“In my opinion, one of the main risks is to invest without understanding the product you are investing in or the various factors that could affect your short position,” warns Laure Fouin, Digital Assets & Blockchain Group Co-Head and Partner. Osler’s office in Montreal.
At the same time, the expert recalls that the term “cryptocurrency” covers several different realities. “Cryptocurrency is a virtual digital asset based on blockchain technology and an encrypted computer protocol. This includes both traditional cryptocurrencies such as bitcoin and ether, as well as stablecoins backed by an asset whose price is considered stable (for example, the dollar),” Lor Fuan summarizes.
Thus, the risks of investing differ depending on the type of cryptocurrency, and in each case, it is important to consider internal and external risks. “The main internal risk of investing in bitcoin is that the short price of bitcoin will fall as the investor wants to liquidate their position for one reason or another, while the main external risk remains, as is the case with any other asset. channels (such as foreign venues that have been the subject of warnings from Canadian securities administrators), the expert emphasizes.
Another theoretical intrinsic risk associated with a stablecoin is that the value of the asset backing it will fall. However, it is important to understand how a stablecoin is “pegged” to an asset, and therefore the real level of correlation.
“Stablecoins can be backed by currency (FIAT), cryptocurrencies, or commodities (such as gold) in the form of real collateral, often with over-collateral that is effectively set aside to reimburse stablecoin holders if needed. but they can also be algorithmic only, i.e. not maintain a reserve of the underlying asset, but rather rely on an algorithm that increases or decreases the supply of tokens in the hope of stabilizing the price in line with the underlying asset. As LUNA Terra has proven, the risk of investing in an algorithmic stablecoin is not limited to the price of the underlying asset, but rather one should study how the algorithm and arbitrage mechanisms work in order to understand the applicable risks,” Lor Fuan summarizes.
Towards a stronger regulatory framework
The CSAs are clear: the cryptocurrencies themselves can be securities or derivatives, or the contracts or instruments under which cryptocurrencies are traded can be securities or derivatives (called crypto asset contracts or crypto contracts).
“In this case, cryptocurrencies or the contracts under which they are exchanged are subject to distribution requirements in the form of prospectuses and through registered securities dealers and Derivatives Law in the case of derivatives,” Lor Fuan concludes.
The question to ask, she says, is rather: under what circumstances are contracts or instruments for cryptocurrencies that are not themselves securities considered securities under the CSA concept of “contracts for cryptoassets”?
“The concept of a cryptoasset contract is based on no immediate delivery: when a contract or instrument for buying, selling or supplying cryptocurrencies does not give rise to obligations for the immediate delivery of cryptocurrencies and is not resolved by the immediate delivery of cryptocurrencies, the CSA may consider it a security,” she replies.
“Recently, the Financial Markets Tribunal in Ontario clarified in the specific case of a foreign platform conviction (Mek Global Limited (Re), 2022 ONCMT 15) that in such a case, the contract for a crypto asset constitutes an “investment contract” within the meaning of Securities Law because in the absence of immediate delivery, the investor depends on the efforts of their counterparty to store and then deliver the cryptocurrency in a timely manner,” she adds.
Eight platforms currently have an exception to continue offering contracts for crypto assets under a temporary limited brokerage regime and under certain conditions aimed at protecting investors. These platforms must also move to register as a broker with the Investment Industry Regulatory Organization of Canada (IIROC) within a set period.
In addition to the CSA, anti-money laundering authorities have clarified that cryptocurrency exchanges are subject to the laws and regulations they administer.
“So if regulators continue on the same path, we can expect not so much a new regulatory framework, but primarily more frequent enforcement of existing rules and regulations through prospectus requirements (and transparency, which comes with it) and registration requirements (including financial stability, safety of assets, insurance and other related obligations),” notes Lor Fuan.
Some cryptocurrency exchanges have recently had to suspend their activities due to volatility reasons. How can investors ensure that this situation does not happen to them?
Do not deal with foreign platforms that do not comply with the rules in force in Canada, Laure Fouan replies.
“We are lucky in Canada to have the regulatory framework and the big players in the market. I would draw a parallel here with binary options trading platforms that were popular a few years ago: Autorité des Marchés financiers (AMF) multiplied investor notifications and lists of unauthorized sites, but for a long time investors continued to trade with them, which in some cases led to serious losses , and in other cases fell victim to outright fraud by illegal platforms. Today, it is clear that such platforms must be authorized by the AMF and distribute their products, which are derivatives, through a properly registered derivatives broker, and it is hoped that the number of victims of fraud has decreased. »
From a cybersecurity point of view, it is also possible to protect yourself from the risk of hacking, the expert assures.
“By analyzing the conditions applicable to the eight platforms mentioned above, we see a basis in regard to custody and insurance: custody of at least 80% of the assets of clients of these platforms must be entrusted to a custodian qualified under the securities laws. and insurance is required against the loss of client assets, such as hacking, copying, loss or theft of keys, internal theft or other fraud by employees or managers,” Laure Fuan explains.
These various points show that it is very important to be well informed before investing in cryptocurrencies and to carefully study the companies and platforms that you choose to entrust your money to.