The burgeoning crypto ecosystem in Canada operates within a multi-faceted regulatory framework.
In 2014, Canada distinguished itself as the first country in the world to pass legislation specifically regulating the cryptocurrency industry. This milestone was accomplished when the Parliament of Canada enacted Bill C-31, which expanded the scope of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act to encompass Canadian cryptocurrency exchanges.
At the federal level (as well as in the Province of Quebec), dealers in virtual currency must register as money service businesses. Crypto asset trading platforms (CTPs), token issuers, and certain digital wallet providers commonly fall under this categorization, providing a baseline regulatory measure for crypto operations in Canada.
The Current Environment and Evolution of Crypto Regulation
However, the more contentious area is the application of provincial securities laws to the industry. The Canadian Securities Administrators (CSA) have overseen an evolving approach to this domain, resulting in the emergence of a regulatory structure of considerable complexity. Approximately 10 CTPs are currently registered as securities dealers (specifically, in the category of “restricted dealer”) under the CSA’s interim regulatory framework for centralized cryptocurrency exchanges. Another two are registered in the category of “investment dealer” with the Investment Industry Regulatory Organization of Canada (IIROC) as part of the CSA’s final regulatory framework, and another 10 have filed pre-registration undertakings (PRUs) with their principal regulator.
“Securities law may apply to trading activities where a user is granted a contractual right to crypto assets on a trading platform.”
The critical moment in the evolution of the relationship between cryptocurrency dealers and the CSA came with the publication of CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets in January 2020. This guidance interpreted securities law for CTPs, specifically in terms of how existing securities law might apply to the trading of cryptocurrencies. CSA Staff noted that securities law may apply to trading activities where a user is granted a contractual right to crypto assets on a trading platform (a so-called “Crypto Contract”, which is a novel concept that is by all accounts unique to Canada), which will give rise to a derivative that resembles a futures contract. CSA staff consider a CTP that sells a crypto asset – but does not immediately deliver that crypto asset to a user – to be subject to securities legislation. This is because the platform is merely offering a contractual right or claim to the underlying crypto asset, which enables the client’s right to future delivery of the underlying crypto asset, thus falling into the definition of a derivative.
This rather unique interpretation of securities and derivatives law allows the CSA to assert jurisdiction over CTPs that are trading in crypto assets that are not themselves securities or derivatives (such as Bitcoin). It allows the CSA to monitor and police platforms that, as a result of allowing users to custody their crypto assets on the exchange’s platform, subject their users to insolvency risk (credit risk), fraud risk, performance risk, or hacking risks.
This regulatory perspective has been supplemented by additional guidance documents. On March 29, 2021, the CSA and the IIROC jointly issued Staff Notice 21-329 Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements, which elaborated on the applicable regulatory requisites for CTPs in Canada, underlining that these platforms would not be subjected to newly introduced rules. Rather, the existing securities laws could be modified in the context of registration conditions, recognition, and discretionary exemption, thereby enabling CTPs to function within a regulated framework. The Notice further highlighted the need for a balanced approach to promoting capital market innovation and ensuring investor protection along with fair market practices. It differentiated between CTPs functioning akin to marketplaces (“Marketplace Platforms”) and those involved in the trading of security tokens or Crypto Contracts that do not fall under marketplace operations (“Dealer Platforms”). It was noted that certain CTPs may exhibit operational features of both types.
“To continue operating in Canada while pursuing registration, these platforms must now provide a publicly available undertaking.”
In August 2022, the CSA announced a new requirement for CTPs working toward registration under securities laws. To continue operating in Canada while pursuing registration, these platforms must now provide a publicly available undertaking. This move sought to create transparency for Canadian users about the regulatory status of various CTPs.
A significant recent development in crypto securities law came in February 2023 with the publication of CSA Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings Changes to Enhance Canadian Investor Protection, setting out changes to enhance Canadian investor protection. This established a stricter PRU and prompted a 30-day timeline for unregistered CTPs operating in Canada to fulfill new requirements.
“Stablecoins serve an important function in the ecosystem, by permitting traders to quickly move in and out of volatile crypto positions without having to convert back into fiat.”
CSA Staff Notice 21-332 also provided some much-anticipated guidance on how stablecoins might be regulated in Canada (stablecoins being coins that are backed on a 1:1 basis with national currency or “fiat” in crypto parlance, in an effort to maintain stability). Stablecoins serve an important function in the ecosystem, by permitting traders to quickly move in and out of volatile crypto positions without having to convert back into fiat. Also, a wide variety of businesses now use stablecoins primarily as payment instruments, to make international remittances, to convert fiat currency for other fiat in a fast and cost-effective manner, and to pay their employees and independent contractors who may reside out of the country.
Notably, in CSA Staff Notice 21-332, the CSA proclaimed that Stablecoins (or Value-Referenced Crypto Assets or VRCAs, as they are called in the Notice – mainly because the CSA believe that calling them “stablecoins” is misleading) “may constitute securities and/or derivatives.” CTPs must obtain the consent of their principal regulator before trading stablecoins, and only fiat-anchored stablecoins will be permitted to be traded. CTPs trading stablecoins will be required to provide monthly reserve attestations, which must be professionally audited. There will be requirements on the nature and quality of the reserve assets held (i.e. must be cash or “highly liquid” securities) and a slew of mandatory disclosures which CTPs will be required to make to users. The CSA declared that transparency surrounding reserve of assets, governance, and stabilization mechanisms of their value are key issues “that require appropriate regulation” to protect stablecoin holders.
Challenges and Opportunities of Crypto Regulation
The current regulatory framework presents both challenges and opportunities. Notably, CTPs registered in accordance with the CSA’s interim and final framework face limitations on their product and service offerings. Prohibitions on trading derivatives, futures contracts, options, and other more exotic product offerings may limit choice for Canadian consumers and hinder the competitiveness of Canadian CTPs on a global scale. Canadian crypto enthusiasts may be tempted to use riskier, unregulated international platforms to purchase the products and services they are restricted from purchasing in their own country.
“Prohibitions on trading derivatives, futures contracts, options, and other more exotic product offerings may limit choice for Canadian consumers and hinder the competitiveness of Canadian CTPs.”
Additionally, the CSA’s position on stablecoins may have broader implications. Despite the fact that some stablecoins are more akin to prepaid products and payment instruments, the CSA maintains that stablecoins may constitute securities and/or derivatives, presenting potential conflicts with existing regulatory provisions governing consumer transactions, including the Consumer Protection Act in Ontario and the federal Bank Act.
However, Canada’s proactive stance on crypto regulation could be attractive to companies mired in regulatory uncertainty in other jurisdictions. Moreover, the stringent conditions applied to CTPs could help prevent significant loss of consumer and investor funds, as seen with the bankruptcies of Celsius and Voyager Digital, among others.
Towards a Prosperous Future
As Canada navigates the complexities of the crypto regulation landscape, a forward-looking, flexible approach is crucial. Recognizing that stablecoins and other crypto assets may require distinct regulatory considerations outside the scope of securities laws, there’s a need for bespoke legislation and regulation tailored explicitly to the crypto industry.
“Stablecoins and other crypto assets may require distinct regulatory considerations outside the scope of securities laws.”
Moreover, for crypto assets resembling traditional prepaid products and payment instruments, federal regulators should collaborate with their provincial counterparts and come to a consensus on jurisdictional issues. For example, there is a strong case to be made that certain fiat-anchored stablecoins should be regulated pursuant to the federal Bank Act or the incoming Retail Payments Activities Act (as opposed to being regulated by provincial securities legislation), notwithstanding that on a purely technical reading, these products may fall under the broad and comprehensive provincial securities regime.
In Canada, our securities law framework is based on a “catch and release” model, with broad, inclusive definitions of a security and a derivative, but with a multitude of specific exemptions for certain products because there may be an alternative framework available which protects investors. In the case of certain fiat-anchored stablecoins and other cryptocurrencies, new exemptions could be drafted into existing securities laws which would exempt these products from the ambit of securities regulation, since an alternative, slightly modified federal framework might be a cleaner fit.
“Regulatory “safe harbours” might serve to decelerate the current blockchain, crypto, and web3 brain drain happening right now in Canada.”
In essence, the ambition should be to cultivate an environment where consumers and investors are protected and informed, where innovation flourishes and where companies can take solace in regulatory “safe harbours” which might serve to decelerate the current blockchain, crypto, and web3 brain drain happening right now in Canada. By striking the right balance, Canada can set a global standard in the crypto regulation space, paving the way for a robust and inclusive future economy.
Moving forward, Canadian regulatory authorities (including provincial securities regulators and federal banking/payment regulators) must maintain an open dialogue with industry players, academics, and the public. More open and public consultation periods on proposed new crypto regulations and policies are desperately required. We are seeing far less public consultation on crypto regulation than was the case with other, less widely popular products and services, such as OTC derivative products. This seems counter-intuitive and could spurn discontent and misunderstanding. Canada cannot afford to continue to lose talent and the stream of revenue that this industry will continue to generate for years to come.
This discussion should not be limited to the crypto community but must also extend to traditional finance sectors, including the banking sector and the payment space, encouraging collaborations to capitalize on the unique strengths of fintech, finance, and crypto. Regulators need to be cognizant of the crypto industry’s dynamic nature and remain agile, updating their rules as the landscape evolves, but in a way that encourages feedback from industry and is actually customized and tailored based on that feedback.
A transparent and open rule-making process with more broad public consultation will result in greater inclusivity and buy-in from industry, and inter-jurisdictional cooperation and regulatory carve-outs for certain products will no doubt serve to staunch the Canadian crypto brain-drain.
In conclusion, Canada’s regulatory approach should not be seen as a fixed stance but rather as a continuously evolving perspective, responding thoughtfully (and not simply reacting) to the ever-changing crypto environment. A flexible, forward-looking regulatory approach will allow Canada to leverage the benefits of the crypto industry while mitigating potential risks, thus paving the way for a thriving and sustainable future economy.