Mining For Virtual Currencies – The SEC Charges Fraud

Virtual currencies such as bitcoin have grown in popularity. With that popularity it may well have been inevitable that the SEC would bring enforcement actions centered on the new phenomenon, alleging fraud. A new variation of those actions is the predicate for the Commission’s most recent enforcement action in the area – mining for virtual currency. SEC v. Gara, Civil Action No. 3:15-cv-01760 (D. Conn. Filed Dec. 1, 2015).

The defendants in this action are Homero Joshua Garza, founder and CEO of GAW Miners, LLC. He also owned and controlled ZenMiner. Both companies are named as defendants.

Virtual currency can be “mined.” Not of course in the traditional sense of mining for gold but in the virtual sense. Mining for virtual currency is the process of solving equations to confirm transactions and earn new coins. Certain currencies such as bitcoin self-generate units of currency. “Miners” are those who run special computer software to solve complex algorithms that validate groups of transactions in the currency. They are rewarded with newly created coins if they are the first to solve the algorithms. As competition increases among minors, increased computer processing power or “hash rate” is required to solve the equations and receive the reward.

Mr. Gaza rapidly evolved his business operations from initially purchasing and reselling equipment for virtual mining through cloud hosting to selling Hashlets, the predicate of this case. The purchaser of Hashlets supposedly acquired the right to profits from a slice of the computing power owned by GAW Miners and/or ZenMiners. Hashlet owners were required to do little more than click-and-drag their Hashlet icons over to icons of the mining pools and select one. Profits were to come from the efforts of GAW Miners and/or ZenMiner.

Most investors acquired Hashlets through a web-based shopping portal with either U.S. currency or bitcoin. Press releases and the website claimed Hashlets were the “world’s first digital cloud miner.” Profits were to be posted to investor accounts each day.

Potential customers were told that Hashlets would always be profitable and never obsolete. They were also informed that Hashlets were engaged in mining for virtual currency through pools available in ZenCloud. Potential investors also learned that ZenPool engaged in mining.

Investors snapped up Haslets. Over about four months beginning in mid-August 2014 over 10,000 investors purchased units which ranged in price from $10 to $50. GAW Miners and ZenMiner raised at least $19 million.

Unfortunately the representations made about Hashlets were not true. Neither GAW Miners nor ZenMiners had anything close to the computing power for the Hashlets sold. Without the computing power the revenues from mining were minimal to nonexistent. To conceal this fact from investors GAW Miners used revenue from ongoing sales to fund payouts to investors – essentially Hashlets operated as a Ponzi scheme. While new investors were solicited for newly created opportunities, mining for virtual currency became less profitable. The scheme began to unwind. Variations of the scheme were announced to no avail.

The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23415 (December 1, 2015).