Regulatory Takeaways
The facts we uncovered about Quadriga are limited to Quadriga and should not be taken as an indication that similar misconduct has taken place at other crypto asset trading platforms. However, crypto asset trading platforms involve unique risks and our review showed that members of the investing public may not fully understand these risks. We believe it is important to underscore those risks and outline the evolving regulatory guidance in relation to this area of the market.
The risks of investing in crypto asset trading platforms are discussed in Consultation Paper 21-402 Proposed Framework for Crypto-Asset Trading Platforms (the Consultation Paper), a joint consultation paper produced by the CSA and Investment Industry Regulatory Organization of Canada (IIROC) issued on March 14, 2019. These risks are also discussed in Issues, Risks and Regulatory Considerations Relating to Crypto Asset Trading Platforms, a report published by the International Organization of Securities Commissions.
As with any novel business with a developing regulatory framework, bad actors can take advantage of these circumstances to defraud investors.
Crypto asset trading platforms are an emerging area of the markets operating in an evolving regulatory landscape. As with any novel business with a developing regulatory framework, bad actors can take advantage of these circumstances to defraud investors. While even the most robust regulatory regime cannot detect every instance of fraud, regulatory oversight plays an important role in fraud detection and prevention and in protecting investors.
We are highlighting key takeaways both for investors who are using or contemplating using crypto asset trading platforms as well as for crypto asset trading platforms that are making efforts to operate responsibly and to comply with Ontario securities law.
Key takeaways for investors
In Canada many crypto asset trading platforms are not registered
Many crypto asset trading platforms are not registered and have taken the position that they are not required to register with securities regulators. This is an important message to communicate to users and potential users of these platforms, as they may have false impressions about the extent of crypto asset trading platform regulation.
Using a crypto asset trading platform carries risks
Trading on crypto asset trading platforms carries unique risks. Many platforms maintain custody and control of their clients’ crypto assets and clients merely have claims against the platform for those assets. These claims are vulnerable to the solvency, proficiency and integrity of the platform operators. Clients may be exposed to risks associated with the potential unsafe, improper or unauthorized use of their assets. In addition, crypto asset trading platforms may not operate transparently. Clients may have limited or no information about how the platform is storing and handling their assets, whether and how platform principals are trading with their clients on the platform, whether the platform has sufficient assets to support all its clients’ claims or the authenticity of reported volumes on the platform.
Platform clients should conduct due diligence and be alert for signs of fraud
Anyone considering entrusting their assets to a crypto asset trading platform should take steps to learn about the platform’s operations and approach to risk management, prior to using it. This may not be possible with the current level of disclosure offered by some platforms. Clients should also be alert for signs of fraud.
Key takeaways for crypto asset trading platforms
Crypto asset trading platforms may have to register with the Commission and should take appropriate steps to comply with Ontario securities law
For guidance on the issue of whether securities legislation may apply to their business, platform operators should consult the Staff Notice, referenced above, which was published by the CSA in January 2020 (in addition to the Consultation Paper discussed previously, published in March 2019).
A key factor for this analysis is whether the platform makes immediate delivery of a crypto asset to a client. A platform would generally not be subject to securities legislation if the underlying crypto asset being traded is not a security or derivative, and there is immediate delivery of a crypto asset to the client after a transaction. (The Staff Notice provides more detail on the meaning of “immediate delivery” in this context.) In contrast, if a platform retains possession and control of the crypto assets being traded on the platform, securities law may apply. In accordance with the recent guidance in the Staff Notice, in our view, platforms that hold and control clients’ platform assets and only deliver a client’s assets after the client requests their withdrawal will generally involve securities or derivatives under Ontario securities law.
Platforms should ensure that they have systems and controls in place to manage risks
Having an internal system to manage risks, including those related to business continuity, key personnel and regulatory compliance, is an important step that responsible platform operators can take to preserve the integrity of their businesses, protect client assets and foster investor confidence in their platforms.
Platforms should disclose key information to clients
Providing clients with accurate information about key aspects of their operations—such as asset custody and storage practices, fees, reported volumes, platform security measures, internal controls, and conflicts of interest—will facilitate informed decisions by investors and promote investor confidence in the platform.