Are Virtual Currencies Securities? The Case of Canada.


The dominant conversation within the financial regulatory oversight bodies is which regulatory authority has the power to oversee the Crypto market, reign it in and protect the consumer and keep financial systems safe?

  1. Today (3rd August 2022) it’s been reported that in the USA there is a push to transform the derivatives regulator Commodity Futures Trading Commission (CFTC) into the main crypto oversight body with a Senate Bill that gives sweeping new powers to oversee the assets class.

Crypto industry executives have been pressing the CFTC to get more power. They have been resisting the power of the Securities and Exchange Commission’s assertions that many digital coins are under the SEC’s purview. This resistance comes from the fact that the SEC is more stringent and its reign may defeat the very purpose why virtual currencies exist: to provide an alternative independent payment system that would operate free of central state control.

Having studied 12 jurisdictions in North America, Latin America, Europe, Africa, and Asia on the legalities and regulations guiding virtue currencies, the question of whether virtue currencies are securities always arises and the answer is elusive. One jurisdiction that has moved leaps and bounds in clarifying the legal status of virtue currencies from a market point of view is Canada. This has mainly emerged out of case law.

The Securities Act (Ontario) defines a security to include, among other things, an investment contract. The seminal case in Canada for determining whether an investment contract exists is Pacific Coast Coin Exchange v. Ontario (Securities Commission) [1978] 2 SCR 112, which is itself based on the better known 'Howey Test' set out by the Supreme Court of the United States in SEC v. W.J. Howey Co., 328 U.S. 293 (1946)) where the Supreme Court of Canada identified the four central attributes of an investment contract, namely:

  1. an investment of money.
  2. in a common enterprise.
  3. with the expectation of profit; and
  4. this profit is to be derived in significant measure from the efforts of others.

If an instrument satisfies the Pacific Coin test, it will be considered to be an investment contract and, therefore, a security under Canadian securities laws.

The application of the Pacific Coin test to virtual currencies is not always straightforward, however.

Industry participants have taken the position that utility tokens, which have a specific function or utility beyond the mere expectation of profit (such as providing their holders with the ability to acquire products or services) should not be considered securities. This position appears to have been accepted by The Canadian Securities Administrators (CSA) which is an umbrella organisation of Canada's provincial and territorial securities regulators whose objective is to improve, coordinate and harmonise regulation of the Canadian capital markets which has acknowledged that proper utility tokens may not be securities. The CSA has also acknowledged that it is widely accepted that some of the well-established virtual currencies that function as a form of payment or a means of exchange on a decentralised network, such as Bitcoin, are not currently in and of themselves, securities or derivatives and have features that are analogous to commodities such as currencies and precious metals.

In assessing whether a particular virtual currency will be considered a security subject to Canadian securities laws, the CSA will consider the substance of the virtual currency over its form. The CSA has outlined a number of considerations in determining whether an investment contract exists. While no single factor is determinative, the CSA has stated that the existence of some or all of the following circumstances may cause a virtual currency to be considered an investment contract:

  1. the underlying blockchain technology or platform has not been fully developed.
  2. the token is immediately delivered to each purchaser.
  3. the stated purpose of the offering is to raise capital, which will be used to perform key actions that will support the value of the token or the issuer's business.
  4. the issuer is offering benefits to persons who promote the offering.
  5. the issuer's management retains a significant number of unsold tokens.
  6. the token is sold in a quantity far greater than any purchaser is likely to be able to use;
  7. the issuer suggests that the tokens will be used as a currency or have utility beyond its own platform, but neither of these things is the case at the time the statement is made;
  8. management represents or makes other statements suggesting that the tokens will increase in value;
  9. the token does not have a fixed value on the platform;
  10. the number of tokens issuable is finite or there is a reasonable expectation that access to new tokens will be limited in the future;
  11. the token is fungible;
  12. the tokens are distributed for a monetary price; and
  13. the token may be reasonably expected to trade on a trading platform or otherwise be tradable in the secondary market.

A particular virtual currency that meets the criteria of the Pacific Coin test or has certain characteristics described in the CSA guidance may be properly considered an investment contract and therefore a security, subject to Canadian securities laws.

The US scenario is more complex as it is fascinating, and it will form my next discussion.

By Seodi White

Keywords: Blockchain, Cryptocurrency, Legal and IP

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