We can look back to 2023 as a year of categorization and enforcement in the crypto space across the world, with significant local and international developments impacting the crypto markets and their regulation in Canada. This was no surprise, as such developments came following the turbulence of 2022 where many important crypto institutions crashed and went bankrupt, resulting in immense financial consequences for investors and users involved.
Attempts to qualify crypto assets at law, to develop applicable regulations and to enforce current legislation have multiplied since late 2022 and throughout last year. The Canadian Securities Administrators (CSA) released various staff notices to provide a more precise legal framework for crypto assets, including differentiated frameworks according to types of stablecoins. In general, regulators in the United States and Canada have been focused on integrating crypto trading platforms (CTPs) by clarifying and enforcing existing legislation,1 all the while courts have considered applying existing securities principles to crypto assets, which leads to interesting outcome differences in the US with SEC v Ripple Labs, Inc.2 and SEC v Terraform Labs Pte. Ltd.3
Crypto assets now undoubtedly represent a permanent asset class and many activities involving crypto assets give rise to distinctive legal risks and implications. In particular, arrangements involving these new assets, depending on the facts, can be subject to securities legislation as further discussed below. Failure to comply with applicable securities laws can result in significant penalties and enforcement actions. To avoid such consequences, it is critical that all participants in crypto markets understand how their activities will be treated under the current regulatory framework.
This update focuses on recent developments in the legal framework for securities in Canada as they apply to crypto activities and markets across the country.
Legal framework in Canada
There is no federal national statutory framework governing securities law in Canada since each province has its own securities regulator enacting specific legislation in the province. The CSA, however, generally acts as an umbrella regulatory body that includes provincial securities commissions and, among other things, is tasked with harmonizing the securities regulatory framework across Canada. Quebec’s Autorité des marchés financiers (AMF) and the Ontario Securities Commission (OSC), along with other provincial securities regulators, require compliance (unless otherwise specified) with CSA notices and other CSA regulatory initiatives on crypto assets.
Crypto assets such as Bitcoin, Ethereum and Tether are digital assets using distributed ledger technology, also known as blockchains. These blockchains are not controlled by a single central authority and are instead controlled by users through decentralized cryptographic consensus mechanisms. The functions, structures, governance and rights of these digital assets vary based on the different crypto products. With established crypto assets being increasingly traded, new crypto assets continuously emerging and securities regulators tightening control over these digital assets, demystifying the legal classification of crypto assets is more relevant than ever.
Nature of Crypto Assets
The main legal issue when crypto assets are involved is that of qualification and more precisely whether the relevant crypto assets constitute securities. The qualification of a particular crypto asset or crypto contract as a security is key in determining the applicable legal framework. The law, however, is still developing on this matter.
This question was addressed in 2018 by the CSA in Staff Notice 46-308 where it stated that determining whether a particular crypto asset is a security would be fact specific and depend on the particular circumstances of such crypto asset.4 Specifically, the CSA endorses a purposive interpretation of the investment contract test set out in Pacific Coast Coin Exchange v Ontario Securities Commission,5 which aims at investor protection. Staff Notice 46-308 sets out a non-exhaustive list of factors that may imply the presence of one or more elements of an investment contract, notably:
- The issuer’s management retains a significant number of unsold tokens from the offering or “pre-mines” a significant number of tokens before they are publicly available;
- Management makes statements suggesting that the tokens will appreciate in value, or compares them to other cryptocurrencies that have increased in value; and
- Management makes representations that tokens are reasonably expected or marketed to trade on crypto trading platforms or to otherwise be freely tradeable in the secondary market.
In its 2019 Consultation Paper 21-402, the CSA acknowledges that some of the well-established crypto assets such as Bitcoin are not currently per se securities or derivatives, but rather have certain features that are analogous to existing commodities such as currencies and precious metals.6 However, the CSA confirms in the same document that most crypto assets offerings have involved a distribution of securities taking the form of investment contracts.
Consultation Paper 21-402 also stated that “[if] crypto assets that are securities and/or derivatives are traded on a Platform, the Platform would be subject to securities and/or derivatives regulatory requirements.”7 In the same vein when ruling on a relief application, the OSC stated in 2021 that while “bitcoin, ether and anything commonly considered a crypto asset, digital or virtual currency, or digital or virtual token […] are not themselves securities or derivatives,” companies involved in trading these digital assets would be subject to securities legislation.8
This generally means the foundations for the application of securities legislation based on the nature of the crypto assets involved arise in two distinct situations: (1) during the initial coin offering (ICO) of such crypto assets and (2) the trading of such crypto assets on CTPs.
Applicability of Securities Legislation
If a crypto asset constitutes an investment contract and is consequently categorized as a security, any offering of such crypto asset is subject to securities laws. That a crypto asset qualifies or not as a security is particularly important in the context of an ICO because the issuer is, unlike CTPs, directly offering the assets to its “customers.” Courts have simply applied the Pacific test in these situations.
For instance, in a 2018 decision Quebec’s Tribunal administratif des marchés financiers (TMF) ruled that the ICO of PlexCoin, a new cryptocurrency about to launch at that time, constituted investment contracts subject to the Securities Act in Quebec.9 This conclusion was upheld by the Court of Quebec.10 While there may be some agreement among securities regulators and courts in Canada that Bitcoin specifically is not a security, courts notably distinguished Bitcoin from PlexCoin on the basis that, unlike the former, a group of a few identifiable people was effectively managing PlexCoin as well as its underlying project.11
Outside of ICOs, the activity of trading crypto assets on CTPs may be captured under securities legislation. CTPs are financial institutions that offer users the ability to transfer, hold and exchange various crypto assets. In Staff Notice 21-327 (SN 21-327) in 2020, the CSA states securities legislation may also apply to CTPs that facilitate the buying and selling of crypto assets if the user’s contractual right to the crypto asset traded itself constitutes a derivative or security.12 As such, securities legislation could be considered as applying to CTPs unless:
(i) the underlying crypto asset itself is not a security or derivative; and
(ii) the contracts or instruments for the purchase, sale, or delivery of a crypto asset
(A) results in an obligation to make immediate delivery, and
(B) is settled by the immediate delivery of the crypto asset to the user according to the typical commercial practice.
Immediate delivery in the above context means the immediate transfer of ownership, possession, and control of the crypto asset from the CTP to the user without the user having to further rely on the CTP for use, enjoyment, and control of that crypto asset. Most trading activities on CTPs do not involve immediate delivery. For this, the CSA published Staff Notice 21-329 in 2021 to provide guidance on the specific securities legislation requirements applicable to CTPs according to their business models and on the discretionary exemptive relief that CTPs may obtain from the CSA under appropriate conditions.13
After publishing an update in August 2022 in which the CSA required CTPs in Canada to file for registration with their principal regulators and provide a pre-registration undertaking (PRU), the CSA clarified the legal framework applicable to CTPs in Staff Notice 21-332 (SN 21-332) in February 2023.14 The CSA confirmed that, “CTPs that operate in Canada and trade securities or derivatives are required to comply with Canadian securities law requirements, including registering with securities regulators” and it imposed an obligation on CTPs to provide a complete PRU to their principal regulators15.
We note that registration requirements have been enforced on CTPs up to this day. In 2022, following a notification for registration from the OSC preceding SN 21-332,16 the Ontario Capital Markets Tribunal imposed severe sanctions on an unregistered CTP, including a permanent market participation ban.17 In September 2023, the TMF imposed a $2 million administrative penalty and ordered the closing of the non-compliant CTP’s website based, among other things, on CSA staff notices 21-327, 21-329, 21-330 and 21-332.18 To determine that a breach of a Securities Act has occurred, both decisions stated, consistently with the CSA in SN 21-327, that crypto contracts were investment contracts within the meaning of same set out in Pacific and its Quebec equivalent.19
In addition, SN 21-332 clearly states that “CTPs are prohibited from permitting Canadian clients to enter into crypto contracts to buy and sell any crypto asset that is itself a security and/or a derivative.”20 Registered CTPs must establish policies and procedures to determine the nature of crypto assets. Likewise, if a registered CTP that is made aware of or informed that a regulator or securities regulatory authority views any crypto asset as a security or derivative, in accordance with the terms of registration and the exemptive relief, it must “stop permitting its clients to buy or deposit such crypto asset through a crypto contract.”21
Under the current framework, CTPs must be aware of developments in case law and legislative enactments by regulatory authorities in Canada and abroad on the qualification of any crypto asset as a security or derivative.
Specific Requirements for Stablecoins
With Staff Notice 21-333 (SN 21-333), the CSA imposed specific regulations on issuers and CTPs involved in trading crypto assets that are designed to maintain a stable value over time by referencing the value of a fiat currency or any other value or right (or combination thereof), called value-referenced crypto assets (VRCAs), which are also known as stablecoins. The CSA was already of the view under SN 21-332 that VRCAs could “constitute securities and/or derivatives in several jurisdictions.” Further guidance from the CSA in SN 21-333 to registered CTPs on VRCAs states, among other things, that:
- registered CTPs had to contact their principal regulator as soon as possible on implementing the terms and conditions of the staff notice;
- issuers of fiat-backed stablecoins were expected to provide an undertaking to the CSA by December 1, 2023;
- registered CTPs had, by December 29, 2023, to stop offering VRCAs except those that reference Canadian or US dollars on a one-for-one basis and are backed by a segregated reserve of cash and cash equivalents, called fiat-backed crypto assets (FBCAs), and had to stop offering wrapped tokens; and
- registered CTPs will need to stop offering VRCAs (1) for which the issuer has not provided the required undertaking and (2) that do not publish audited annual financial statements and monthly assurance reports on reserve levels, as of April 30, 2024.
Under SN 21-333, CTPs will also have by April 30, 2024, to comply with additional requirements for prescribed disclosures, disclaimers in marketing materials and updated know-your-product policies and procedures, including monitoring compliance of VRCAs. These guidelines, however, are temporary and the CSA has invited both issuers and CTPs to submit information and comments on VCRA regulations.22 We can therefore expect upcoming regulatory developments on stablecoins in Canada.
Analysis and future considerations
To summarize the current situation: the classification of relevant crypto assets is of utmost importance both for ICOs and trading on CTPs. The investment contract test set out in Pacific remains the applicable way to determine if certain crypto assets are considered securities. Categorization is not just a requirement for CTPs and issuers since the CSA also published guidance concerning investment funds seeking to invest in crypto assets.23 We expect this trend of “categorization” by official institutions to continue in 2024.
Until now, securities regulators in Canada have been proactive, aware of developments in case law and in crypto markets, and aptly adapting and clarifying regulations surrounding economic activities involving crypto assets in Canada. Simultaneously, Canadian courts have broadly aligned with US case law developments in distinctive local decisions. Some international organizations are also providing guidance on crypto assets ̶ the International Swaps and Derivatives Association has released its “digital asset derivatives” definitions24 and the International Organization of Securities Commissions released consultation reports on crypto and digital asset markets and on decentralized finance.25
Regulatory frameworks applicable to crypto assets in Canada are evolving rapidly. It is important that interested participants in crypto markets conduct careful and exhaustive due diligence well before engaging in any activities involving crypto assets, and assess (and receive legal advice) on all applicable compliance requirements. Participants and their advisors should also familiarize themselves with both the guidance provided by Canadian regulators and with case law developments in Canadian courts in order to ensure compliance with all applicable requirements.
The author wishes to thank law student Éden Bélanger for his help in preparing this legal update.
