Most Canadian crypto exchanges likely fall under securities laws, according to new guidance

New guidance from the umbrella group for Canadian securities regulators indicates that many of the country's crypto exchanges will fall under national securities laws.

The Canadian Securities Administrators (CSA) published the notice on Thursday, which in part follows a published framework from March 2019 in which the group “stated that if crypto assets that are securities or derivatives are traded on a Platform, such Platform would be subject to securities legislation.”

In Thursday’s notice, the CSA stated that such laws “may also apply to Platforms that facilitate the buying and selling of crypto assets, including crypto assets that are commodities, because the user’s contractual right to the crypto asset may itself constitute a derivative.”

What's more, the guidance states that exchanges that maintain control of customer funds are subject to such laws, even if they don't necessarily trade assets that might be considered securities or derivatives. Non-custodial exchanges – that is, trading platforms that don't handle or control customer funds – appear more likely to not fall under them. 

As the group notes:

“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.”

It’s that “immediate” delivery aspect that may wind up capturing many of Canada’s current exchanges. The CSA notice includes an extended discussion on the nature of immediate delivery, ultimately noting that it would consider such an event occurring if the exchange:

• “...immediately transfers ownership, possession and control of the crypto asset to the Platform’s user, and as a result the user is free to use, or otherwise deal with, the crypto asset without further involvement with, or reliance on the Platform or its affiliates, and the Platform or any affiliate retaining any security interest6 or any other legal right to the crypto asset…”
• “[If] following the immediate delivery of the crypto asset, the Platform’s user is not exposed to insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the Platform.”

When reached for comment, Adam Goldman, founder and president of Canada-based Bitbuy, said that the company "is encouraged by the CSA adding clarity to its proposed framework in March 2019."

"Having a defined regulatory landscape will promote the cryptocurrency industry in Canada, and will provide platforms that seek to lawfully participate in the financial system a clear path forward, while at the same time protecting the rights of Canadians," he told The Block. 

Thomas Beattie, CEO of Canadian financial services firm Voleo, told The Block that he believes "the regulators nailed it."

"If I cut to the essence of what the CSA has done here, it is continuing their mandate of protecting the public. Too many scams and collapses have occurred for regulators to ignore the risk that the public faces when their funds are held by platforms that don’t segregate client assets or offer them appropriate protections," he said.

Legal perspectives

Cornell Law professor Robert Hockett told The Block that when a digital asset is not immediately delivered but stored on the exchange, there is a risk that the asset will lose its value, resulting in loss for the customers.

As such these exchanges are actually offering “the right to something in the future” that may expose investors to risk and speculation.

“They [Canandian regulators] are saying that… the distinction that really matters is a transaction where you are immediately receiving the underlying thing you are buying and a transaction where you have the right to something in the future,” Hockett said, adding:

“And because of the latter, the time-spanning commitment is inherently risk-prone and inherently speculative, and in that sense, it’s a security with the meaning of the laws we use to regulate security transactions and security exchanges.”

Christine Duhaime, a crypto legal expert based in Canada, described the move as “a solid move for consumer protection” in comments to The Block.

“I think they understand how exchanges and wallets work and are making all exchanges that take custody for any period of time of customer assets, subject to securities law, thereby eliminating any more risk to users in Canada,” she said, going on to note:

“But as an operator in Canada or a US or foreign one who on-boards Canadian residents, it makes them now subject to our securities law regardless of their coins listed.”

Duhaime added that there are more than a dozen regulators tied to securities oversight and that “it’s complicated here to do business although they try to each work together to ease the legal work.”

“It ends risky behaviour though, and finally in Canada gives exchanges a regulator,” she went on to say. “A place to call for guidance and to have legal certainty. The ecosystem needed that.”

In 2019, Canada became ground-zero for scrutiny of crypto exchanges when QuadrigaCX collapsed following the death of its operator, Gerald Cotten. The fall of QuadrigaCX is currently the subject of investigations by U.S. and Canadian authorities.

Last November, a crypto exchange called Einstein shut down, reportedly owing more than 16 million Canadian dollars to its customers.

“It might have some influence here in the U.S… because everybody is looking for guidance from everybody.”