Crypto-Mining to be qualified as Alternative Investment Fund (AIF)
This post’s scope
While it seems clear to many legal experts that native Cryptocurrencies like Bitcoin (BTC) or Monero do not qualify as Security Tokens, a lot of discussion worldwide is going on in relation to regulation of mining activities. Read, for example, the article Mining Bitcoin in the cloud is like renting a money printer and or Philippines’ SEC Demands Crypto Cloud Mining Contracts To Be Registered As Securities
The purpose of this post is to consider whether crypto-mining qualifies as an-to-be regulated activity mainly based on the Alternative Investment Fund Managers Directive 2011/61/EU (“AIFMD“). This Directive aims to provide for an internal market for AIFMs and a harmonised and stringent regulatory and supervisory framework for the managing of alternative investment funds within the Union of all AIFMs, including those which have their registered office in an EU Member State (EU AIFMs) and those which have their registered office in a third country (non-EU AIFMs). Provisions of the AIFMD require specific authorizations and reporting and disclosure requirements assuring that the financial market authorities have the information they need to monitor financial systems in the EU as well as to fulfill their investor protection duties .
Please note that we are not lawyers but industry people. For the purpose of this post, we had discussions with lawyers and regulation experts but by no means this post should be regarded as a legal opinion. Our intention is to create awareness and start a discussion around crypto-mining, regulation, and investors protection. As a matter of fact, crypto-mining is a space with many bad actors, scams and fraudulent schemes. Hence, we consider regulation (within reasonable limits) as an appropriate remedy to make the crypto-space safer for investors and good actors.
What are we talking about — AIF Definition
Under the EU Directive for AIFMD (2011/61/EU) , an alternative investment fund or “AIF” is defined as follows:
any collective investment undertaking, including investment compartments thereof, which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors. AIFs are investment funds that are not undertakings for collective investment in transferable securities (UCITS) and do not require authorisation pursuant to the UCITS Directive.
Both open-ended and closed-ended vehicles and listed as well as unlisted vehicles can be AIFs for the purposes of the Directive. The term “collective investment undertaking” is not defined either in the Directive or under European law.
The basic definition of an AIF can be cornered by the following key elements (see UK FCA Handbook for example):
- collective investment undertaking (CIU) with
- a pooling of capital
- raised from investors (direct or indirect)
- for the purpose of investment
- based on a defined investment policy with a view for the benefit of those investors in accordance with that policy, and
- the intention to generate pooled returns for those investors.
It’s important to understand that the term undertaking in the context of the AIFM Directive covers a wide range of entities and goes beyond the Glossary definition of undertaking. Furthermore it includes legal entities (profit, non-profit), partnerships, unincorporated associations and funds set up as a trust.
Finally, for the qualification of a venture as an AIF, it is immaterial whether:
- the activity takes place once, on several occasions or on an ongoing basis;
- the transfer of capital is in the form of subscriptions in cash or in kind.
Collective Investment Undertaking, Control, and Operational Activity
Investors of a collective group typically have no day-to-day discretion or control over the investment. That’s typically done by a dedicated management. Day-to-day discretion or control is defined in the ESMA final report as:
a form of direct and on-going power of decision — whether exercised or not — over operational matters relating to the daily management of the undertakings’ assets and which extends substantially further than the ordinary exercise of decision or control through voting at shareholder meetings on matters such as mergers or liquidation, the election of shareholder representatives, the appointment of directors or auditors or the approval of annual accounts.
An AIF is any undertaking for collective investment including its sub-funds thatgathers capital from a number of investors in order to invest the funds received according to a pre-determined investment policy for the benefit of those investors, without the capital gathered directly serving any operational activity.
Licensed or registered AIF Managers
In order to be allowed to manage AIFs, an alternative investment fund manager must be licensed as an AIFM. If the AIF managed by the AIFM does not exceed certain asset thresholds, they may simply register their services instead of obtaining a license.
In this context, it should be noted that registered-only AIFMs are not permitted to market any AIFs to retail investors or qualified retail customers or to engage in cross-border marketing or cross-border management.
Crypto-Mining Ventures as Collective Investment Undertaking (CUI)
Given the AIF/AIFM definitions and explanations above, it’s pretty clear that crypto-mining undertakings with a collective group of investors (people) and shared infrastructure definitely (in our opinion) qualify as collective undertakings in the sense of the legal meaning.
A collective crypto-mining venture is typically defined by
- pooling of capital (in cash or in kind),
- defined investment policy (crypto-mining resources to participate as a pool in blockchain-related crypto-mining activities)
- generation of pooled returns (cryptocurrencies such as Bitcoins or Ether)
- the absence of investor’s day-to-day discretion.
Usually, crypto-mining ventures are offered with two alternative business models:
- Cloud-mining: investors simply buy hash-rates via FIAT or crypto from the pool (e.g. Genesis Mining) and receive a respective share of the pooled returns (mined cryptocurrencies)
- Hosted Mining: investors purchase one or more dedicated mining servers from the mining operator (or a related company) which are afterwards pooled and hosted by the mining operator (e.g. Wachsende Werte in Austria)
Under both business modells, investors are pooling their invested capital without having a day-to-day discretion and/or control over their investments. Typically, those crypto-mining ventures are part of large mining pools, i.e. they are a sort of multi-level pooling organization which gives the single cypro-mining venture and their respective investors even less control over their investments.
That said it’s pretty obvious that crypto-mining ventures typically have to be qualified as AIF under the respective national laws and so the national AIFM regulation applies. Because of the broad definition of undertaking it doesn’t matter how the crypto-mining venture is structured and organized in detail. Actually, some crypto-mining ventures such as the Austrian Wachsende Werte deploy a rather complicated structure with for-profit entities selling mining hardware and non-profit entities pooling the mining hardware and the mining returns.
Crypto-Mining and Operational Activity
According to the definition of AIF, the capital raised from investors has to be used for investment purposes on the basis of a defined investment policy.
Typically, a crypto-mining venture gathers capital to purchase exclusivly mining equipment. The operation of the venture is then financed by a percentage of the mining returns. Furthermore, the operational activities of a crypto-mining venture are neglectable in relation to the investment activities. The operational activities comprise the initial implementation of a crypto-mining infrastructure and the administration of the cryptomining infrastructure. Once, the mining infrastructure is set up and mining servers are installed the operation typically runs for 24 to 36 months without any further operational activities required.
We would argue that the operational activities of a traditional i.e. real estate AIF are quite comparable to the operational activities of a crypto-AIF regarding volume (time and/or capital) and nature of the activities (set-up, maintenance, controlling and administration, etc.).
Many crypto-mining ventures such as Wachsende Werte in Austria are structured like typical investment funds with a vehicle for the operational activities and a separate vehicle for the crypto-mining activities which could be regarded as a sort of sub-fund.
Conclusion: Crypto-Mining definitly could be qualified as AIF
Considering all arguments, it is pretty obvious to us that crypto-mining ventures typically are to be considered as an activity covered by the Alternative Investment Fund Managers Directive (AIFM). Crypto-mining ventures definitely meet all criteria defined by the EU Directive.
It is immaterial for the AIF qualification whether the funds administered are provided by investors in cash, cryptocurrency, or mining hardware. Hence, even if the crypto-mining venture is structured as a 2-way-process with selling the mining server inthe first step and taking the server then back for hosting and mining operation in the second step, it qualifies as AIF.
Treating crypto-mining ventures as AIF would significantly increase investor protection in the crypto-space. AIF Regulation e.g would require crypto-mining ventures to have reasonable equity levels. Furthermore, people (AIFM) managing the business have to be registered resp. licenced and are therefore sufficiently reliable and also are experienced people.
The possibility to address retail investors in multiple jurisdictions requires a specific licence. Several EU member states offer a “regulation-only” alternative for AIF managers but this alternative does not permit to address retail investors and, additionally, a regulated-only AIF manager may not operate across multiple jurisdictions.
What about Crypto-MLM schemes then?
At the moment Crypto-MLMs focused on crypto-mining such as Nexus Global typically address retail investors across multiple jurisdictions. Being qualified as an AIF would require specific reporting and disclosure as well as an AIFM who could be hold responsible for any wrongdoings.
Today, those Crypto-MLMs operate as unregulated, non-licensed, and non-registered collective investment undertakings. They usually raise millions of FIAT from retail investors globally without any prospectus and without any upfront investor protection.
This post is meant as the start of a a discussion. In case you have some input to our thoughts please come back and contact us. If you liked the post please give us your hands and clap. Thank you for your attention.