Many Canadian crypto businesses decided to comply with crypto regulations that won’t arrive until 2020. At the same time, Canada’s regulators are going after fraudulent ICOs. Can regulators and crypto companies learn to work together? Here’s how Canadian crypto regulation is shaping up in 2018.
The story so far…
In mid-2018, CoinIQ did a deep dive into cryptocurrency regulation in Canada. While we won’t repeat everything here, it is worth reviewing some of the main points. If you want all the details, check out the article.
As in many countries, Canada’s regulation of cryptocurrency is a work in progress. The most important regulations fall in two areas: anti-money-laundering (AML) and securities. AML regulations require businesses that handle money to know who they are dealing with and report suspicious behavior to the government. Securities regulations focus on protecting investors from fraud.
Crypto AML in Canada
For the past 4 years, Canadian crypto exchanges have operated in regulatory limbo. The Canadian Parliament passed legislation in 2014 classifying some crypto companies as money services business (MSBs). They would be required to register with the government, confirm their customers’ identities and report suspicious transactions.
A quirky aspect of the Canadian system, however, kept the law from going into force. FINTRAC, the Financial Transactions and Reports Analysis Centre of Canada, finally launched a 3-month public comment period on crypto MSB regulation in early June 2018 ahead of introducing the rules in 2019.
And then FINTRAC hit a snag.
Before Canada’s next national election in October 2019, the government enters a caretaker period and cannot issue major new regulations. That caretaker period would have overlapped with the introduction of the new crypto MSB rules.
So FINTRAC’s crypto MSB regulations are on hold until sometime in 2020 at the earliest.
Crypto securities in Canada
Canada’s debate over initial coin offerings (ICOs) and whether tokens are securities mirrors those in other major financial centers. Many of the ICOs over the past two years collapsed due to incompetence or outright fraud. With rising awareness of crypto among the general public, Canada’s regulators believe extending securities regulations to token offerings will protect investors.
In 2017, the Canadian Securities Administrators (CSA) issued a staff notice advising fintech companies in general on “what obligations may apply under securities laws.” Canada’s provincial governments, which do the actual regulation and enforcement of securities laws, acted against several token-issuers that violated those laws.
At the same time, the provincial securities commissions want to support Canada’s crypto innovators. Several provinces have created regulatory sandboxes that waive certain regulations for crypto startups.
Preparing for FINTRAC
Regulation is coming. Even if FINTRAC put its plans on hold, the regulator will implement the new crypto MSB rules eventually. It’s simply a question of when. Many of Canada’s crypto exchanges, in anticipation of the regulations, are already changing the way they do business.
Some crypto exchanges already fall under FINTRAC’s existing regulations. These companies qualify as MSBs because they handle their customers’ fiat currency in one of three ways:
- Converting customers’ money from one fiat currency to another.
- Transferring customers’ money to another person or institution.
- Issuing or redeeming “negotiable instruments” like money orders.
Crypto exchanges provide any of these services, must register as a MSB. Coinsquare, for example, lets you convert between Canadian dollars and other fiat currencies. The exchange had to register with FINTRAC even though the KYC requirements alienate potential customers.
In a Globe & Mail story about Canadian crypto regulation, Coinsquare CEO Cole Diamond explained that AML/KYC procedures alienate some crypto traders from regulated exchanges. “Our revenue and trading volume could be at least five-times larger if we did not have an internal compliance regime.”
Registering as a MSB has other downsides as NDAX CEO Bilal Hammoud explained in a CoinIQ interview. “Banks don’t usually like to deal with money service businesses,” Hammoud said. “They consider that as a very high risk and it’s something that they don’t have the appetite for to start with. So being a money service business is definitely one of the biggest risks.”
Pure crypto-to-crypto exchanges, many bitcoin ATM operators and other crypto businesses won’t be subject to regulation by FINTRAC for a few more years. Even so, many have decided that they will follow the rules anyway.
These companies have put know-your-customer (KYC) procedures in place. Exchange employees designated as compliance officers develop and document these procedures and ensure everyone else in the company understands what to do. Reporting systems flag suspicious activity and pass the information on to FINTRAC.
This is why new customers at many Canadian crypto exchanges must go through the KYC process. Even if they only want to deal in crypto, customers must provide proof-of-identity and proof-of-residency before they can access an exchange’s full suite of features. The exchange will use that information to weed out, or “de-risk”, bad actors or flag suspicious accounts.
CoinIQ’s review of Vancouver-based Einstein Exchange pointed out that, despite not offering services subject to FINTRAC regulation, the pure-crypto exchange already complies with anti-money-laundering rules. In a recent communication with CoinIQ, Einstein Exchange CEO Michael Gokturk said, “We’ve had to de-risk dozens of accounts due to their illegal activities with respect to [FINTRAC regulations].” In comments quoted by The Globe and Mail, Mr. Gokturk explained that “the best exchanges will welcome regulation and transparency and that’s what we’re trying to do. We welcome it with open arms.”
BitBuy documents all of the things it does to comply with FINTRAC regulations despite not being an “official” MSB. Among the things the exchange does voluntarily:
- Employing a compliance officer.
- Conducting KYC and due diligence.
- Monitoring for suspicious activity.
- Voluntary reporting to FINTRAC.
Although none speak about it out loud, some soon-to-be-regulated crypto companies aren’t doing anything. For small businesses and startups, it may be a question of money and resources. Compliance has costs, so if the regulations are two years away, why worry about it?
That kind of attitude ought to raise red flags among potential customers. Developing the procedures, systems and culture needed to work in a regulated environment takes time. A company that kicks the can down the road may not be ready to work with FINTRAC.
Pushing compliance into the future is also a sign that the company’s leadership is willing to take shortcuts. How much effort have they put into securing their hot and cold wallets?
Securities on Canada’s Blockchains
Next year’s national election may not have much effect on the development of crypto-related securities regulation. Since securities regulation happens at the provincial level, the federal government’s caretaker period has less impact. At the moment, Canadian securities regulators are taking a three-pronged approach — education, enforcement and engagement — to protect investors, combat fraud and foster crypto innovation.
Regulators hope to raise awareness among investors of the risks involved in cryptocurrency trading. The CSA and Canada’s provincial regulators issued an investors alert in mid-2018 “urging Canadians to be cautious when considering buying crypto assets through trading platforms.” The alert emphasized that none of the crypto trading platforms are true exchanges or regulated marketplaces. Canada’s security regulators warned investors of the higher risks, since “key investor protections may not be in place.”
At the same time, regulators are working with the crypto industry to improve projects’ compliance with the nation’s securities regulations. A CSA Staff Notice helps a range of crypto companies navigate the regulatory landscape. Consider people providing advice on crypto investments, for example. They cannot discuss a token that their province considers a security without filing to become a registered investment advisor.
Going after bad ICOs
On the enforcement side, Canada’s securities regulators joined American regulators in a coordinated crackdown on ICOs called Operation Cryptosweep. Since its launch in May, Operation Cryptosweep now has more than 200 investigations underway.
“Sponsors of these products should seek the advice of knowledgeable legal counsel to ensure they do not run afoul of the law,” said the president of the North American Securities Administrators Association, Joseph P. Borg. “Furthermore, a strong culture of compliance should be in place before, not after, these products are marketed to investors.”
Working with Industry
Besides worrying about money-laundering or investment fraud, regulators in Canada want to work with the crypto industry. Fostering innovation in Canada’s financial sector is also a mandate for the regulators. Both sides of the table have launched several initiatives over the course of 2018.
The Blockchain Research Institute (BRI) hosted a roundtable on blockchain regulation attended by regulators, financial industry executives and entrepreneurs from the crypto sector. The BRI is a think tank founded by Don and Alex Tapscott, the authors of Blockchain Revolution: How the Technology Behind Bitcoin is Changing Money, Business, and the World.
The report summarizing the roundtable discussion made several recommendations for ways regulators can help the crypto industry.
- Allow banks to serve cryptocurrency businesses.
- Develop blockchain-based digital identification systems.
- Distinguish between the different kinds of tokens.
- Develop a national strategy for Canada’s blockchain industry.
“Canada is uniquely positioned to become the global hub for innovation in this second era of the internet,” said Don Tapscott. “If we are to do that, we need to bring stakeholders from a variety of different sectors together to establish common goals and work together to achieve them.”
The Canadian Securities Administrators and the provincial securities regulators created a regulatory “sandbox” for blockchain and other fintech companies. The regulators will waive certain regulations to lower the costs and risks for companies developing blockchain-based projects.
The Ontario Securities Commission joined the Global Finance Innovation Network. The group of 11 securities regulators want to collaborate on fintech-related policies that would benefit crypto companies. Among their proposals is a “global sandbox” that would help startups operate internationally.
Crypto in Canada’s fiat world
Several other developments show how blockchain technologies and cryptocurrency are gaining momentum in Canada’s financial sector.
The Bank of Montreal recently demonstrated the prototype for a blockchain-based settlement system that enables securities trading. Bank of Montreal’s Kelsey said, “We understand the potential that blockchain brings to the capital markets and we look forward to continuing to drive innovative solutions to help our clients.”
First Block Capital, a registered cryptocurrency investment company, launched the closest thing to a Bitcoin ETF yet. FBC Bitcoin Trust is a mutual fund trust that lets accredited investors buy units of without having to hold any bitcoin. In a similar vein, Coinsquare subsidiary Coincapital listed an exchange-traded fund that tracks the stocks of companies developing blockchain innovations.
Although the idea of regulations runs counter to the crypto-anarchy philosophies of many early crypto adopters, regulations are coming. Canada’s regulators have given the crypto innovators a lot of leeway. The crypto industry’s success over the past few years, however, now makes it big enough to matter.
The potential for fraud, money-laundering and other criminal activity is real enough that FINTRAC and other regulators must act to protect Canada’s investors. At the same time, regulators are acting in ways to foster crypto innovation.
The crypto industry and its future regulators aren’t marching in lockstep, but they are slowly drifting in the same direction.