash flow in order to sustain operations. Either they can sell the mined cryptocurrencies or they can sell some of their installed capacity in exchange for short term fiat money.
Investors normally buy these contracts looking forward to future valuation of the mined cryptos. It is relatively obvious that the cash value of cryptos mined via the cloud will not be immediately profitable, otherwise the cloud miners would simply dump the coins rather than going through all the trouble of selling mining power. Instead, there is a future expectation of making a profit from the cloud-mined coins.
Therefore we have 2 of the Howey questions answered for us about cloud mining: contracts are bought as an investment and there is an expectation of profits from this investment.
The third question in a Howey test is where most cryptocurrency projects get stuck in uncharted legal territory due to their decentralized nature.
Fortunately, for mining contracts, the answer isn’t too convoluted.
Some argue that item 3 of the Howey test is satisfied here as well: when you purchase mining contracts, you are investing in a common enterprise. There’s a centralized entity that does the mining for you.
Note that this is open to interpretation and courts have had different understandings about what common enterprise means.
Quoting Findlaw once more:
The term “common enterprise” isn’t precisely defined, and courts have used different interpretations. Most federal courts define a common enterprise as one that is horizontal, meaning that investors pool their money or assets together to invest in a project. However, other courts use different definitions.
The fourth and final Howey test question asks whether the investor controls the means of making profits.
If they do, then the asset is not considered a security.
In the case of cloud mining this is, again, debatable.
After a mining contract is purchased, the buyer becomes responsible for choosing the right algorithm and to get the cloud mining operation started. In this sense, the ROI depends on choices made by the contract buyer. Everything else, though, does not depend on him, but neither does it depend on the actions performed by the cloud mining operation! There is nothing the cloud mining operation can or will do to increase your profits if, for example, network difficulty soars because of some external factor. There is no actor that is working for you on the background to make mining difficulty go higher or lower, therefore the cloud miner does not necessarily qualify as a promoter or third party entity that is working for your profit.
As you can see, cloud mining does not really fit into the concept of a security.
In fact, most cryptocurrency projects don’t.
You’re not buying an asset that can be considered an investment in the traditional sense. It’s a service contract that may or may not be profitable in the long run.
In our opinion the answer is no, cloud mining does not qualify as a security.