Web3 Legal Guide What are the legal risks of investing in overseas mining farms?

Navigating the Legal Risks of Investing in Overseas Mining Farms A Guide to Web3 Compliance

Since the issuance of the “Notice on the Rectification of Virtual Currency Mining Activities by the National Development and Reform Commission and other departments” (Development and Reform Operation [2021] No. 1283) (“924 Notice”), domestic mining has become practically impossible.

In that case, is investing in overseas mining farms a perfect alternative? Will investing in overseas mining farms suffer the same unwarranted disaster as the 924 Notice? In this article, Lawyer Mankun will discuss with you.

The main aspects involved in investing in overseas mining farms are domestic/foreign purchase of mining machines, selecting suitable locations, and conducting production and operations overseas.

01. Can mining machines be purchased domestically?

Mining machines are machines used to run mining programs and earn virtual currencies.

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Prior to the 924 Notice, buying and selling mining machines was essentially a normal sales contract. However, after the 924 Notice, mining was classified as a project “with high energy consumption and carbon emissions, low contribution to the national economy, limited driving force for industrial development and technological progress, and increasingly prominent risks arising from the production and trading of virtual currencies, which detrimentally impact the promotion of high-quality economic and social development and energy conservation and emission reduction.” As a result, the effectiveness of mining machine sales contracts can easily be deemed invalid by the court on the grounds of harm to public interests. After the contract is deemed invalid, the equipment costs and the equipment itself will be returned to each party.

A typical case is the Hu Xingrui v. Wang Gang sales contract dispute published by the Second Civil Division of the Supreme People’s Court in the Top Ten Commercial Cases of National Courts in 2022. In terms of the consequences of the court’s ruling, for the party buying the mining machine, the main risks associated with the determination of a mining machine sales contract as invalid are:

1. Loss of significant capital occupancy. The buyer has made the payment, but the seller has not delivered the goods, resulting in significant capital being tied up without recourse for loss of capital occupancy.

2. If the mining machine itself has quality issues, it is impossible to demand continued performance or compensation through legal means. Since the contract is invalid from the beginning, even if the seller delivers the mining machine, if quality issues arise and the seller refuses to resolve them, resorting to litigation would be in vain.

3. Loss of expected profits. In a bull market, if the price of the currency continues to rise but the seller breaches the contract and fails to deliver as agreed, the buyer’s anticipated mining income will be lost, and it will be difficult to obtain court support for this loss of expected profits.

In addition to civil risks, considering the 924 Notice and the current practice of domestic e-commerce platforms and second-hand trading platforms fully delisting and blocking mining machines and similar goods, in extreme cases, it is not ruled out that the act of purchasing mining machines domestically may be deemed as administrative illegal behavior by law enforcement agencies and thereby subject to administrative penalties.

02. Are there risks in exporting mining machines?

The “Foreign Trade Law,” “Export Control Law,” “Data Security Law,” and other related laws and regulations have established prohibitions or restrictions on the export of goods, technology, and services.

Regarding mining machines specifically, exporting companies should carefully determine whether the intended export of mining machines and their components falls under the national prohibition or requires prior export permits, based on the existing “Catalog of Prohibited Export Goods,” “Catalog of Export License Management Goods,” “Catalog of Prohibited Export and Restricted Export Technologies in China,” and “Catalog of Import and Export License Management for Dual-Use Items and Technologies.” If the intended export is for used equipment, it is necessary to legally assess, inspect, and dispose of the relevant information stored internally from a data security perspective. Otherwise, the mining machine exporting company may face administrative penalties, and in cases constituting a crime, criminal responsibility may be pursued.

For used mining machines, it is also necessary to avoid being classified as “solid waste” by the importing country during export, which could result in the risk of being required to return or be locally disposed of.

In addition, the transaction price of goods in international trade has always been the focus of customs supervision in various countries. During the process of exporting mining machines, cooperating with overseas import companies to modify key customs accompanying documents such as mining machine sales contracts or invoice prices may involve foreign criminal risks such as smuggling.

03. Can domestic companies directly mine overseas?

Domestic entities directly investing in overseas mining farms do not violate relevant domestic regulations, but this type of structural arrangement will be subject to multiple legal jurisdictions, and lawyer Man Kun does not recommend it. According to the provisions of the “Administrative Measures for Overseas Investment of Enterprises (NDRC Order No. 11),” Article 2, Article 5, Article 13, Article 14, as well as the “Notice on Further Guiding and Regulating the Direction of Overseas Investment (State Council General Office [2017] No. 74),” “National Development and Reform Commission <Notice on the Release of the Catalog of Sensitive Industries Overseas Investment (2018 Edition)> (Development and Reform Foreign Investment [2018] No. 251),” etc., virtual currency “mining” operations do not fall under the current regulations prohibiting or restricting overseas investment by domestic enterprises.

Therefore, according to the current laws and regulations of our country, domestic companies investing in overseas mining farms do not violate relevant domestic regulations. However, it is not recommended to conduct production and business activities directly in overseas locations without establishing local entities under the domestic entity, as this structural arrangement can lead to multiple legal jurisdictions and deprive the company of local tax advantages, legal protection, and market access, making it an unsuitable design for conducting overseas business.

04. Running mining operations overseas is not that easy either

The moon abroad may not always be round. The laws, regulations, and policy provisions regarding mining abroad may also lack coherence and stability, requiring thorough due diligence beforehand.

Many countries such as Canada, Australia, Iran, Ukraine, and certain state governments in the United States have legalized cryptocurrency mining through regulations, but usually require permits from regulatory authorities, known as “licensed mining.” If mining is conducted without permission or if mining is conducted in violation of the electricity conditions specified in the license, it will also face investigation or punishment by the regulatory authorities of that country.

According to Tasmin News Agency, in January 2021, Iranian authorities seized 1620 cryptocurrency “mining farms” and confiscated 45,000 Bitcoin “mining machines” because these “mining farms” illegally consumed subsidized electricity from the state-owned energy supplier Tavanir during the mining process.

According to Tencent News on April 16, 2022, the Iranian government will increase penalties for illegal cryptocurrency mining using subsidized electricity through new regulations. According to the new regulations, the increased penalties include at least tripled fines up to a maximum of five times, imprisonment for offenders, and revocation of business licenses for repeated violations. According to Reuters, in June 2021, the Iranian police confiscated 7,000 cryptocurrency “mining machines” in an abandoned factory in the capital, Tehran, for illegal “mining” without permission.

In addition to the risks associated with mining, some governments of countries experiencing energy shortages may impose temporary bans to control cryptocurrency mining activities. For example, on December 28, 2021, the Iranian government issued a ban on Bitcoin mining, ordering the closure of authorized Bitcoin mining centers to avoid an electricity shortage crisis. This ban will be in effect until March 6, 2022. Therefore, when investing in overseas mining farms, it is advisable to consult the relevant regulations of the country regarding mining activities, as failure to do so may result in hefty fines or confiscation of mining machines due to violations of laws or temporary bans.

For countries subject to international sanctions or foreign exchange controls (that recognize the legalization of Bitcoin), selling the cryptocurrency obtained from “mining” in that country or remitting foreign exchange may require compliance with their respective regulatory provisions. Failure to do so may result in legal risks such as frozen accounts, and may even face criminal charges for illegal activities such as capital flight, illegal transactions, money laundering, etc.

05. Suggestions from lawyer Man Kun

1. When signing mining machine purchase and sale contracts domestically, pay attention to the seller’s ability to perform. If subject to domestic law, the effectiveness of mining machine purchase and sale contracts may be considered invalid by the court, as it may be deemed to undermine the public interest.

2. The mining machine cannot be exported at will. Carefully determine whether the planned exported mining machine and its components belong to items prohibited from export by the country or whether relevant export permits need to be obtained in advance. If it involves internal storage information, data compliance is required.

3. The laws, regulations, and policies of foreign mining may not be coherent and stable, so a comprehensive due diligence should be conducted in advance.

References:

https://mp.weixin.qq.com/s/QlBHJzXOjkdZVv_QdtDimQ

https://www.defidaonews.com/media/6767976

https://medium.com/@metalaw.cn/%E4%B8%80%E6%96%87%E8%A7%A3%E6%9E%90%E8%99%9A%E6%8B%9F%E5%B8%81-%E5%87%BA%E6%B5%B7%E6%8C%96%E7%9F%BF-%E7%9A%84%E6%B3%95%E5%BE%8B%E9%A3%8E%E9%99%A9-23f9b00a51ba

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