A new era for crypto

The rise of cryptocurrencies has seen multiple twists and turns over the years. Recent efforts to bring trading platforms into compliance with securities regulations are an indication that crypto-assets are entering a new era.

In late March, the Canadian Securities Administrators (CSA) released long-awaited new guidelines for trading crypto-assets. A few weeks later, Purpose Investments, a Toronto-based investment firm, became the first North American company to offer Bitcoin and Ether exchange-traded funds (ETF). Both trade on the Toronto Stock Exchange.

"We're so proud to be a part of this," says Som Seif, founder and CEO of Purpose Investments. "We believe crypto will be more acceptable to consumers over time and we're excited as a Canadian company to be leading in this market."

The CSA's staff notice, which provincial securities commissions adopted, gives crypto entrepreneurs a two-year window to become registered as investment or marketplace dealers.

At the same time, the Ontario Securities Commission issued a statement asking crypto companies to contact the OSC by April 19 to begin "compliance discussions" or face penalties. As of May 25, more than 70 platforms, including 17 platforms based outside of Canada, have contacted the OSC to begin the process.

One company that did not reach out to OSC is Poloniex, an international crypto market based in Seychelles. The OSC filed a Statement of Allegations against Poloniex, stating the company failed to contact the regulator while continuing to serve Ontario residents.

Getting through the interim period will be tricky. Alix d’Anglejan-Chatillon, a partner and co-head of the Financial Products and Services Group at Stikeman Elliott, describes the regulatory environment as a "zigzag course that will be demanding and unpredictable."

"The Canadian platforms will have no option but to work with regulators and get on board," she says. "Foreign platforms will do a cost/benefit analysis on what it takes to keep Canadian users. Some platforms will decide to leave."

One reason Bitcoin and other cryptocurrencies have been so disruptive in the financial services market is that consumers can access digital assets, such as cryptocurrencies that use blockchain, without involving third-party intermediaries.

To be sure, crypto markets are still volatile. Bitcoin lost nearly $750 billion in value when Tesla announced it would stop accepting Bitcoin as payment and Elon Musk began to promote a new "joke" crypto, Dogecoin. The Chinese national bank also banned online payment channels from using crypto.   But in spite of being repeatedly dismissed as a fad, they are increasingly becoming part of the financial landscape.

Seif began to invest in crypto in 2017 out of curiously. He saw long-term potential and in 2018, he approached the Ontario Securities Commission (OSC) and the CSA to discuss regulatory reform. More than 50 organizations responded to a 2019 CSA consultation paper.

"When you have a novel idea, you want to have a long-term relationship with the regulator," says Seif. "The regulator is there to make a better industry. They're trying to understand and support innovation but generally playing catch up with the industry. They have to protect investors, which is very important. If you don't have a strong relationship with the regulator, then it's very hard to lead in innovation because there won't be a strong collaboration on the principal value to the innovation."

Most mainstream investors have avoided using crypto because the securities commissions didn't regulate them. Having crypto ETFs opens new opportunities for retail investors to enter the market.

"The ETFs are a big win for the Canadian market and for our regulators who will be seen to have taken leadership with this move," says Ramandeep Grewal, a partner at Stikeman Elliott. "The regulators are saying, 'we know you're out there, we're willing to work with you,' and are acknowledging the work it will take to bring applicable players within the regulatory fold."

According to the CSA staff notice, the purpose of having a two-year interim period is to balance the flexibility needed to foster innovation in Canadian capital markets and promoting investor protection. Dealer and marketplace platforms can continue operating while going through the registration process with provincial securities commissions and the Investment Industry Regulatory Organization of Canada (IIROC). Registration typically takes two years so the interim period allows platforms to continue operating while coming under the regulatory umbrella.

The driving force behind regulatory reform is protecting the public.

Cryptocurrency is stored in digital wallets protected by passwords. A lost password could mean losing millions. When Gerald Cotten, the CEO of QuadrigaCX, died in 2018, investors lost nearly $200 million in assets because no one had Cotten's passwords to client accounts. Cotten's company was one of the largest Bitcoin exchanges in Canada and the OSC found the company was built as a Ponzi scheme.

"Canadian regulars are seeking to strike the right balance of regulation - investor protection and innovation - but the process is still unfolding," says Alix d'Anglejan-Chatillon, partner and co-head of the Financial Products & Services Group at Stikeman Elliott. "There's an explosion of new business models."

Beyond the pandemic, self-directed investing and the growing acceptance of cryptocurrencies are fuelling growth. As consumers get more comfortable with crypto, there will be a greater need for regulation.  The long-term solution is for the CSA to work with other countries to create a worldwide self-regulatory regime, says d'Anglejan-Chatillon. "It's difficult to escape regulation," she adds. "Most credible platforms know they have to embrace some regulation to be best in class. They turn it into a competitive advantage."

Seif hopes his company can leverage its first-of-its-kind offering into new business opportunities. He sees the future of crypto going beyond financial services. "The question is, what platforms will evolve and develop?" he says. "Bitcoin's value is that it has a structured limited supply and demand is increasing. Ethereum is building technology that has a broader opportunity to change society. Right now, it's like the early 1990s with the internet. It's exciting to see what will happen in the next 5 to 10 years."

Expect a few more twists to the plot.