The View from the Border: A Comparative Analysis of Securities Regulations for Cryptocurrencies in the United States and Canada.

• Author: Lewis, Rose

TABLE OF CONTENTS Overview I. Introduction--The Creation of Cryptocurrency A. What Is Cryptocurrency? B. An Introduction to Decentralization 1. Decentralization for Cryptocurrency C. Cryptocurrency as a Commodity D. Volatility E. Initial Offerings: Crypto ICOs and ITOs 1. Traditional IPO F. Stock Exchanges and Regulators G. Auxiliary Components of Cryptocurrencies 1. Cryptocurrency Exchanges/Cryptocurrency Trading Platforms (CTPs) 2. Cryptocurrency Wallets 3. Mining H. Uses of Cryptocurrency 1. Cryptocurrency as a Currency I. Risks in an Unregulated Market: Examples from the United States and Canada 1. Fraud 2. Fraud and Cryptocurrency a. Breaches b. Celebrity Impersonations, Banking Regulations, Cult Persuasion, and a Ponzi Scheme 2. Liability for Fraud II. Securities Regulations for Crypto in the United States A. Two Pathways for Regulations B. Categorization of Cryptocurrency C. Securities Regulation History in the United States D. Goals of the 1933 Act and 1934 Act 1. Expanded Definition of a Security a. Financial Instrument b. Issued c. Traded d. Capital Market E. Risks Associated with Lack of Registration F. Tax Treatment of Cryptocurrencies G. ICOs and ITOs, Fraud, and Securities Registration H. Why Securities Regulation and Disclosure Are Important I. Howey Test and Jurisprudence 1. Application of Howey to ICOs and ITOs J. Mandatory Disclosure and Exemptions under 1933 and 1934 Act 1. Applying Exemptions to Cryptocurrency K. Case Study: The DAO L. Regulating Substance Over Form 1. Case Study: Ripple's XRP 2. SEC v. Ripple Labs 3. Preventive Measures by Issuers Against Investment III. Securities Regulation for Crypto in Canada A. Canada's Approach B. CSA C. IIROC 1. Other Harmonizing Authorities D. Provincial Regulators and Passport System E. Role of CSA and IOSCO F. OSC and Ontario G. Beginning of Canadian Regulatory Framework--Investment Contract Test H. Six Key Documents in Canada's Crypto Securities Framework 1. CSA Staff Notice 46-307 Cryptocurrency Offerings 2. CSA StaffNotice 46-308 Securities Law Implications for Offerings of Tokens I. CSA Regulatory Sandbox J. OSC Regulations K. Case Study: QuadrigaCX L. Six Key Documents, Continued 1. Joint CSA/IIROC Consultation Paper 21 -402 Proposed Framework for Crypto-Asset Trading Platforms 2. CSA StaffNotice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets 3. CSA StaffNotice 51-363 Observations on Disclosure by Crypto Assets Reporting Issuers 4. Joint CSA/IIROC Staff Notice 21-329 Guidance for Crypto Asset Trading Platforms: Compliance with Regulatory Requirements IV. A Comparison of Canadian and American Securities Regulations for Cryptocurrencies and a Regulatory Proposal A. Structure of the Regulator 1. Approach to Creating Regulations 2. Crypto Culture by Country B. Evaluation of Each System C. Bitcoin and ether--The Decentralized Difference D. Role of International Crypto Asset Requirements E. Jurisdiction of Securities Regulators F. Considerations for International Regulations 1. Decentralization 2. Environmental and Political Considerations 3. Enforcement Considerations 4. Other Considerations G. Stifled Innovation H. A Borderless System I. Striking the Balance J. Why Regulate the Whole Industry? OVERVIEW

This article compares how securities regulators in Canada and the United States have considered their jurisdictions to regulate cryptocurrency. Broadly construed, securities law concerns itself with the issuance and trading of stocks, bonds and other instruments considered securities. Beyond the threshold question of whether cryptocurrencies constitute a security, there are a range of implications for parties who sell digital currencies to the general public in light of the requirements securities regulations impose on reporting issuers. These requirements include obligations to register, to complete periodic filings, to avoid making statements that materially mislead the general public, and to satisfy a wide range of corporate governance prescriptions. Extending the reach of securities regulation into the cryptocurrency arena merits considering when offering currencies for sale should trigger regulatory scrutiny.

This is a timely discussion given the core features of cryptocurrency and its growing presence in financial markets where digital currencies are issued and traded in a manner similar to traditional securities. While leading cryptocurrencies like Bitcoin are not a popular means of payment among the general public, they have attracted speculative investors, causing a dramatic increase in their value. These dynamics continue to fuel debates about whether cryptocurrencies are not merely currencies, but securities or commodities. These debates will shape policy choices rooted in the legal classification of the marketplace where digital currencies are issued and sold.

This article contributes to existing discourse by: (i) examining the posture towards cryptocurrencies adopted by securities regulators in Canada and the United States; and (ii) outlining a set of shared norms both countries might adopt to support investor protection without unduly interfering with cryptocurrency markets. The discussion below is outlined as follows: Part I offers an overview of cryptocurrency, with a particular emphasis on Bitcoin. Building on the general rationale for regulating securities, Part II discusses the U.S. Securities and Exchange Commission's (SEC) increasingly aggressive signals to the cryptocurrency industry, which the SEC's Chair considers "the wild west of our financial system" that requires "rules of the road." (1) Part III looks at the Canadian law's approach to cryptocurrency--based on the Canadian Securities Administrator's release of a January 2020 consultation paper (2)--which relies on staff comment rather than litigation posture to devise prospective rules of engagement. Part IV discusses the applicability of securities law to cryptocurrencies, analyzes the different approaches to creating the existing securities regulation for cryptocurrencies, and proposes considerations for the implantation of global securities regulation for cryptocurrencies.

I. INTRODUCTION--THE CREATION OF CRYPTOCURRENCY

In 2008, the world was revolutionized when an individual, or group, acting under the pseudonym Satoshi Nakamoto, released a whitepaper to a cryptography mailing list. (3) Through this simple act of publication, which occurred on March 24, 2009, Nakamoto changed the landscape of financial transactions with the release of bitcoin, (4) a digital form of currency with no intrinsic value.

1. What Is Cryptocurrency?

   Cryptocurrency is a portmanteau of cryptography, the practice of securing a message's content through disguise as something arbitrary, and currency. Data encryption is a form of cryptography where sensitive information is scrambled into a seemingly nonsensical alphanumeric arrangement that requires a key to unscramble and ascertain the content. Money comes in many forms, including currencies. The common conception of money, government minted dollars and cents used to buy and sell goods and services, is a specific type of currency, "fiat." Legally, money is anything that can function as a medium of exchange, unit of account, and store of value. (5) When the combination of cryptography and currency is interpreted through a global network of computers, the result is a form of purely digital money that is encrypted for user security.

   Cryptocurrency was initially a digital form of money unconnected to the government or any other central authority. Utilizing data encryption, users could anonymously send digitally generated money in the form of cryptocurrency to each other. To give cryptocurrency "relevant" value, the currency's exchange rate against the U.S. Dollar or Canadian Dollar is often used. The value of different cryptocurrencies varies greatly, with one "coin" of a particular currency, for instance one bitcoin, being equivalent to thousands of U.S. Dollars while a single coin from another currency can be worth fractions of a cent. Higher value coins are virtually ineffective for day-to-day transactions with peers; however, coins can be divided into infinitesimally small fractions for transactions of any size as the coins' value rises against a country's fiat.

   In the bitcoin whitepaper, Nakamoto explains the gap and inefficiency in the current monetary framework and the intention behind bitcoin's creation:

   Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model [...] These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.

   What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. In this paper, we propose a solution to the double-spending problem using a peer- to-peer distributed timestamp server to generate computational proof of the chronological order of transactions. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes. (6)

   Nakamoto's intention was to address the inefficiencies created by using a single, trusted centralized authority to verify transactions through proliferation of a purely decentralized cryptocurrency. Instead, the transaction would be recorded publicly and verified through mass user input. Ideally, the...