LULLED INTO CRYPTO COMPLACENCY.

TERENCE CORCORAN

It’s not clear yet how much investors in Quadriga’s cryptocurrency exchange have lost after the sudden death of its 30-year-old founder Gerry Cotten. Was it $250 million of Quadriga’s cryptocurrency inventory locked up in those encrypted accounts that Cotten left no passwords for? Three hundred million? And as the owners of these assets watch their money disappear, a big question hangs over the affair: Where are — and where were — the regulators?

Not our job, said the Bank of Canada. “The Bank of Canada is not responsible for regulating these crypto products,” said Timothy Lane, the bank’s deputy governor, in a speech last October. “Indeed,” said Lane, “the term ‘cryptocurrencies’ is a misnomer. We prefer to call them ‘cryptoassets’ because… they don’t do a good job of performing the basic functions of money.”

Nor do cryptocurrencies do a very good job performing the function of assets, at least not by any normal definition of the word. The world’s best known crypto, bitcoin, was worth $25,000 in December 2017; yesterday it traded around $4,500. Some asset. Across Canada and around the world, total cryptocurrency losses are said to exceed at least $130 billion since the fall from their bubble peaks in 2017. In a world where everything is said to be regulated, where every financial transaction is subject to official oversight, people are led to assume they are somehow protected, when they are not — and this is what happens.

Over at Canada’s bank regulator — the Office of the Superintendent of Financial Institutions — staff have been busy, busy, busy clamping down on the stress risks within Canada’s banks and other financial institutions. News stories this week report that banks and mortgage lenders are saying OSFI’s moves have gone too far and should be rolled back. But when it comes to OSFI’s take on cryptos, the federal agency has been hands-off. It said in January 2017, that while it has “not issued specific guidance related to trading in bitcoin (or other ‘virtual currencies’) and fintech, we expect federally regulated financial institutions to be aware of the risks of engaging in financial activity, including activities that may be linked to bitcoin, and to take appropriate measures if the activity is assessed to be higher risk.”

Since the chartered banks were the first to start moving in on Quadriga last year (CIBC froze $28 million in accounts linked to the company in October because of questions over their ownership) at least they seem to be doing their jobs.

Over at the Financial Consumer Agency of Canada, the federal operation has been busy, busy, busy investigating retail selling practices at the big banks. But it seems to have done nothing to look into the retail sales practices of bitcoin exchanges and other aspects of the overhyped cryptocurrency markets — aside from posting a useful but limp primer on its website warning consumers that there are risks in digital currencies.

Since nobody in Ottawa is doing or has done much even as billions in digital-currency value disappears, that leaves the provincial securities regulators and their national group, the Canadian Securities Administrators (CSA).

Allan Goodman, a partner with Goodmans in Toronto and co-author with Michael Partridge of the Cryptocurrency in Canada newsletter, wonders why it’s taken the Ontario Securities Commission and the CSA such a long time. “They spent over a year looking at a lot of these situations and there has been no pronouncements yet,” Goodman says. “I would have thought by now we would have seen something, but we haven’t seen anything yet.”

Part of the problem is that the cryptocurrency markets operate in direct opposition to the very foundations of any regulatory structure. One glaring illustration of the clash is the securities industry’s “know your client” rule, which is hard to enforce in a crypto market that thrives on nobody knowing who anybody is. In fact, not knowing your client is one of the main purposes of digital currencies. “The technology,” notes Goodman, “has made it all quite complex.” Apparently too complex for securities regulators to come to grips with.

In August 2017, the CSA issued a staff notice that was very good at laying out the problem at hand but fell short in setting out regulatory guidance. Cryptocurrency offerings can “raise investor protection concerns, due to issues around volatility, transparency, valuation, custody and liquidity, as well as the use of unregulated cryptocurrency exchanges,” it said. “Also, investors may be harmed by unethical practices or illegal schemes, and may not understand the properties of the investment products that they are purchasing.”

Since Quadriga operated as one of those unregulated exchanges, could the provincial regulators have tackled the problem sooner? Hard to say. They certainly became bogged down in attempting to determine whether cryptocurrencies are or are not securities, and whether or not a crypto exchange such as Quadriga should be regulated. Goodman and Partridge nicely summarize the CSA position: “The Staff Notice points out that these exchanges are generally unregulated and may not be efficient markets. If a cryptocurrency exchange facilitates trading in securities and operates in Canada, it would have to be recognized as a marketplace under Canadian securities law or be exempt from recognition (to date, no cryptocurrency exchange has been recognized or exempt from recognition in Canada).”

While there are some areas in which regulators have attempted to bring in a regulatory framework, the fact is that after almost a decade of explosive cryptocurrency growth, the regulatory agencies in Canada and around the world have done little or nothing to curb their possibly dangerous and unethical practices, leaving investors and buyers of digital currencies to fend for themselves. One does not want to encourage more regulation, but this is what happens when investors are led to believe they are protected from fraud and failure.