Canadian securities regulators have tightened the reins on cryptocurrency exchanges operating in Canada while they seek registration.

On February 22, 2023, the CSA published its Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings – Changes to Enhance Canadian Investor Protection (“21-332 Guidance”).[1]  Staff notices such as the 21-332 Guidance describe the CSA’s views on best practices for market participants to comply with provincial and territorial securities laws. 

The 21-332 Guidance is targeted at Crypto-Trading Platforms (“Crypto Platforms”) which operate in Canada but are still in the process of registering or seeking exemptive relief.  Undertakings are promises by the Crypto Platforms to abide by certain conditions while they seek registration, or else face enforcement action.

On August 15, 2022, the CSA first introduced the requirement of pre-registration undertakings for Crypto Platforms.  The CSA announced stricter pre-registration conditions on December 12, 2022 which included a ban on margin or leverage trading by Canadian customers, as well as the requirement to safekeep assets with appropriate custodians.

The 21-332 Guidance is designed to avoid the staggering deficiencies that doomed cryptocurrency giants like Voyager Digital, Celsius Network, FTX , BlockFi and Genesis Global[2] and explicitly identifies their insolvencies as the impetus for the tightened requirements.  For Canadian clients, these protections include:

  1. enhanced commitments regarding the custody and segregation of crypto assets;
  2. enhanced commitments to preclude the unregistered Crypto Platforms from pledging, re-hypothecating or otherwise using clients’ crypto assets;
  3. a prohibition on the part of the Crypto Platforms offering margin, credit or other forms of leverage to clients in connection with the trading of crypto assets;
  4. commitments to abide by the enhanced conditions from the Crypto Platforms’ parent entity and global affiliates;
  5. restrictions on relying on crypto assets, including proprietary tokens issued by the Crypto Platforms, in determining its capital for excess working capital purposes and its capital base;
  6. enhanced commitments for filing financial information with the CSA on a regular basis;
  7. enhanced commitments regarding hiring a qualified Chief Compliance Officer during the pre-registration process;
  8. a prohibition on the Crypto Platforms’ clients buying or depositing stablecoins without the prior written consent of the CSA; and
  9. a prohibition on trades in crypto contracts based on proprietary tokens, except with the prior written consent of the CSA.

Crypto Platforms that choose not to comply with the enhanced pre-registration undertakings are required to “off-board” their existing Canadian clients and impose access restrictions for new Canadian clients.

The 21-332 Guidance also reiterates that stablecoins[3] “may constitute securities and/or derivatives”.  The CSA declared that collateralized stablecoins (those that rely on a reserve of assets, such as fiat currency, to maintain a peg) “generally meet” the definition of security and “would meet” the definition of derivative in several jurisdictions.[4]  The CSA also acknowledged the potential conflict of federal (and potentially provincial) banking laws by noting “a VRCA may also be a deposit under provincial and federal legislation” that may be exempt from securities legislation.[5]  Despite the risks of collateralized stablecoins, Crypto Platforms may offer them to clients provided they receive prior written consent from the CSA.[6]

The CSA stated that algorithmic stablecoins (those that rely on algorithms and market conditions to maintain a peg) are “generally riskier” than collateralized stablecoins, but it has not explicitly declared that algorithmic stablecoins qualify as securities and/or derivatives.  The CSA maintains that whether a particular stablecoin qualifies as a security and/or derivative will “depend on the specific facts and circumstances”.[7]  It seems likely that the CSA believes this test was met for algorithmic stablecoins as they warn “would not expect to provide consent” to a Crypto Platforms offering algorithmic stablecoins to clients.[8]

Unregistered Crypto Platforms operating in Canada should consult with their legal counsel to determine if they can comply with the enhanced pre-registration undertakings.

[1] CSA Staff Notice 21-332 dated February 22, 2023, “Crypto Asset Trading Platforms: Pre-Registration Undertakings Changes to Enhance Canadian Investor Protection”.

[2] See 21-332 Guidance at p 1.

[3] The CSA introduces the acronym “VRCA” (Value Referenced Crypto-Asset) to emphasize its view that stablecoins can lose their peg and experience value volatility.

[4] See 21-332 Guidance at pp 10-11.

[5] See 21-332 Guidance at fn 15.

[6] It is unlikely that any of the popular stablecoins traded today would satisfy the CSA, as their issuers are often accused of being opaque about reserves.

[7] A truly decentralized algorithmic stablecoin – i.e., one that operated without ongoing management intervention after initial development was completed  – would likely not satisfy the definition of either security or derivative, posing challenges to the CSA’s jurisdictional reach.

[8] See 21-332 Guidance at p 13.

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