Canada: A Reckoning Is Coming, But Cryptocurrencies Are Here To Stay

Last Updated: January 11 2018
Article by Matt Gold and David Kelman

Security, transparency and profitability are arguably the qualities investors value most.

Still, as we have seen over the past 12 months, investors have been willing to forgo transparency and security for the enormous profit potential of digital tokens, as their value offered through initial coin offerings (ICOs) has skyrocketed. The market during this time has seen unprecedented gains: a 6,000-per-cent increase in Litecoin, 8,000 per cent in Dash and an astonishing 39,000-per-cent price increase in Ripple.

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To grasp the impact in Canada, consider the S&P/TSX Composite index, which provided a steady annual return of 5.3 per cent over the past 12 months. In comparison, bitcoin over the same period provided a staggering return of 1,500 per cent.

As investor interest reaches a fever pitch, token issuers and investors are looking to cash in on the hype. In 2016, the combined total of ICOs raised came to roughly $100-million (U.S.). Conversely in 2017, 135 ICOs were completed with $2.3-billion raised – in the third quarter alone.

Issuers equipped with whitepapers promising revolutionary solutions for emerging industries, often without a well-defined product and unencumbered by the burden of regulation, are raising staggering amounts of capital previously reserved exclusively for darling Silicon Valley startups.

To nobody's surprise, the spectre of government intervention is looming as securities regulators take notice. While many bemoan the centralized regulation of an inherently decentralized technology, a healthy and long-lasting cryptocurrency market will indisputably benefit from the protection regulations bring.

Unfortunately for participants looking to stay on the right side of the law, guidance has been limited. A notice from the Canadian Securities Administrators (CSA) in August, 2017, states that some cryptocurrencies can be characterized as securities and thus protected by Canadian securities-law requirements. Missing from the notice, however, were the considerations that determine what makes cryptocurrencies qualifiable, save for that each coin is "unique" and is to be assessed on a case-by-case basis.

To balance the need to innovate with the need to protect, the CSA has implemented its regulatory sandbox, an initiative launched in February, 2017, that allows fintech businesses to register and obtain exemptive relief from legal requirements under a fast and flexible process to test products, services and applications in Canada.

A small number of firms to date have been granted relief, but such decisions have limited utility for issuers given their case-specific nature.

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As a result, the current regulatory landscape places an enormous financial and operational burden on token issuers trying to break into the market. Without any benefit of knowing the criteria against which their tokens will be reviewed, issuers can only guess if tokens are securities and if they qualify to receive an exemption.

Issuers, often with little initial capital, are faced with a challenging dilemma: Bear the costs associated with applying for relief and potentially bankrupt the company, or risk running afoul of securities regulations.

At the same time, bad actors looking to make a quick buck are pumping out scam tokens with the promise of massive gains. It remains unclear where these issuers are located and incorporated, to whom investors' funds are being sent and where the tokens raised through an ICO will be held.

As the number of ICOs continues to grow outside regulation, so too will the misguided decisions that have been fostering an environment where not much would stop issuers from disappearing with the tokens they have raised, leaving investors behind in a digital dust storm. The class-action lawsuit launched in the United States against token issuer Tezos for failing to deliver on the grand promise of profit is unlikely to be the last.

Until federal and provincial regulators get a firm grasp on the risks and rewards of cryptocurrencies and the ICO funding mechanism in order to present a unified and coherent approach to regulation, the market will remain in a state of flux.

Increased regulatory scrutiny and involvement is the critical step forward in finding a much-needed dose of stability in the frenzied cryptocurrency market. While regulations may stifle the proliferation of ICOs, they should pave the way for legitimate and financially sound issuers with developed products to reach investors.

For now, greed is trumping logic, but for how long? How long until the hype fades, a number of ICOs fail (or turn out to be the frauds many believe them to be), and investors lose money and faith?

A reckoning is coming – but this is not the death knell of cryptocurrencies. A regulatory scheme to govern the actions of token issuers and investors will unlock the longevity of the cryptocurrency market as it inevitably matures.

Originally published in The Globe and Mail.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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