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Cryptocurrency 101

Frédéric Letendre

YULEX, Attorneys and Strategists, LLP

04.12.20


Cryptocurrency 101

With the Bitcoin reaching its highest peak of value in early December 2020 and with Libra (Facebook’s soon-to-be cryptocurrency) changing its name to Diem, the term cryptocurrency is more relevant than ever before.

What is cryptocurrency?

In a nutshell, cryptocurrency is a digital currency with no intrinsic value. As opposed to traditional money systems where banks or other structures usually maintain sole control over currencies, cryptocurrency’s network is completely decentralized. The network is peer-to-peer and all the transactions take place without an intermediary.

These transactions are stored in a database called the “blockchain”, which provides for the transmission of information through multiple devices and assures that the records of such transactions are accessible and easily ascertainable[1].

The properties of cryptocurrency

There are a lot of transactional properties to cryptocurrency, as listed below:

  • irreversible;
  • pseudonymous;
  • fast;
  • global;
  • secure; and
  • permissionless[2]

The Bitcoin: A Pioneer

The most widespread and best-known cryptocurrency is the Bitcoin[3]. Being quoted up to $USD19,166.98 as of December 17th, 2017[4], Bitcoin’s value has known some highs and lows since this peak (reaching as low as $USD3,200.64 on December 16th, 2018) and reaching its all-time peak ($USD19,920.53) on December 1st, 2020,

As of December 4th, 2020, Bitcoin’s value sets around $USD19,000.04.[5]

How to obtain Bitcoins?

There are two ways to obtain Bitcoins: by earning them or purchasing them. People interested in investing in cryptocurrency transactions may proceed by “data mining” through computer hardware: such mining is made “By solving complex mathematical problems, by which method they process or settle cryptocurrency transactions.” Those miners receive cryptocurrency in exchange of their mining services[6]. Otherwise, many cryptocurrencies can be bought and sold in return for traditional currency and can also be transferred from one person to another.[7]

Securities Laws and Cryptocurrency

“Cryptocurrency offerings can provide new opportunities for businesses to raise capital and for investors to access a broader range of investments.”[8]

According to the Canadian Securities Administrators (CSA), there are a lot of these offerings called “initial coins offerings” (ICOs) or “initial tokens offering” (ITO) that meet the definition of a security. This means that securities laws could apply to these transactions if the person selling the securities “is conducting business from within Canada or if there are Canadian investors”. To determine if securities law apply to a projected cryptocurrency offering, CSA is going to consider the substance of the offering, which is why, a business cannot be exempted from the application of securities laws only because they said that cryptocurrencies are software products.

As an example, the CSA states that “if an individual purchases coins/tokens that allow him/her to play video games on a platform, it is possible that securities may not be involved. However, if an individual purchases coins/tokens whose value is tied to the future profits or success of a business, these will likely be considered securities.[9]

So, if you are interested in issuing cryptocurrency as a mean of investment, you could be subject to prospectus and registration requirements.[10] We strongly recommend that you consult with legal counsel in order to know if the coin or token you are interested in is indeed a security and if so, the AMF suggests contacting local regulatory authority in order to authorize your cryptocurrency offering and to discuss regulation options for compliance.

The Status of Cryptocurrency in Canada

In Canada, the digital currencies “are no legal tender[11]“. According to the Currency Act, the Canadian dollar is the only official currency in Canada. The impact of this legislation translates into creditors having no obligation to accept cryptocurrencies as payment, the debtor being bound by his debt[12].

The Canadian Sandbox Initiative

In 2017, the CSA launched a regulatory sandbox initiative “to support financial technology (fintech) businesses seeking to offer innovative products, services and applications in Canada.[13]” One of the business models proposed by the AMF under the sandbox initiative is related to “cryptocurrency or distributed ledger technology-based ventures”. In fact, seeing the uprising popularity of cryptocurrencies, this initiative’s purpose is to ensure the capital market’s efficiency and to protect investors from high-risk or fraudulent activities.

One of the great advantages of this program is that it allows companies to “register and/or obtain exemptive relief from securities law requirements, under a faster and more flexible process than through a standard application, in order to test their products, services and applications throughout the Canadian market on a time-limited basis”[14].

The AMF’s position

According to the Autorité des marchés financiers (i.e., the Quebec Securities Exchange Commission), the use of cryptocurrency is nothing but risky[15]. In reality, they have exposed five major risks:

  1. Volatility risk[16], “the value of cryptocurrency is determined by the public’s interest in it and is based strictly on supply and demand.[17]
  2. Liquidity risk: It could be difficult to exchange digital money for money that qualifies as legal tender. “The bid-ask spread is often very wide due to speculative trading in cryptocurrency.[18]
  3. Technological and operational risk: It may be exposed to hacking and theft because there is no security guaranteed[19].
  4. Legal risk: “Cryptocurrencies may not be regulated. There may be no legal framework to protect consumers who buy goods or services using a cryptocurrency and exchanges may operate without being in compliance with applicable laws. Exchanges may be located outside of Canada and the principals may not reside in Canada. It may, therefore, be difficult to initiate legal action against them. ”[20]
  5. Risk of participating in criminal, terrorist or fraudulent activities or money laundering: through years, cryptocurrencies have been associated with “fraud, money laundering and criminal or terrorist activities”.[21]

Local example

Quebec has, to this day, demonstrated its openness in regard to the integration of new technologies. In fact, the first cryptocurrency compliant with Canadian securities laws has been issued in Quebec as of August 2017. The Impak Coin (MKP) was defined as a:

cryptocurrency dedicated to supporting the growth of the social impact economy. By combining the advantages of blockchain technology, complementary currency principles and the attributes of loyalty programs, Impak Coin has coded rules of use that supports the growth of a socially and environmentally responsible economy.” [22]

This should spike motivation within every person who is interested in investing in cryptocurrency.

Although criticism regarding the presence of cryptocurrencies on the market is harsh, it is inevitable that they will gain an important part of the securities’ market and contribute to a still uncertain part of the economy for the future. To be a forerunner in this business, Canada adopts a flexible regulatory approach towards cryptocurrencies, but warns future investors about the volatility of the digital money.

Conclusion

Cryptocurrencies’ future is still uncertain. Will it replace traditional money? Certainly not in the next decade. Although the last year’s development showed the contrary, the most recent developments teach us that the craze around cryptocurrency seems to renew itself.

Even though the popularity of cryptocurrency is irrevocably growing through time, there are a lot of improvements that must be done before we decide to invest blindly in cryptocurrencies, or to replace traditional money completely in our day-to-day transactions. But, in the next decade, we’ll certainly experience or witness alternative means of payments such as digital token, fintech apps and other e-wallet solutions.

Written by Me Caroline Tremblay, Léa Psenak and Frédéric Letendre

 

[1] Amir ROSIC, on Blockgeeks. What is blockchain technology, URL Address: https://blockgeeks.com/guides/what-is-blockchain-technology/ (page consulted December 4th, 2020).

[2] What is cryptocurrency: everything you need to Amir ROSIC, on Blockgeeks. What is cryptocurrency: everything you need to know, URL Address: https://blockgeeks.com/guides/what-is-cryptocurrency/ (page consulted December 4th, 2020).

[3] AMF. Bitcoin and other virtual currencies: What you need to know, URL Address: https://lautorite.qc.ca/en/general-public/investments/bitcoin-and-other-virtual-currencies (page consulted November 4th, 2020).

[4] COINDESK. Bitcoin (USD) Price, URL Address: https://www.coindesk.com/price/ (page consulted December 4th, 2020).

[5] Ibid.

[6] Mariam AL-SHIKARCHY, Steven BAUM and Laura GHEORGHIU. Canadian taxation of cryptocurrency … so far, in Canadian tax law, Gowling WLG, November 2017, p. URL Address: https://edoctrine.caij.qc.ca/publications-cabinets/gowlings/2017/a89539/en/PC-a102438

[7] CANADA REVENUE AGENCY. Virtual Currency, 2015, URL Address: https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/digital-currency.html (page consulted December 4th, 2020).

[8] CANADIAN SECURITIES ADMINISTRATORS. Cryptocurrency offerings, August 24, 2017. URL Address: https://lautorite.qc.ca/fileadmin/lautorite/reglementation/valeurs-mobilieres/0-avis-acvm-staff/2017/2017aout24-46-307-avis-acvm-en.pdf (page consulted December 4th, 2020).

[9] Id.; To read more examples provided by the CRA, please consult the CSA Staff Notice 46-308 : Securities Law Implications for Offerings of Tokens, June 11, 2018. URL Address: https://lautorite.qc.ca/fileadmin/lautorite/reglementation/valeurs-mobilieres/0-avis-acvm-staff/2018/2018juin11-46-308-avis-acvm-en.pdf (page consulted December 4th, 2020).

[10] Ross MCKEE, Chris HEWAT and Liam CHURCHILL. “Industry responds to CSA guidance on cryptocurrency offerings”, dans Capital markets bulletin, Blakes, September 2017, URL Address:https://edoctrine.caij.qc.ca/publications-cabinets/blakes/2017/a92307/en/PC-a101830 (page consulted December 4th 2020).

[11] FINANCIAL CONSUMER AGENCY OF CANADA. Digital currency, URL Address:  https://www.canada.ca/en/financial-consumer-agency/services/payment/digital-currency.html (page consulted December 4th, 2020)  ; Currency Act, L.R.C. 1985 c. C-52, art.7(1).

[12] Art.1564 Civil Code of Quebec, chapter CCQ-1991 ; Marc LACOURSIÈRE, « Les défis juridiques du paiement virtuel », dans Barreau du Québec, Service de la formation continue, Développements récents en droit bancaire (2017), vol 427, Cowansville (QC), Yvon Blais, 2017, p.29.

[13] Cryptocurrency offerings, supra note 9.

[14] Id.

[15] Autorité des Marchés Financiers, AMF cautions investors, issuers and sponsors: Initial cryptocurrency or token offerings, Posted on January 15th, 2018. URL Address: https://lautorite.qc.ca/en/general-public/media-centre/news/fiche-dactualites/initial-cryptocurrency-or-token-offerings-1 (page consulted December 4th, 2020).

[16] LA PRESSE.CA. Le bitcoin poursuit sa chute, posted on February 5th, 2018. URL Address :  http://www.lapresse.ca/affaires/marches/201802/05/01-5152761-le-bitcoin-poursuit-sa-chute.php (page consulted December 4th, 2020) : « Le bitcoin, en forte baisse depuis plusieurs semaines, poursuivait sa chute mardi, tombant sous les 6400 dollars alors qu’il frôlait les 20 000 dollars en décembre, après une série de mauvaises nouvelles pour la monnaie virtuelle. » and LA PRESSE.CA. Le bitcoin, première et plus populaire des cryptomonnaies, posted on November 30th, 2020. URL Address :  https://www.lapresse.ca/affaires/marches/2020-11-30/le-bitcoin-premiere-et-plus-populaire-des-cryptomonnaies.php (page consulted December 4th, 2020) : «(Londres) Le prix du bitcoin, première cryptomonnaie décentralisée, a dépassé lundi son sommet historique et a atteint plus de 19 800 dollars.»

[17] Bitcoin and other virtual currencies: What you need to knowsupra note 4.

[18] Id.

[19] Id.

[20] Id.

[21] Id.

[22] IMPAK COIN. FAQ, URL Address: https://mpk.impak.eco/en/faq/ (page consulted December 4th, 2020).