Regulating cryptocurrency exchanges: Unclear definitions

Tuesday, March 03, 2020

In this, the first of our three-part series examining legal developments in the cryptocurrency arena, we take a look at the state of cryptocurrency regulation in Canada and elsewhere.

“The uncertainty about whether cryptocurrencies should be regulated as currency, commodities or securities continues both globally and especially in Canada,” said Lori Stein in Osler, Hoskin & Harcourt LLP’s Toronto office. “One of the threshold issues is whether cryptoassets that are not securities should be regulated as such.”

What is clear is that cryptoasset trading platforms, perhaps more commonly known as cryptocurrency exchanges, are top of mind for the Canadian Securities Administrators (CSA), who have evidenced their distaste for terminology that uses the word “exchange” in relation to cryptoasset trading.

“The difficulty is that ‘exchange’ is defined under securities legislation and these platforms are definitely not covered under that definition,” said Usman Sheikh in Gowling WLG’s Toronto office. “The core difficulty is that they combine the dealer, custody and marketplace functions while our laws — which did not contemplate the emergence of cryptoassets when they were formulated — presume a segregation of these roles.”

Only recently has meaningful regulatory guidance emerged in Canada.

“In a bulletin released in January, the CSA suggests that platforms which do not immediately transfer ownership, possession and control of all cryptoassets purchased by customers are likely dealing in derivatives or securities, and will be the object of enforcement under securities laws,” Stein said. “The CSA also provides guidance on their view as to when physical delivery actually happens.”

Still, although the CSA’s January bulletin does set out the conditions under which securities legislation would not apply, the position of platforms that deal in commodities or currencies, like bitcoin and ethereum, remains unclear.

“The bulletin puts platforms on notice that they may be engaging securities law even when they might be dealing in what may be regarded as a commodity if they have created a derivative or security relationship with the customer,” Sheikh said.

Complicating the scenario is the fact that context for the guidance is lacking.

“No cryptoasset dealers are currently registered with IIROC [Investment Industry Regulatory Organization of Canada] and no mechanism currently exists by which they can register,” Stein said. “So, what you have is a regulator prepared to enforce laws for which no framework is in place, which creates a great deal of uncertainty.”

Many “well-meaning” platforms who trade in cryptoasset securities, Stein adds, have registered as money services businesses with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and have anti-money laundering (AML) measures and policies in place. This despite the fact that dealers in virtual currency will not become reporting entities under Canadian AML laws until June 2020.

As it turns out, guidance on cryptocurrency regulation has not made much more progress on the international front.

“It’s only recently that IOSCO [International Organization of Securities Commissions] published its proposal for the regulation of cryptoasset platforms,” Stein said. “On the whole, there’s been a lot of discussion but not so much resolution.”

This having been said, the Ontario Securities Commission released a decision in October 2019 that would allow 3iQ, a Canadian investment manager, to offer the world’s first publicly traded bitcoin investment fund.

The OSC’s ruling reversed the earlier refusal of the director of the Investment Funds and Structured Products Branch of the OSC to issue a receipt for 3iQ’s preliminary prospectus.

“The notion of professionalizing investing in risky assets to mitigate risks should be encouraged, not discouraged,” the commission wrote. “Ontario capital market participants should be encouraged to engage with the commission, and not incentivized to avoid doing so. Pooling of investor funds under a professional management structure to address and mitigate risks in an underlying asset market is innovative and should be encouraged, especially when it provides an alternative to investors acquiring bitcoin through unregulated vehicles.”

The decision, then, bodes well for the future of cryptoasset investment vehicles.

“Overall, the decision is encouraging for the development of new fund products that invest in new asset classes and sends a strong message in support of innovation in capital markets in Canada,” Stein said.

This is the first in a three-part series.

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