Crypto Assets and Cryptocurrency
What are Crypto Assets?
Crypto assets are purely digital assets that use public ledgers over the internet to prove ownership. They use cryptography, peer-to-peer networks and a distributed ledger technology (DLT) – such as blockchain – to create, verify and secure transactions. They can have different functions and characteristics: they may be used as a medium of exchange; a way to store value; or for other business purposes. Crypto assets generally operate independently of a central bank, central authority or government.
A distributed ledger is a type of database that stores electronic records shared and replicated across many locations and maintained by members of this decentralized network. Each new transaction must be agreed upon by all members of the network before it is added to the ledger. Blockchain is one type of distributed ledger that arranges the data in chunks and chains them together. This unique way of structuring data gives blockchain transactions additional security as they are irreversible. Blockchains can be used to store many types of data but have recently become popular for their use of storing cryptocurrency transaction history.
Some of the more common types of crypto assets you may encounter are:
Cryptocurrency (or virtual currency) is likely the most well-known type of crypto asset. Cryptocurrency is a digital currency or medium of exchange. It can be used:
- To exchange for products or services, like fiat currency (such as Canadian dollars or US dollars)
- For speculative purposes, such as trading on a crypto asset trading platform (CTP)
- As a store of value
It was created as an alternative to fiat money, but cryptocurrency is not considered legal tender in Canada. Cryptocurrencies have no inherent value; their perceived value is based largely on supply and demand in the market. Examples include Bitcoin, Ether, Ripple and Litecoin.
Cryptocurrencies are generally not considered to be securities and, therefore, are generally not subject to securities laws. For example, when you buy a cryptocurrency and take immediate delivery of the crypto asset into your digital wallet, this transaction is generally not subject to securities laws. However, if you trade cryptocurrency on a CTP and the CTP holds your cryptocurrency in a digital wallet for you on their platform, this creates an ongoing contract based on the value of the underlying crypto asset, and this contract is subject to securities regulation. CTPs that provide this service for users must be registered with the appropriate securities regulator(s). You can check that a CTP is registered by using the free National Registration Search tool from the Canadian Securities Administrators.
There may be some circumstances where a cryptocurrency would be considered a security. This may need to be determined on a case-by-case basis by examining the specific situation, scenario or characteristics of the cryptocurrency. Because technology and regulation in this area is evolving, if you are uncertain if securities laws apply to a cryptocurrency you are considering, contact FCNB.
There are income tax implications in using cryptocurrency to generate income, capital gains or to pay for goods or services. You should consult the CRA’s Guide for Cryptocurrency Users and Tax Professionals to ensure you understand how to comply with your taxes.
A utility token uses a distributed ledger or blockchain platform to provide access rights to a specific product or service (potentially one that is still in development), or to be used to purchase specific products or services. The provider of the products or services typically issues the tokens, which can only be used within the issuer’s network.
Security tokens are often sold or auctioned in an Initial Coin Offering (ICO) or an Initial Token Offering (ITO) that allows businesses to raise money to fund an idea or business model. The business offers security tokens in exchange for fiat money or other crypto assets. The security token often comes with a stake in the project and additional benefits, such as voting rights, profit sharing or dividends. However, a project may not succeed, and investors should remember they are putting their funds toward supporting an idea of a business model – not a fully realized product or service.
Non-fungible tokens (NFTs) are tokens that exist on a distributed ledger or blockchain, which record ownership of a unique tangible or intangible object – such as a song, a digital image, a video, designer clothing, etc. Non-fungible means these tokens cannot be exchanged for one another; each one is unique. NFTs are relatively new, even for crypto assets, and the regulatory scheme and marketplace for NFTs are rapidly evolving.
Buying, Selling and Holding Crypto Assets
Initial Coin Offerings
Security tokens may be sold or auctioned in an Initial Coin Offering (ICO) or an Initial Token Offering (ITO). These “Token Generating Events” are used to raise funds for an idea or a business model. Interested supporters can buy tokens with regular currency or another cryptocurrency. The token likely has no value at the time you buy it but may be exchangeable in the future for a new cryptocurrency to be launched by the project, or a discount or early rights to a product or service proposed to be offered by the project. Because there are no guarantees or certainty that the token will have any future value or that the project will succeed, investors should be very cautious when buying into an ICO. The level of disclosure and information available is typically far less than would be available for a typical investment opportunity. Investors should be prepared to lose some, or all, of their original investment.
Depending on the circumstances of the ICO, the tokens may be securities. If they are, then they may be subject to securities law. If you are uncertain, if securities laws apply to the ICO or the tokens you are considering, contact FCNB.
ICOs are high risk, and their structure makes them fertile ground for fraud and abuse. Anyone considering participating in an ICO or other token generating event should be wary of promises of guaranteed returns, plagiarized or otherwise fake investment documents, contracts or website content, and fake or lack of information about the business and company leadership. If you are considering participating in an ICO or are uncertain about the validity of an ICO you are considering, we encourage you to seek professional advice or a second opinion.
Digital and Physical Wallets
You can purchase cryptocurrency directly, receive immediate delivery of the assets and deposit them into your digital wallet or physical data storage device. A digital wallet is an online service that stores your cryptocurrency and allows you to conduct transactions, such as buying goods or services, or trading or transferring your virtual currency. You have sole control over your digital wallet, but risk losing access to your crypto assets if you forget your password, accidentally delete your wallet or are the victim of hacking.
Physical hardware devices designed for storing crypto assets, often referred to as “cold wallets,” are often a secure way to store crypto assets because they are not connected to the internet. Anyone planning to hold large quantities or values of cryptocurrency or other crypto assets may want to consider cold wallet storage. These devices also require you to remember and closely guard your password.
Crypto Asset Trading Platforms
Crypto asset trading platforms (CTPs) are online applications or systems that bring together buyers and sellers of crypto assets to facilitate transactions or trades.
Some CTPs provide a platform for users to buy and sell crypto assets and receive immediate delivery of these assets into their own wallets. This means that the user makes the purchase and the platform has the obligation to deliver the crypto assets directly to the individual, who stores them in their own wallet, over which they retain full control.
Some CTPs retain custody of the crypto assets in a wallet controlled by the CTP. This creates a dependency or reliance on the platform by the user. The user’s crypto assets are stored on the platform and the platform retains control over the assets until the user transfers them off the platform, either into their own wallet or by receiving an equivalent value in fiat currency.
Depending on the model of the CTP, securities laws may apply, and the CTP may need to be registered or recognized by the appropriate securities regulator(s) as a securities or derivatives marketplace or exchange. It’s important to know what the requirements are so you can do your homework before you sign up to use any trading platform. Review the Regulation of Crypto Assets section to learn more about how regulation protects you. If you are uncertain if a CTP has to be registered, contact FCNB. You can check registration by using the free National Registration Search tool from the Canadian Securities Administrators.
Cryptocurrency investment funds allow you access to cryptocurrencies without directly purchasing, owning and trading the coins yourself.
A cryptocurrency exchange traded fund (ETF) works similarly to a regular ETF. Instead of tracking an index, sector or commodity, a cryptocurrency ETF tracks one or more digital tokens.
Blockchain funds are similar to other investment funds that invest in a particular industry or sector of the economy. In this case, blockchain funds invest only in companies that have operations related to blockchain technology.
Regulation of Crypto Assets
Under New Brunswick securities law, an individual or firm must be registered with FCNB if they are in the business of trading or advising in securities or derivatives in New Brunswick, unless a registration exemption applies.
The regulatory framework regarding crypto assets and crypto asset trading platforms is developing. This can leave purchasers, speculators and investors confused about when and if securities regulations apply. In some cases, the crypto asset is clearly a security – for example, a security token that carries rights traditionally attached to common shares, such as voting rights and rights to receive dividends. In other cases, the crypto asset is a derivative – for example, a token that rises or falls in value based on the value of an underlying asset, such as the stock of a publicly traded company.
Recently, the Canadian Securities Administrators, in collaboration with the Investment Industry Regulatory Organization of Canada (IIROC), have issued guidance about the application of securities legislation and regulatory requirements to crypto assets. Here are some scenarios in which securities law may apply:
- If crypto assets that are securities or derivatives are traded on a crypto asset trading platform, the CTP would be subject to securities legislation. In addition, if a CTP trades contracts or instruments that are derivatives based on crypto assets, the CTP would also be subject to securities legislation.
- A CTP does not provide immediate delivery of the crypto asset, creating an ongoing reliance and dependence on the platform by the user. If a CTP stores a user’s crypto assets in a wallet controlled by the platform, creating an ongoing reliance on the CTP to trade or transfer the crypto assets, this creates a contract subject to securities law.
- If an ICO issues security tokens, securities laws may apply.
This list is not exhaustive. A number of circumstances may trigger the application of securities legislation. As such, the application of securities legislation is often determined on a case-by-case basis.
For more details about regulation of crypto assets and crypto asset trading platforms, please review the following:
- CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets
- Joint CSA/IIROC Staff Notice 21-329 Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements
How does Regulation Help Investors?
If a CTP is registered or recognized as a securities or derivatives marketplace or exchange, it will be subject to certain requirements to provide a level of protection. These include risk management, disclosure and dealing honestly, fairly and in good faith with clients. You can check registration by using the free National Registration Search tool from the Canadian Securities Administrators.
While registration exists to provide investors with an added layer of security, just because a firm, CTP or individual is registered does not mean they are without risk. Always evaluate each opportunity and be sure you fully understand the asset and risks involved before you invest, purchase or speculate in cryptocurrency or other crypto assets.
If you are uncertain about regulatory requirements of a crypto asset or CTP you are considering, contact FCNB before making any purchase decision.
Red Flag: When someone selling a crypto asset or a related product suggests they don’t need to comply with regulations, be skeptical.
Several areas of risk associated with crypto assets exist, including high volatility, liquidity risk, and heightened potential for fraud. Before buying or selling crypto assets, consider the risks listed below. Anyone considering speculating, buying or trading crypto assets should have a clear understanding of the asset and the risks involved.
Volatility: Prices of crypto assets rise and fall dramatically, often driven by media or social media hype, and few constraints on price manipulation exist.
Liquidity: When trading on a crypto asset trading platform, the CTP may not have enough crypto assets to cover your order. There are also no guarantees the demand for any given crypto asset will continue, which may make it difficult to transfer your crypto assets into fiat money.
Online Risk: Crypto asset service providers and intermediaries may exist anywhere in the world. It can be difficult or even impossible to identify or locate the service provider or intermediary and take any action if you have a problem.
New Technology: As a relatively new technology, the public interest in or demand for crypto assets may not continue to grow or be sustainable. When a new crypto asset launches, often it is based on an idea – not a proven business model. There is no guarantee the project will succeed. There is also no certainty that crypto assets will weather future changes and challenges related to technology development, regulatory changes or political challenges.
Technical and Cybersecurity: Technology and platforms used for crypto assets, such as online wallet companies and exchanges, are susceptible to cybersecurity threats and hacking, putting your deposits at risk. Crypto asset transactions are also at risk of delayed or failed transactions, and loss of access to your digital wallet (and your crypto assets) if you lose your password.
Potential for Fraud: Any individual or company that trades or advises in securities or derivatives must be registered with FCNB. A CTP, depending on how it operates, may be subject to securities regulation. Some CTPs claim to be registered businesses, but this is not the same as being registered with a securities regulator. Always check registration with the National Registration Search tool.
Recently, scammers have been offering investment opportunities that claim to provide guaranteed returns and recruitment bonus compensation packages. These are often red flags of fraud and should be approached with caution. Crypto assets are extremely volatile and guaranteed returns in a crypto-related investment are extremely unrealistic and unlikely.
Avoiding Loss and Fraud
No investment is without risk, and crypto assets are particularly risky. While there’s no guarantee that you won’t suffer any losses when speculating, buying or trading crypto assets, here are some things to consider that may help you avoid loss or fraud:
- Check registration. Anyone who sells or provides advice in securities or derivatives in New Brunswick must be registered with FCNB. Check registration by using the free National Registration Search tool from the Canadian Securities Administrators. Report any unregistered or fraudulent activity to FCNB.
- Do a quick internet search on the company to see if it has faced any disciplinary action.
- Check investor alerts to see if any regulators have issued warnings about the company:
- Ensure any payment method you might use is secure and does not put your personal financial information at risk. Be cautious when sending money overseas. Once you transfer funds offshore it may be difficult or impossible to get your money back if there is a problem.
- Do not buy, speculate or invest if you do not understand the technology, asset or risks involved.
Watch for these common red flags that may indicate a crypto-related scam:
- Claims of regulatory exemption: When someone selling a crypto asset or a related product suggests they don’t need to comply with regulations, be skeptical. Don’t mistake business registration for registration with the securities regulator.
- Guaranteed returns: Crypto-related scams often promise guaranteed daily returns. Crypto assets are volatile and guaranteed returns are incredibly unlikely.
- Risk-free promises: Crypto assets have many risks associated with them. As with any investment, be sure you know the risks you are exposed to before you speculate, buy or trade any crypto asset.
- Unsolicited, high pressure sales pitches and/or recruiting bonuses: Crypto-related scams typically make use of social media, relationships and high energy pitches of extreme returns to pressure you into buying. The goal is to make you feel afraid of missing out on an opportunity your friends are profiting from. Be very cautious of any crypto-related offer that comes to you through social media and is accompanied by bonus compensation plans for recruiting your friends. Some ICOs also promote aggressively through social media. Be skeptical if you receive an unsolicited crypto-related pitch.
- Unregistered activity: Review our section on crypto asset regulation and make sure the company, platform or individual you are considering is properly registered if required. You can search registration using the free National Registration Search tool from the Canadian Securities Administrators. If you are uncertain about registration requirements or if securities laws apply to an offer, you can contact FCNB.
Learn more about common “Red Flags of Fraud”.