Some Bitcoiners may surprise you by their warm welcome of the SEC’s efforts to rein the crypto industry. Bitcoin is classified as a commodity, not a security. Therefore, “Bitcoin maximists” have seen the crackdown both as a moral and tactical victory. The “laser-eyed” set doesn’t hesitate to share Gary Gensler’s skepticism about more centralized tokens such as Solana and Cardano, or even good old Ethereum.

This article is part of CoinDesk 2023 Mining Week sponsored by Foundry.

Bitcoin, and other proof-of work tokens that are similarly structured, are commodities instead of securities. This is because there isn’t a central entity collecting capital in exchange for the promise of future returns. Proof-of-work chains like Bitcoin are a protocol and not a product or platform. You can participate in the common enterprise by following the rules.

If you’re looking to get into crypto, but don’t want to risk being caught by the SEC, then you should probably hold Bitcoin. The SEC’s legal adventures in 2023 have seen a steady increase in “Bitcoin dominance,”, or Bitcoin’s market share.

This does not mean that bitcoin miners can be completely exempt from SEC risk. In fact, it is very easy to wrap commodity Bitcoin in arrangements that clearly are securities contracts. This nuance, in light of the recent split decision in the SEC case against Ripple may offer some insight on the relationship between the token itself and the contracts, agreements and transactions that surround it.

Cloud mining: The dark side

Cloud miners were initially targeted by SEC action in 2015 for offering colocation and management to make mining easier, similar to other cloud providers such as Amazon Web Services.

Read more: Anthony Power, How Miners are Preparing for Bitcoin’s Next Halving

Many early cloud miners had flawed business models. Cloud mining contracts vary, but they typically offer a certain amount of computing power, or hashrate, for a fixed monthly cost. It was a form of security because it implied that a standard performance would be maintained for the management and use of a pooled resources. The model was also prone to fraud, and this became the bigger problem.

“The reputational cloud [of cloud-mining] has been an affront to our entire industry,” Kent Halliburton says, President and COO at Sazmining (for a detailed explanation of hosted mining and cloud mining see below). “Because many people were hurt and hosed. We asked, if hashrate is being sold, how can you be selling a security? We wanted to be completely clear about it.”

Cloud mining is flawed from a regulatory and trust perspective because selling hashrate is a guarantee that a certain output will be achieved over time. This depends on the management expertise of the seller. Deception and poor management are also possible: cloud miners have, either maliciously or incompetently, sold more hashrate that their machines were capable of generating, and ended up running ponzi scheme-like schemes by using new buyer money to keep up.

The SEC charged Josh Garza’s GAW Mining in 2015, and it was probably the most famous cloud mining scam. Cloud miners still exist: in 2022, a company called Mining Capital Cloud Corp faced fraud charges.

Is ‘hosted mining’ a safer option?

This does not mean that all services related to remote mining are securities by nature.

Matt Walsh, a partner at Castle Island, a Bitcoin-centric VC company says: “I believe the structuring is very important.” What are you exposed to? “A passthrough or a physical machine?”

Castle Island invests in River Financial. This is one of several firms that offer “hosted mining”, or “mining-as-a-service”, as an alternative to the cloud mining model. These firms do not sell hashrate but individual machines instead. They charge monthly fees for remote control. Sazmining and Compass offer hosted mining services.

Hosted mining firms, among other features, allow customers to monitor their machines in real-time, reducing the chances of deception or overcommitment. Sazmining, according to Halliburton, sends block rewards straight into owners’ wallets. This eliminates the risk of custody. Although they give estimates of output, returns can vary depending on network conditions.

If you work hard, everything is secure

These contrasts can be applied to other aspects of crypto- and securities law. Cloud mining and hosted mining are similar to different models of offering third-party stake services for proof-of -stake systems. Kraken agreed to shut down its staking services and pay a small SEC penalty in February. Coinbase, however, has pledged to challenge the classification for its staking services as securities offerings.

Read more: Jeff Wilser, Crypto Miners are Pivoting To AI (Like Everybody Else).

According to some analysts, Kraken’s staking service is a yield-bearing product that involves more management intermediaries. Coinbase acted instead as a direct conduit to the on-chain stake systems, without engaging in any management or strategy for customers.

Celsius is a good example of how to transform boring Bitcoin mining in to the regulatory equivalent of radioactive wast. While posing as a safe crypto “bank”, Celsius engaged in high-risk speculation on an unorganized mishmash assets and ideas. It turns out that one of them was a small Texas mining operation that was disposed following Celsius’ bankruptcy.

The mining operation, while only a small part of Celsius’ business model (a wildly reckless and disorganized speculation), was implicated in SEC allegations that Celsius had violated securities laws. Even if you ignore Celsius’ fraud, anyone who deposits money into a crypto fund and receives returns from a mining operation that they do not manage is putting their money at risk.

Paraphrasing the Howey Test: that’s how to turn an innocuous orange into a contract for producing an orange, and an otherwise harmless thing into a risky securities contract.

Ben Schiller is the editor.