Cryptocurrencies Not Custodied By Owners Are Now Subject to Securities Laws in Canada

Cryptocurrencies Not Custodied By Owners Are Now Subject to Securities Laws in Canada

On January 16th, 2020, the Canadian Securities Administrators (CSA) issued significant guidance related to cryptocurrency use throughout its jurisdiction. The regulator says cryptocurrency trading platforms that do not facilitate customers holding their assets themselves, must follow securities regulations.

Why do Cryptocurrencies in Canada Have to Follow Securities Laws?

In the past, securities regulators in Canada have maintained a ‘hands-off’ reputation when it comes to the regulation of cryptocurrency. Regulators have worried that the opposite approach would negatively impact innovation.

Instead, authorities in Canada have developed sandbox programs for companies to test and experiment with digital assets in a controlled and regulated environment. Regulators have also leaned on issuing warnings to investors regarding the risky and often times unregulated aspect of cryptocurrency trading.

After a major announcement, all of that has now changed. Following a series of recent events in Canada, regulation regarding both cryptocurrency trading platforms and custody will now see added requirements.

With the exception of those who have a received an exemption, companies providing cryptocurrency trading services in Canada — and even those outside Canada but who serve Canadian customers — can no longer hold the cryptocurrencies of their customers in pools maintained by the exchange. This is a stark difference from what has been allowed up until the guidance was issued.

In the announcement, the CSA says,

“Staff is aware that some Platform operators are of the view that the Platforms they operate are not subject to securities legislation because they only allow for transactions involving crypto assets that are not, in and of themselves, derivatives or securities. However, based on our analysis of how trading occurs on Platforms, we note that some Platforms are merely providing their users with a contractual right or claim to an underlying crypto asset, rather than immediately delivering the crypto asset to its users. In such cases, after considering all of the facts and circumstances, we have concluded that these Platforms are generally subject to securities legislation.”

In general, the OSC says there are some criteria which define when a platform is not subject to its securities regulations. In order for this to be the case, 1) the underlying crypto asset itself must not be a security or a derivative, and 2) the contract or instrument used in the purchase, sale, or delivery of the crypto asset results in immediate delivery of the asset and 3) is settled by that immediate delivery.

The QuadrigaCX Story Explained

The new guidance is likely a result of several past situations in Canada which negatively impacted investors. The most infamous of which stems from late 2018, involving QuadrigaCX.

QuadrigaCX was a cryptocurrency trading platform founded by Gerald Cotten. Unbeknownst to many, Cotten was nearly operating the platform by himself. Approximately 76,000 individuals used the platform — which held $250 million CAD worth of user funds.

In December of 2018, Cotten died after a battle with Crohn’s disease. The announcement of Cotten’s death was not immediately made to the public, as QuadrigaCX allowed customers to deposit funds for another ten weeks.

Apparently there was no back-up plan in the unfortunate case of Cotten’s death. He was the sole individual with access to the funds, resulting in thousands of users permanently unable to access $250 million CAD worth of assets.

Across the globe, a number of securities commissions are becoming increasingly active in the digital asset space. In the United States for example, SEC Chairman Jay Clayton has said the Initial Coin Offering (ICO) — a blockchain-powered fundraising method which raised nearly $6 billion in 2017 alone — is a securities offering. Hardly any however, sought the necessary exemptions or fulfilled their requirements to be compliant.

A number of other jurisdictions across the globe have issued similar guidelines. As a result, the ICO diminished, while the Security Token Offering (STO) emerged. The STO leverages the benefits of blockchain technology, but also constitutes a regulatory compliant securities offering.

In 2019, the security token industry saw notable progress. Many anticipate even more in 2020.

What do you think about Canadian Securities Administrators increasing their involvement in the cryptocurrency space? Is this an appropriate response to the situations Canada has faced? We want to know what you think in the comments section below.

Image courtesy of The Canadian Encyclopedia.

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