The Virtual Currency Regulation Review: Canada
Securities and investment laws
Securities regulation in Canada is primarily a matter of provincial jurisdiction. While each province and territory has its own rules and securities regulators, the securities regulatory framework is largely streamlined and harmonised across Canada, with certain provincial or regional variances.2 However, legislative jurisdiction in the area of derivatives is divided between the federal and provincial governments, and the harmonisation of rule-making in this area has been more elusive.
Generally, the basic purposes of the securities laws are to provide protection from unfair, improper or fraudulent practices, foster fair and efficient capital markets, and confidence in those capital markets, and contribute to the stability of the financial system and the reduction of systemic risk.3 Securities regulation in Canada generally governs the distribution and trading of both securities and derivatives. The distribution and trading of securities and derivatives is primarily regulated through the imposition of prospectus requirements, dealer, adviser and investment fund manager registration requirements, and certain requirements imposed upon those operating exchanges, alternative trading facilities or other marketplaces that facilitate their trading, as well as related reporting and disclosure requirements.
The Canadian Securities Administrators (CSA) is an umbrella organisation of Canada's provincial and territorial securities regulators whose objective is to improve, coordinate and harmonise regulation of the Canadian capital markets. The CSA has published three staff notices with respect to virtual currencies with a view to being responsive to the evolving activity related to virtual currencies: Staff Notice 46-307 – Cryptocurrency Offerings,4 Staff Notice 46-308 – Securities Law Implications for Offerings of Tokens;5 and Staff Notice 21-327 – Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets.6 The CSA and Investment Industry Regulatory Organization of Canada (IIROC) also published a more comprehensive joint consultation paper7 (the Consultation Paper) seeking input on various considerations relating to the potential regulation of virtual currencies. Jointly, the Staff Notices and the Consultation Paper have helped provide insight into the evolution of securities law as it applies to cryptoassets. Some contextual insight was also provided through the report (the Quadriga Report) published by the Ontario Securities Commission (OSC) of the collapse of Quadriga Fintech Solutions Corp (Quadriga).8 While ultimately no enforcement action was taken (given the passing of the main principal at Quadriga), the Quadriga Report signals that although investor protection remains the utmost priority, Canadian regulators are also committed to fostering innovation and competition in this industry.
i Applicability of Canadian securities laws to virtual currencies
Virtual currencies may be subject to Canadian provincial securities laws to the extent that a virtual currency is considered a security or a derivative for the purposes of such laws, such as the Securities Act (Ontario). The Securities Act defines a security to include, among other things, an investment contract. The seminal case in Canada for determining whether an investment contract exists is Pacific Coast Coin Exchange v. Ontario (Securities Commission),9 where the Supreme Court of Canada identified the four central attributes of an investment contract, namely:
- an investment of money;
- in a common enterprise;
- with the expectation of profit; and
- which profit is to be derived in significant measure from the efforts of others.
If an instrument satisfies the Pacific Coin test, it will be considered an investment contract and, therefore, a security under Canadian securities laws.
The application of the Pacific Coin test to virtual currencies is not always straightforward, however. Industry participants have taken the position that utility tokens, which have a specific function or utility beyond the mere expectation of profit (such as providing their holders with the ability to acquire products or services) should not be considered securities.10 This position appears to have been accepted by the CSA and IIROC in the Consultation Paper, in which it was acknowledged that proper utility tokens may not be securities. However, the CSA has also noted that most of the offerings of virtual currencies purporting to be utility tokens that its staff had reviewed involved the distribution of a security, usually in the form of an investment contract.11
The CSA and IIROC have also acknowledged that it is widely accepted that some of the well-established virtual currency assets that function as a form of payment or means of exchange on a decentralised network, such as Bitcoin, are not currently in and of themselves, securities or derivatives and have features that are analogous to commodities such as currencies and precious metals.12 In assessing whether a particular virtual currency will be considered a security subject to Canadian securities laws, the CSA will consider the substance of the virtual currency over its form.13 The CSA has outlined a number of considerations in determining whether an investment contract exists. While no single factor is determinative, the CSA has stated that the existence of some or all of the following circumstances may cause a virtual currency to be considered an investment contract:14
- the underlying blockchain technology or platform has not been fully developed;
- the token is immediately delivered to each purchaser;
- the stated purpose of the offering is to raise capital, which will be used to perform key actions that will support the value of the token or the issuer's business;
- the issuer is offering benefits to persons who promote the offering;
- the issuer's management retains a significant number of unsold tokens;
- the token is sold in a quantity far greater than any purchaser is likely to be able to use;
- the issuer suggests that the tokens will be used as a currency or have utility beyond its own platform, but neither of these things is the case at the time the statement is made;
- management represents or makes other statements suggesting that the tokens will increase in value;
- the token does not have a fixed value on the platform;
- the number of tokens issuable is finite or there is a reasonable expectation that access to new tokens will be limited in the future;
- the token is fungible;
- the tokens are distributed for a monetary price; and
- the token may be reasonably expected to trade on a trading platform or otherwise be tradable in the secondary market.
A particular virtual currency that meets the criteria of the Pacific Coin test or has certain of the characteristics described in the CSA guidance discussed above may be properly considered an investment contract and therefore a security, subject to Canadian securities laws.
ii Virtual currency offerings in Canada
Canadian securities laws generally require the filing of a prospectus to qualify any distribution of securities. No person or company may trade in a security where the trade constitutes a distribution unless a prospectus has been filed or the trade is made in reliance upon a prospectus exemption. Securities originally distributed under a prospectus exemption are generally subject to resale restrictions that require the issuer to have been a reporting issuer (i.e., a public company) for a specified period of time and, in some cases, that the securities be held for a specified period of time. To the extent that a virtual currency is considered a security or a derivative, the issuance or distribution to the public is subject to prospectus, qualification or similar requirements, or must be effected pursuant to applicable exemptions from prospectus or derivatives qualification requirements.
There are a number of options available for distributing securities in Canada on a prospectus-exempt basis, generally referred to as exempt distributions or private placements. Most of these are harmonised under National Instrument 45-106 – Prospectus Exemptions.15 The CSA has indicated that persons wishing to distribute virtual currencies may do so pursuant to these exemptions.16 Specifically, distributions may be completed pursuant to the accredited investor exemption, which provides a prospectus exemption for trades of securities to entities and individuals that are qualified accredited investors.17
Distributions may also be made to investors who do not qualify as accredited investors in reliance on the offering memorandum prospectus exemption.18 To rely on this exemption, investors must be provided with a written document that contains certain prescribed disclosure, but this exemption does not require the same level of disclosure as a prospectus. Importantly, an investor has certain rights in connection with this type of investment, including a two-business-day withdrawal right and a right of action for rescission or damages if the offering memorandum contains a misrepresentation.19 Non-reporting issuers (generally, unlisted companies) that rely on the offering memorandum exemption will generally be required to provide to the applicable securities regulatory authority audited annual financial statements and a notice describing how the money raised has been used. The financial statements and notice must be made available to investors within 120 days of each financial year end.
A number of companies have successfully completed virtual currency offerings in compliance with applicable securities law requirements and bespoke exemptions from such requirements. Montreal-based Impak Finance Inc (Impak) was the first Canadian company to complete a virtual currency offering with the approval of Canadian securities regulators. Impak issued Impak Coin (MPK), a virtual currency based on the Waves blockchain platform, for gross proceeds of over C$1 million by way of private placement, in reliance on the offering memorandum exemption.20
A few months later, Token Funder Inc (Token Funder) completed the first virtual currency offering under the oversight of the Ontario Securities Commission (OSC). Token Funder was established for the purpose of creating a smart token asset management platform that is intended to, inter alia, facilitate capital raising by third-party issuers through the offering of blockchain-based securities, including tokens and coins.21 Token Funder issued its virtual currency, FNDR, in reliance on the offering memorandum exemption. In this case, the OSC granted an exemption from the dealer registration requirement for a period of 12 months from the date of the decision, subject to a number of conditions similar to those imposed on Impak.22
In May 2019, ZED Network Inc (ZED) became the first company to obtain exemptive relief from the prospectus and dealer registration requirements (discussed below) under Canadian securities laws for the distribution and trading of the ZED digital remittance and foreign exchange blockchain tokens to (1) money transfer operators (MTOs) registered as money services businesses in Canada with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC Registered MTOs), and (2) MTOs appropriately registered or authorised to operate as money services businesses, or its equivalent, in accordance with the laws of foreign jurisdictions (Foreign Registered MTOs), as applicable.23
More recently, on 27 March 2020, the OSC granted a time-limited exemption to B2C2 OTC Ltd (B2C2) from the dealer registration and prospectus requirements that would otherwise be applicable to a trade in or distribution of an over-the-counter (OTC) derivative between B2C2 and a 'permitted counterparty' in Ontario, New Brunswick, Newfoundland and Labrador, Prince Edward Island, the Northwest Territories, Yukon and Nunavut.24 The underlying interest of the OTC derivatives that will be entered into between B2C2 and a permitted counterparty may consist of, among others, 'a currency, including fiat and cryptocurrency'. B2C2 will also become a 'market participant' under Ontario securities law and, as such, must comply with applicable books and record-keeping requirements.
It is important to note, however, that B2C2 is a London-based OTC market maker that is regulated by the Financial Conduct Authority (FCA) in the United Kingdom and licensed to transact with institutional and other non-retail clients in relation to certain specified investments. It is likely that the regulation by the FCA and the restriction of the regulated activities to non-retail permitted counterparties were material factors in the B2C2 decision. In an important decision, the OSC granted TokenGX Inc (TGX), an affiliate of Token Funder Inc (TFI), a time-limited exemption to facilitate secondary trading on a platform known as Freedom (FRX). TGX obtained registration as an exempt market dealer until 16 April 2021, subject to some restrictive terms and conditions. This enables qualified investors in Ontario to purchase and sell certain tokens on the FRX platform.
Importantly, TGX cannot distribute securities of investment funds without prior OSC approval, must treat all tokens traded as securities, must not take custody of tokens for its clients and must ensure that purchasers of tokens on FRX who are not accredited investors are subject to the same eligible and non-eligible caps as outlined above. Additionally, TGX must file the requisite forms to seek membership with IIROC and become an alternative trading system for securities law purposes, both within six months of the date of the order.25
The experiences of Impak, Token Funder, ZED, TokenGX and B2C2 demonstrate the importance of bespoke exemptions in ensuring Canadian securities laws are met while meeting the demands of Canadian investors.
iii Regulatory considerations for intermediaries
Any person or company engaging in, or holding themselves out as engaging in, the business of trading or advising in securities, and, in certain Canadian jurisdictions, in derivatives, must register as a dealer or as an adviser or, where available, conduct these activities pursuant to an exemption from the dealer or, as the case may be, adviser registration requirement under the applicable securities laws. A person or entity that directs the business, operations and affairs of an 'investment fund' must comply with the investment fund manager registration requirements or obtain an exemption from such requirements. Registration requirements are generally harmonised under National Instrument 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations,26 which sets out requirements for dealers and advisers dealing with capital, proficiency, insurance, financial reporting, know your client, investor suitability, client disclosure, safekeeping of assets, record-keeping, account activity reporting, complaint handling and other compliance matters.
In Canada, the requirement to register as a dealer or adviser is triggered where a person or company conducts a trading or advising activity with respect to securities or derivatives for a business purpose.27 The mere holding out, directly or indirectly, as being willing to engage in the business of trading in securities may trigger the requirement to register as a dealer; however, a number of factors must be considered when determining whether registration is required, including whether a business:
- engages in activities similar to a registrant;
- intermediates trades or acts as a market maker;
- carries on an activity with repetition, regularity or continuity;
- expects to be remunerated or compensated; and
- directly or indirectly solicits.28
In the context of virtual currency distributions, the CSA has noted the following additional factors in determining whether a company may be considered to be trading in securities for a business purpose:29
- soliciting of a broad range of investors, including retail investors;
- using the internet to reach a large number of potential investors;
- attending public events to actively advertise the sale of a virtual currency; and
- raising a significant amount of capital from a large number of investors.
The CSA has stated that persons facilitating offerings of virtual currencies that meet the business trigger must collect know your client information and perform suitability assessments to ensure that purchases of virtual currencies are suitable, including with respect to investment needs and objectives, financial circumstances and risk tolerance.30
The creation and marketing of products related to virtual currencies are also subject to derivatives-related regulatory requirements, including in relation to qualification, registration and trade data reporting in a number of Canadian jurisdictions, including specifically Quebec, where the rules in relation to OTC and exchange-traded derivatives are more fully developed.31
The CSA has also issued proposals to establish a harmonised framework of registration and business conduct requirements for OTC derivatives market participants.32 The proposals expressly define a commodity to include a cryptocurrency.
iv Exchanges and other platforms
As marketplaces, exchanges are regulated pursuant to their applicable provincial securities statutes, as well as National Instrument 21-101 – Marketplace Operation (NI 21-101),33 National Instrument 23-101 – Trading Rules (NI 23-101)34 and their related companion policies.
NI 21-101 defines a marketplace as a facility that brings together buyers and sellers of securities, brings together the orders for securities of multiple buyers and sellers, and uses established non-discretionary methods under which the orders interact with each other.35
An exchange is a marketplace that may:
- list the securities of issuers;
- provide a guarantee of a two-sided market for a security on a continuous or reasonably continuous basis;
- set requirements governing the conduct of marketplace participants; or
- discipline marketplace participants.36
To operate as an exchange in Canada, a person or company must first apply for recognition as an exchange or for an exemption from the recognition requirement.37 As another type of marketplace, alternative trading systems, which provide automated trading systems that match buyer and seller orders, are also regulated under NI 21-101 and NI 23-101.
It follows that exchanges or other platforms that facilitate the purchase, transfer or exchange of virtual currencies that are considered securities or derivatives may be subject to recognition requirements as securities or derivatives exchanges or marketplaces.38 In the institutional market, prescribed or negotiated exemptions may be available in respect of platform-related recognition requirements under securities or derivatives laws, subject to the satisfaction of certain conditions and acceptance by the applicable regulators.
The guidance set out in Staff Notice 21-327 further expands upon the circumstances in which the CSA will consider 'any entity that facilitates transactions relating to crypto assets' to be subject to securities legislation requirements relating to platform recognition. Mainly, the CSA has cautioned that securities legislation may also apply to platforms that facilitate the buying and selling of cryptoassets, including cryptoassets that are commodities, because the user's contractual right to the cryptoasset may itself constitute a derivative. This will generally be the case where the platform is determined to be merely providing users with a contractual right or claim to an underlying cryptoasset, rather than immediately delivering the cryptoasset.39
While regulators will consider all the terms of the relevant contract or instrument, the CSA has taken the view that if there is no immediate delivery of the cryptoasset, then securities legislation will generally apply. Immediate delivery will be considered to have occurred if:
- there is immediate transfer of ownership, possession and control of the cryptoasset and the user is free to use, or otherwise deal with, the cryptoasset without any further involvement with, or reliance on the platform or its affiliates, and the platform or any affiliate retaining any security interest or any other legal right to the cryptoasset; and
- following the immediate delivery, the user is not exposed to insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the platform.
Other factors to be considered include:
- contractual arrangement between the platform and the user;
- immediate settlement of transaction;
- margin and leverage trading;
- typical commercial practice with regard to immediate delivery;
- immediate transfer to a user's wallet; and
- ownership, possession or control over the transferred cryptoasset.
To date, no virtual currency trading platform has been recognised as an exchange, or otherwise authorised to operate as a marketplace or dealer in Canada.40 As such, the CSA has kept a watchful eye, however, and urged Canadians to be cautious when buying virtual currencies. The CSA has issued a steady stream of market advisories alerting market participants to risks related to products linked to virtual currencies, including futures contracts, on both regulated and unregulated platforms.41,42
v Asset management and investment funds
The demand for economic exposure to virtual currencies is high and investment funds have been a popular vehicle for obtaining this exposure. However, persons operating or administering collective investment structures that hold or invest in virtual currencies may also be subject to investment fund manager registration requirements in addition to dealer, adviser and prospectus or private placements requirements. The structures themselves may also be subject to reporting and conduct requirements that apply to investment funds.
In September 2017, First Block Capital Inc became the first registered investment fund manager (IFM) in Canada for a fund dedicated solely to investments in virtual currencies.43 The British Columbia Securities Commission (BCSC) granted First Block Capital registration as an IFM and exempt market dealer in order to operate a Bitcoin investment fund, subject to certain bespoke exemptions from the applicable regime.44 In its decision, the BCSC imposed a number of conditions on First Block Capital, including the requirement to seek the prior approval of the BCSC to:
- establish or manage any virtual currency investment fund;
- change the investment objective of the virtual currency investment fund;
- change the entity that maintains custody of the specified virtual currencies held by any investment fund;
- change the entity responsible for the execution of trades in specified virtual currencies; and
- change the firm's policies and procedures used to value any virtual currency held by any investment fund managed by the firm.45
The BCSC also imposed a number of other obligations on First Block Capital with respect to oversight of the third-party custodians and brokers.46
Additional investment fund managers have also been approved by the CSA since the First Block Capital decision.47
The CSA has encouraged fintech businesses interested in establishing a virtual currency investment fund to consider:
- the prospectus requirements when distributing securities to retail investors;
- the legal and operational suitability of virtual currency exchanges;
- the registrations required with respect to the investment fund;
- the valuation methodology for the virtual currencies; and
- the virtual currency expertise of the custodian for the virtual currencies.48
Although certain virtual currency investment fund applications have been successful, it has proven difficult for these funds to become accessible to the general public. In October 2018, 3iQ Corp (3iQ) filed a non-offering preliminary prospectus on behalf of the Bitcoin Fund (3iQ Fund), a non-redeemable investment fund established as a trust under the laws of the province of Ontario, in its capacity as investment fund manager of the Fund.49
On 15 February 2019, the Director, Investment Funds and Structured Products (the Director) of the OSC decided that it would be contrary to the public interest to issue a receipt for the 3iQ Fund's preliminary prospectus.
On 15 March 2019, 3iQ and the 3iQ Fund made an application to the OSC seeking an order to set aside the decision of the Director to refuse to issue a receipt for the final non-offering prospectus of the 3iQ Fund and an order directing the Director to issue the receipt.50 The hearings were held in June and July 2019 before an OSC panel consisting of a single commissioner. The panel ordered that the Director's decision be set aside and that a prospectus receipt be issued for the 3iQ Fund.51 A preliminary prospectus was filed and a receipt issued on 27 November 2019.
Importantly, the 3iQ decision challenges the recent trend of expansive interpretation of the 'public interest' under securities legislation, offering a more restricted interpretation. Concerns about market manipulation and valuation were assuaged by the Fund's investment in Bitcoin, as opposed to all cryptoassets; its pursuit of a buy-and-hold strategy; and trading of Bitcoin only on regulated markets. The panel also found sufficient evidence of trading in Bitcoin for it to be considered a liquid asset, including trading on regulated exchanges. Furthermore, the decision signalled that the underlying regulatory objectives may ultimately be better serviced by encouraging market participants to enter through the 'front door', engaging regulatory oversight from the outset, rather than through transactions such as reverse takeovers.
The Financial Transactions and Reports Analysis Centre (FINTRAC) is Canada's financial intelligence unit. FINTRAC administers the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA)52 and its associated regulations, and assists in the detection, prevention and deterrence of money laundering and terrorist financing activities.53 The PCMLTFA applies to a wide range of regulated entities, including money services businesses (MSBs). It requires that reporting entities develop a risk-based compliance programme to identify clients, monitor business relationships, keep records and report certain types of financial transactions.54
Effective 1 June 2020, the PCMLTFA was amended to expressly regulate businesses dealing in virtual currencies.
To mitigate the money laundering and terrorist activity financing vulnerabilities of virtual currencies, while at the same time not excessively obstructing innovation, the final amendments did not target virtual currencies themselves, but the persons or entities engaged in the business of dealing in virtual currencies. These 'dealing in' activities include virtual currency exchange services and value transfer services. Persons and entities that are dealing in virtual currency would be financial entities, or domestic or foreign MSBs (FMSBs). As required of all MSBs, persons and entities dealing in virtual currencies must implement a full compliance programme and register with FINTRAC. Foreign MSBs are also subject to the same obligations (e.g., to register with FINTRAC, exercise customer due diligence, report transactions and keep records) for these activities. Furthermore, an FMSB found to be non-compliant with the PCMLTFA and its regulations could face an administrative monetary penalty, and in the case of a failure to pay, revocation of its MSB registration, making it ineligible to do business in Canada.
The final amendments define the term 'virtual currency' as:
- a digital representation of value that can be used for payment or investment purposes that is not a fiat currency and that can be readily exchanged for funds or for another virtual currency that can be readily exchanged for funds; or
- a private key of a cryptographic system that enables a person or entity to have access to a digital representation of value referred to in point (a).
The final amendments do not specifically outline what constitutes dealing in virtual currency, although guidance published in connection with the 9 June 2018 proposed amendments states that dealing in activities would include virtual currency exchange services and virtual currency transfer services.55 A virtual currency exchange transaction is defined to mean an 'exchange, at the request of another person or entity, of virtual currency for funds, funds for virtual currency or one virtual currency for another'.56
FINTRAC has also provided guidance to determine when the provision of services to persons located in Canada may subject an entity to FMSB registration. The guidance focuses primarily on whether the services are 'directed' to persons or entities in Canada and states that an entity will be considered to be 'directing' services if:57
- the business's marketing or advertising is directed at persons or entities located in Canada;
- the business operates a '.ca' domain name; or
- the business is listed in a Canadian business directory.
However, even where none of the foregoing criteria apply, FINTRAC has stated it is still possible that an entity may be considered to direct services at persons or entities in Canada based on a consideration of the following additional criteria:58
- describing services as being offered in Canada;
- offering products or services in Canadian dollars;
- making customer service support available to clients in Canada;
- seeking feedback from clients in Canada; and
- having another business in Canada promote the services to clients in Canada.
In addition to revising the definition of virtual currency, the amendments extend important record-keeping, reporting and identity verification obligations to MSBs, including foreign FMSBs. Notably, an individual's identity may now be verified using technology capable of assessing an identification document's authenticity. Furthermore, while an entity must still determine if the individual presenting the government-issued photo identification document matches the name and photo of the person, this process can now be done through digital means such as live video chats.
Quebec has enacted separate MSB legislation, which is administered by the AMF. The Money-Services Businesses Act59 requires that any person or entity who operates a money-services business for remuneration be registered as an MSB. MSB registration issues in Quebec should be considered in connection with any virtual currency businesses with a Quebec nexus.
Canadian federal legislation also provides for economic and political sanctions, including additional monitoring and reporting obligations and prohibitions. These rules include offences such as knowingly collecting or providing funds to terrorist organisations or associated individuals, or dealing with sanctioned governments, entities or individuals.
Regulation of miners
The process of virtual currency mining, which utilises specialised, high-speed computers, is energy-intensive. While virtual currency mining is not specifically regulated in Canada at this time, the use of virtual currency mining hardware may be subject to provincial or municipal requirements, or both, relating to the use of energy.
Canada's cold temperatures and low electricity costs make it particularly attractive for virtual currency miners.60 This increased demand for electricity has caused some provincial and municipal governments to re-evaluate how to process requests from virtual currency miners going forward.
On 25 April 2019, Quebec's Régie de l'énergie issued a decision61 regarding the rates and conditions for electricity use by blockchain (including virtual currency) clients. In its decision, the Régie de l'énergie, among other things, approved the creation of a new 'blockchain' consumer category and approved the creation of a reserved block of 300 megawatts (MW) for this category, of which 50MW must be allocated to blockchain projects of 5MW or less. On 5 June 2019, Hydro-Quebec launched a request for proposals with respect to the allocation of the 300MW block reserved for the blockchain consumer category. Projects will be evaluated based on economic and environmental criteria, including number of direct jobs in Quebec, total payroll of direct jobs in Quebec, capital investment in Quebec and total electricity use.
Criminal and civil fraud and enforcement
Given the relatively nascent stage of the market, the policing of virtual currencies and virtual currency offerings in Canada presents unique enforcement challenges for both criminal prosecutors and securities regulatory authorities. While most of the litigation in the virtual currency market to date has occurred outside Canadian borders, a few Canadian cases warrant discussion.
In 2017, PlexCorps undertook an initial offering of its own virtual currency, PlexCoin. PlexCorps distributed to prospective investors.62 On 20 July 2017, at the request of the AMF, Quebec's Financial Markets Administrative Tribunal issued various ex parte orders against PlexCorps, PlexCoin and related businesses, prohibiting them from engaging in activities for the purpose of directly or indirectly trading in any form of investment described in Section 1 of the Securities Act (Quebec),63 The orders effectively required PlexCorps to abandon the planned token offering. PlexCorps disregarded the order and pursued the offering.64 In July 2019, three individuals in connection with PlexCoin agreed to the reimbursement of 'substantially all the amounts' related to the PlexCoin project that were frozen by the Financial Markets Administrative Tribunal.65 In June 2020, the AMF instituted penal proceedings against these three individuals, charging them with seven counts of offences related to illegal distribution activities.66
In 2019, CoinLaunch Corp (CoinLaunch), a service provider based out of Ontario that operated in the emerging cryptoasset sector had been advertising a package of 'crypto consulting' marketing and promotional services and facilitated offerings to the public of Buggyra Coin Zero token (BCZERO) and the EcoRealEstate (ECOREAL).67 The OSC found that CoinLaunch engaged in and held itself out as engaging in the business of trading in securities, without registration under Ontario securities law where no exemption from the registration requirement was available. The OSC and CoinLaunch reached a settlement agreement.68
On 6 May 2019, the BCSC began investigating Einstein Capital Partners Ltd, Einstein Exchange Inc, Einstein Law Corporation and Michael Ongun Gokturk (collectively, the Einstein Group) after learning, among other things, that customer funds could be at risk from being accessed and repaid, and applied for a court order to preserve the Einstein Group's assets. The Einstein Group investigation is ongoing at the time of writing.
In December 2018, the sole officer and director of Quadriga, the operator of a platform that facilitated the purchase and sale of virtual currencies, died suddenly. It was alleged that this individual was the only Quadriga employee with knowledge of the encrypted passcodes required to gain access to Quadriga's virtual currency cold wallets and, as a result, upon the passing of the individual, the majority of Quadriga's virtual currency assets could not be located.
On 14 April 2020, the OSC published a report detailing the regulator's account of what had transpired at Quadriga, finding that the downfall of the cryptoasset trading platform resulted mainly from the fraud of Quadriga's co-founder and CEO, which included fraudulent trading, covering shortfalls with clients deposits and misappropriation of funds.69 The report found that client assets were not segregated from the platform's own funds, clients did not have control over those assets, and a mix of hot wallets and other cryptoasset trading platforms were used to store those assets, moreover without appropriate disclosure to clients. Other shortfalls cited in the report included inadequate books and records as well as proprietary trading by the CEO and founder with platform clients using alias accounts. Consistent with the guidance set forth in Staff Notice 21-327, the OSC also noted that the fact that the platform retained custody, control and possession of client assets and delivered those assets only following withdrawal requests brought it within the realm of securities regulation, with such client entitlements constituting securities or derivatives.
Notably, however, the OSC was careful to note that such misconduct should not be understood to apply to the cryptoasset platform industry as a whole and that '[p]roperly conducted, cryptoasset trading is a legitimate and important component of [the Canadian] capital markets', and it remains committed to working with this industry and to foster innovation.
i Taxation of virtual currencies
For Canadian tax purposes, the Canada Revenue Agency (CRA) has taken the position that virtual currencies constitute a commodity rather than a currency.70 As such, gains or losses resulting from the trade of virtual currencies are taxable either as income or capital for the taxpayer.71 Whether a transaction is on the account of income or capital is a question of fact. As with any transactions in securities, the CRA examines the following criteria to determine the nature of a transaction:
- the primary and secondary intentions of a taxpayer;
- the frequency of transactions;
- the period of ownership;
- the taxpayer's expertise and knowledge of virtual currencies markets;
- the relationship between the virtual currency's transaction and the taxpayer's business;
- the time spent engaged in virtual currencies activities;
- the type of financing required to support the taxpayer's cryptocurrency activities; and
- the taxpayer's advertising of the activities, if any.
Where a transaction is considered on capital account, the taxpayer will be required to include in computing its income for the taxation year of disposition one-half of the amount of any capital gain (a taxable capital gain) realised in such year. Subject to and in accordance with the provisions of the Income Tax Act,72 the taxpayer will generally be required to deduct one-half of the amount of any capital loss (an allowable capital loss) realised in the taxation year of disposition against taxable capital gains realised in the same taxation year. Allowable capital losses in excess of taxable capital gains for the taxation year of disposition generally may be carried back and deducted in any of the three preceding taxation years or carried forward and deducted in any subsequent taxation year against net taxable capital gains realised in such taxation years, to the extent and under the circumstances specified in the Tax Act. Where a transaction is considered on income account, the resulting gains are taxed as ordinary income and the losses are generally deductible.
ii Virtual currency mining
The tax treatment of virtual currency mining will depend on whether the activity is undertaken for profit or as a personal endeavour.73 A personal endeavour is an activity undertaken for pleasure and does not constitute a source of income for tax purposes, unless it is conducted in a sufficiently commercial and business-like way. However, the mining of virtual currencies is likely to be considered a business activity by the CRA considering the complexity of such activity. The mining of virtual currencies would therefore require the taxpayer to compute and report business income in compliance with the Income Tax Act, including the rules with respect to inventory.
More precisely, the CRA has stated that Bitcoin received by a miner to validate transactions is consideration for services rendered by the miner.74 Where a taxpayer is in the business of Bitcoin mining, the Bitcoin received must be included in the taxpayer's income at the time it is earned. The CRA confirmed that the miner must bring into income the value of the services rendered or the value of the Bitcoin received, whichever is more readily valued, and in most cases, the CRA expects the value of the Bitcoin received to be more readily valued and, accordingly, this is the amount to be brought into income.75
iii Paying with virtual currencies
Where a virtual currency is used as payment for salaries or wages, the amount must generally be included in the employee's income computed in Canadian dollars.76 As a result of the qualification of virtual currencies as a commodity, the use of virtual currencies to purchase goods or services is subject to the rules applicable to barter transactions.77 Therefore, where virtual currencies are used to purchase goods or services, the value in Canadian dollars of the goods or services purchased must be included in the seller's income for tax purposes, rather than the value of the virtual currencies.78 However, the CRA has stated that the fair market value of the virtual currency at the time the supply is made must be used to determine the goods and services tax and harmonised sales tax payable on the purchase of a taxable supply of a good or service.79
iv Specified foreign property
The CRA has finally stated that virtual currencies situated, deposited or held outside Canada fall within the definition of specified foreign property, as defined in the Tax Act.80 As such, Canadian residents must report to the CRA when the total costs of virtual currencies situated, deposited or held outside Canada exceed C$100,000 at any time in the year by filing Form T1135 with their income tax return for the year.
v Collection of goods and services tax and harmonised sales tax with respect to virtual currency transactions
There is currently no legislation indicating how to address the collection of goods and services tax and harmonised sales tax (GST/HST) in virtual currency transactions. The CRA's position on the characterisation of virtual currencies for GST/HST purposes is equally unclear. On 17 May 2019, the Department of Finance sought to clarify this issue by releasing draft legislation81 amending the Excise Tax Act (ETA)82 to include explicit reference to virtual currencies. The proposed amendment adds 'virtual payment instruments' to the definition of 'financial instruments' in Section 123(1) of the ETA, thus rendering any sale of the virtual currency or transaction involving virtual currencies as a form of payment exempt from GST/HST collection. If the draft legislation is enacted and adopted as proposed, the changes would be effective as of 18 May 2019.
To achieve a balance between investor protection and innovation, the CSA has introduced the CSA regulatory sandbox, an initiative to support financial technology businesses seeking to offer innovative products, services and applications in Canada.83 The initiative, along with province-specific initiatives, such as the OSC's Launchpad, allow firms to register or obtain exemptive relief from securities law requirements, or both, under a faster and more flexible process than through a standard application, to test products, services and applications in the Canadian market on a time-limited basis.84 Regulated offerings of virtual currencies such as Impak Coin, FNDR and ZED and approvals of virtual currency investment funds, represent early success stories of the CSA regulatory sandbox.
On 30 June 2020, the Bank of Canada announced that, in cooperation with the Bank for International (BIS) Settlements, it will be launching a BIS Innovation Hub centre to 'advance fintech innovation within the central banking community'.85
Market events such as those described in this chapter have, however, highlighted certain risks that the CSA is seeking to address through rule-making and exemptive relief. It is clear that while Canadian securities regulators will attempt to make and enforce rules that foster innovation, and fair and efficient capital markets, they will seek to prioritise investor protection, particularly in the retail space.
In the Matter of Wealthsimple Inc
On 7 August 2020, the OSC granted Wealth Digital Assets Inc (WDA) time-limited relief from certain registrant obligations, relief from the prospectus requirement and derivatives trade data reporting requirements to allow WDA to trade cryptoassets and operate a platform that facilitates the buying, selling and holding of cryptoassets.86 WDA is a wholly owned subsidiary of Wealthsimple Financial Corp (WFC). WFC also owns Wealthsimple Inc, a Canadian registered adviser, and Canadian ShareOwner Investments Inc (ShareOwner), a registered dealer. This decision represents the first such authorisation for a platform that facilitates trading of cryptoassets through bespoke exemptive relief.
The decision is subject to conditions dealing primarily with trading restrictions, third-party due diligence, platform operations and reporting requirements, including:
- trading only of Bitcoin and Ether, through 'crypto rights contracts', using cryptoassets or Canadian dollars;
- investment limits of C$30,000 over a 12-month period;
- maintenance of custody by Gemini Trust Company, LLC, a New York trust company regulated by the New York State Department of Financial Services and a 'qualified custodian' under Canadian securities law;
- due diligence of WDA's cryptoasset liquidity providers to address regulatory status;
- operation of a closed-loop system to minimise fraud, money laundering and client error;
- filing of annual unaudited financial statements until such a time when audited financial statements are available;
- reporting of aggregate client and trade volume data;
- compliance with Canadian anti-money laundering legislation and monitoring of client activity; and
- providing clients with educational and informational updates on an ongoing basis.
WDA must also work 'actively and diligently with IIROC' to ensure a transition from the WDA platform to ShareOwner. Importantly, WDA will not operate as a marketplace or clearing agency.
The relief is to expire on the earlier of 24 months or the date WDA transitions the platform to ShareOwner. The OSC noted that the decisions should not be taken to be precedent-setting. Nevertheless, In the Matter of Wealthsimple Inc represents an important development in the Canadian fintech community by demonstrating that conventional regulatory frameworks can be adapted to meet the demand for cryptoasset trading platforms.
1 Alix d'Anglejan-Chatillon, Ramandeep K Grewal and Éric Lévesque are partners and Christian Vieira is an associate at Stikeman Elliott LLP.
2 While the province of Quebec has a separate Derivatives Act that regulates over-the-counter and exchange-traded derivatives, derivatives regulation in the remaining provinces is governed by the securities and, in certain provinces, commodities futures legislation.
3 Securities Act, R.S.O. 1990, c. S.5, s. 1.1.
4 Canadian Securities Administrators, Staff Notice 46-307 – Cryptocurrency Offerings (2017), 40 OSCB 7231 (Canadian Securities Administrators, 2017).
5 Canadian Securities Administrators, Staff Notice 46-308 – Securities Law Implications for Offerings of Tokens (Canadian Securities Administrators, 2018).
6 Canadian Securities Administrators, Staff Notice 21-237 – Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets (Canadian Securities Administrators, 2020) (Staff Notice 21-327).
7 Canadian Securities Administrators and Investment Industry Regulatory Organization of Canada, Consultation Paper 21-402 – Proposed Framework for Crypto-Asset Trading Platforms (Canadian Securities Administrators and Investment Industry Regulatory Organization of Canada, 2019) (the Consultation Paper).
8 Ontario Securities Commission, QuadrigaCX: A Review by Staff of the Ontario Securities Commission, 14 April 2020.
9 Pacific Coast Coin Exchange v. Ontario (Securities Commission),  2 SCR 112, which is itself based on the better known 'Howey Test' set out by the Supreme Court of the United States in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
10 ibid., footnote 5.
11 ibid., footnote 7.
12 ibid., footnote 7.
13 ibid., footnote 5.
14 ibid., footnote 5.
15 Ontario Securities Commission, National Instrument 45-106 – Prospectus Exemptions (2018).
16 ibid., footnote 4.
17 ibid., footnote 4.
18 ibid., footnote 4.
19 ibid., footnote 14 at s. 2.9.
20 Ontario Securities Commission, AMF Impak Finance Decision, 16 August 2017.
21 Ontario Securities Commission, OSC Token Funder Decision, 17 October 2017.
23 Ontario Securities Commission, OSC ZED Network Decision, 21 May 2019.
24 Ontario Securities Commission, B2C2 OTC Ltd, Re, 27 March 2020, 43 OSCB 3429.
25 Ontario Securities Commission, TokenGX Inc, Re, 22 October 2019, 42 OSCB 8511.
26 Ontario Securities Commission, National Instrument 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations.
27 Ontario Securities Commission, Companion Policy 31-103 CP – Registration Requirements, Exemptions and Ongoing Registrant Obligations.
29 ibid., footnote 4.
30 ibid., footnote 4.
31 Autorité des marchés financiers, Notice relating to the public offering of derivatives on cryptocurrencies and other innovative assets (22 May 2018).
32 Canadian Securities Administrators, Notice and Request for Comment – Proposed National Instrument 93-102 Derivatives: Registration and Proposed Companion Policy 93-102 Derivatives: Registration (published 19 April 2018 for comment until 17 September 2018), and Notice and Second Request for Comment – Proposed National Instrument 93-101 Derivatives: Business Conduct and Proposed Companion Policy 93-101CP Derivatives: Business Conduct (published 14 June 2018 for comment until 17 September 2018).
33 Ontario Securities Commission, National Instrument 21-101 – Marketplace Operation (2018).
34 Ontario Securities Commission, National Instrument 23-101 – Trading Rules.
35 ibid., footnote 31.
37 ibid., footnote 4.
38 Canadian Securities Administrators, CSA Investor Alert: Caution Urged for Canadians Investing with Crypto-Asset Trading Platforms, 6 June 2018.
39 ibid., footnote 6.
40 ibid., footnote 6.
41 For example, the CSA reminds investors of the inherent risks associated with virtual currency futures contracts (18 December 2017). OSC Study: Lack of understanding of crypto assets puts Ontarians at risk (28 June 2018).
42 CSA Investor Alert: Caution Urged for Canadians Investing with Crypto-Asset Trading Platforms (6 June 2018).
43 British Columbia Securities Commission, B.C. Securities Commission grants landmark bitcoin investment fund manager registration (6 September 2017).
47 See, for example, Canadian Securities Administrators, Majestic Asset Management; Canadian Securities Administrators, Rivemont Investments Inc; and Canadian Securities Administrators, 3iQ Corp.
48 ibid., footnote 4.
49 Ontario Securities Commission, OSC 3iQ Corp. Decision, 15 February 2019.
50 3iQ Corp. Press Release: 3iQ Appeals Decision of OSC Director on The Bitcoin Fund. 19 March 2019.
51 Ontario Securities Commission, 3iQ Corp. and The Bitcoin Fund, Re, 20 October 2019, 42 OSCB 8673.
52 Proceeds of Crime (Money Laundering) and Terrorist Financing Act, S.C. 2000, c.17.
53 Financial Transactions and Report Analysis Centre of Canada, FINTRAC Annual Report Maximizing Results Through Collaboration, 2017.
54 ibid., footnote 51.
57 Government of Canada, Foreign Money Services Businesses (FMSBs), 1 June 2020.
59 Money-Services Businesses Act, CQLR, c. E-12.000001.
60 Hooman B, 'Crypto-miners flood into Canada, boosting the hopes of small towns looking for a break', Financial Post, 9 April 2018.
61 Régie de l'énergie decision D-2019-052 (29 April 2019).
62 Jonathan Montpetit, 'Alleged Cryptocurrency fraud by Quebec company highlights need for more regulations, experts say', CBC News, 6 December 2017.
63 Quebec Securities Act, 1982, c.48; 2001, c.38. s.1.
64 Autorité des marchés financiers, AMF urges utmost caution regarding solicitations relating to PlexCoin, 3 August 2017.
65 Autorité des marchés financiers, Recent developments regarding PlexCoin, 3 October 2019.
66 Autorité des marchés financiers, AMF brings penal proceedings against three individuals, 19 June 2020.
67 Ontario Securities Commission, CoinLaunch Corp. Re, 24 July 2019, 42 OSCB 6515.
69 Ontario Securities Commission, QuadrigaCX: A Review by Staff of the Ontario Securities Commission, 14 April 2020.
70 Canada Revenue Agency, Document No. 2013-0514701I7, 23 December 2013.
71 Canada Revenue Agency, Fact Sheets & Taxpayer Alerts, What You Should Know About Digital Currency, 17 March 2015.
72 Income Tax Act, RSC 1985, c.1.
73 Canada Revenue Agency, Document No. 2014-0525191E5, 28 March 2014.
74 Canada Revenue Agency, Document No. 2018-0776661I7, 8 August 2019.
75 ibid., footnote 73.
76 ibid., footnote 72.
77 ibid., footnote 68.
78 ibid., footnote 70.
79 ibid., footnote 69.
80 Canada Revenue Agency, Document No. 2014-0561061E5, 16 April 2015.
81 Department of Finance Canada, Draft Legislation Relating to the Excise Tax Act, 17 May 2019.
82 Excise Tax Act, RSC 1985, c. E-15.
83 Canadian Securities Administrators, CSA Regulatory, Sandbox, 2018.
85 Bank of Canada, 'Bank of Canada partners with the Bank for International Settlements to launch innovation centre', 30 June 2020.
86 Ontario Securities Commission, In the Matter of Wealthsimple Digital Assets Inc, 7 August 2020.