Canadian Securities Regulator Leans On Custodial Exchanges, ‘Not Your Keys, Not Your Coins’

  • Canadian regulators issue guidelines, says platform holding crypto assets that are commodities also subject to securities legislation
  • Exchanges won't be subject to this if they immediately deliver the coins to users

In the wake of cryptocurrency exchange Quadriga debacle, Canadian Securities Administrators (CSA) published a notice on Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets” on Jan. 16, 2020.

The notice reiterates that if crypto assets that are securities or derivatives are traded on a platform they are subject to securities legislation.

But in some cases, the regulator says even crypto assets that are commodities would be subject to securities legislation because, “the user’s contractual right to the crypto asset may itself constitute a derivative.”

The platforms won’t be subject to the legislation if the crypto asset itself is not a security or derivative and is delivered to the user. As per the notice,

“a transaction involving a crypto asset may be subject to securities legislation if the transaction does not result in an obligation to make and take delivery of the crypto asset referred to in the transaction immediately following the transaction.”

Nic Carter, the founding partner of Castle Island Ventures, says,

“this is a very strong endorsement of ‘not your keys, not your coins' from the regulators themselves.”

The immediate delivery will be considered to have occurred if the platform immediately transfers ownership, possession, and control of the crypto asset to the platform’s user, and as a result, the user is free to use the crypto asset without the further involvement of the platform or its affiliates. Also, following the immediate deliver the user is not exposed to credit risk, fraud risk, and performance risk on part of the platform.

There is no obligation to immediately deliver the crypto assets if the exchange requires the users to transfer ownership and possession from the platform’s address to the user-controlled address upon the user’s later request. The notice clarifies,

“For example, if the terms and conditions of a contract or instrument transacted on a Platform only require the Platform to transfer crypto assets to the user-controlled wallet on request, the contract or instrument described above would be subject to securities legislation.”

Carter comments,

“As far as I can tell non-custodial platforms get a ringing endorsement here.”

He said, this hard push against the pushing back of custodial exchanges “should give US exchanges pause ” and “give Proofs of Reserve some attention,” a protocol to make exchanges prove that they hold a sufficient amount of assets on deposit.

CSA advises platforms to consult with their legal counsel and contact local authorities to discuss whether securities legislation applies to their activities. The authority intends to take enforcement action against platforms that do not comply with securities legislation. However, they,

“welcome innovation and recognize that new fintech businesses may not fit neatly into the existing framework.”

As such an initiative called CSA Regulatory Sandbox will support fintech businesses seeking to offer innovative products, services, and applications in Canada.

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