How should regulators approach the consumer risks of cryptocurrency investing?

Canadian consumers need to “exercise caution” when engaging with the unregulated world of cryptocurrencies. Policymakers, meanwhile, should step up their efforts at monitoring these new assets, and educating the public about their risks. 

These are the conclusions of Ottawa-based non-profit Public Interest Advocacy Centre, echoing similar warnings from some of the world’s most respected voices, including Nobel prize winners, central bankers, and even comedians.

Cryptocurrencies “are just not ready for prime time yet,” particularly for your average Canadian, said John Lawford, PIAC executive director, in a telephone interview.  “There are just too many weaknesses,” including security breaches, lack of consumer redress, not to mention the colossal waste of energy that the current systems require. In its latest report, Assessing the Emergence of "Alternative" Currencies and Legal Risk: the Consumer's Perspective, PIAC called for the creation of “a working group of key stakeholders to review the risks to consumers.”

PIAC’s proposals are hardly radical. But they do underscore a much greater issue: the delicate balancing act that policymakers around the world must perform as each new technology offers its citizens economic bounty as well as jeopardy. As the erosion of privacy shows, regulators and legislators haven’t always succeeded, and this tension will continue given Canada’s “hotbed of innovation” status.

So far, crypto is small beer compared to other asset classes. PIAC points out that as a percentage of the population, few Canadians use it either for payments or investments. But this doesn’t mean it will remain on the sidelines, particularly given the vast amounts of real-world money that it has attracted. At its peak last December, the global market hit about $800 billion. 

Since then, crypto prices have plunged, though that is unlikely to shake the faithful. Some liken the recent rout to the dot-com boom and bust of the early aughts, before people figured out how to monetize the internet. More importantly, observers say, there exists genuine excitement for the future potential of blockchain, the technology that underpins Bitcoin, as a way to rein in tech giants’ awesome power. The decentralized systems that public blockchains will one day help develop — however currently imperfect — offer a way to wrest control from the Facebooks and Googles of this world, and once again liberate information, they say. 

“The alternative is terrifying,” said Carsten Sorensen, associate professor in Digital Innovation at the London School of Economics, when asked why the crypto-community is so optimistic about finding solutions given the current buggy reality. “We need to let people experiment.”

Regardless of blockchain’s future progress, governments still need to be mindful of the here and now. Control of money supply is a basic government responsibility, said Lawford, as is protecting consumers; the hey-you-never-know style of investing isn’t really appropriate for your average Joe or Jane, he added. People need to be warned.

While there are variations in their uses, most notably the platform Ethereum, the definition of cryptocurrency is generally understood to be peer-to-peer digital “money” that is validated by cryptography, with 10-year-old Bitcoin as the original and by a long way the most successful example. Bitcoin, and its imitators, can be used to buy things and services (legal and illegal), but enjoy no protection if things go wrong. Because of the high processing cost and price volatility, commerce is not their primary function. In Canada, as in other parts of the world, cryptocurrencies are attractive for their speculative potential. Holders of digital assets are banking on ever-increasing values, or for those who bother to have an opinion — a rosy future for blockchain. 

This hasn’t exactly worked out for all. Having reached a high of about $20,000 in December, following a 15-fold gain for the year, Bitcoin has lost about two-thirds of its value. Many other “alternative” coins, a variation on the original, just ceased to exist.

Indeed, initial coin offerings (ICOs), a form of crowdfunding that non-professional investors took up early on, has come under the scrutiny of regulators and watchdogs. Since their debut a few years ago, startups keen to find a low cost, low hassle, low dilution way of raising funds have launched thousands of new digital “coins” or “tokens.” Even though tokens grant no ownership (investors bet on price increases), ICOs raised about USD 14 billion in the first half of 2018—compared with $5.5 billion in 2017.

Though it has enabled promising young tech companies to fund ideas, the market has also attracted plenty of nutty proposals and out-right frauds. Regulators in many jurisdictions, including Canada, issued warnings that most of these coins actually represent securities, and would be judged as such (see Canadian Securities Administrators Staff Notice 46-307, 308). As a result, many firms excluded regular Canadians from participating. 

Some observers say Canadian securities regulators have gotten it more or less right regarding consumer protection, so far. “It’s a difficult space to regulate because every week, every month something new is happening,” said Carol Derk, co-leader of Borden Ladner Gervais Cryptocurrency and Blockchain group. “They’ve reached a balance that seems to work.”

Over the course of the summer, ICO activity has dropped off, thanks in part to stiffening oversight and questions about crypto’s ability ever to go mainstream. Whether the model will evolve, and something new will take its place is a matter for speculation. For now, companies appear to understand that they can’t bend the rules, no matter how innovative the technology. “Firms are realizing they have to comply, and they’re looking at their options,” says Derk.

Regulators have tried to accommodate these nascent businesses, mindful — undoubtedly —that Canada has been tipped as global crypto fintech “hub.”  Provincial regulators like the Ontario Securities Commission have created “sandboxes” where young firms can test their wares and receive guidance on a case-by-case basis. But this combination has also helped drive firms away from Canada.

“The regulators are trying to be open and helpful, but they’re in an impossible position, trying to protect investors playing catch-up with the technology,” said Will Shaw, a partner at Fasken Martineau, which has assisted in both national and international ICOs. “This is a product that many people just don’t understand.”

For the time being, the dramatic plunge in the value of cryptocurrencies and the stricter rules may cool enthusiasm for all things crypto. Policymakers have kicked issues like strengthening money laundering codes in the long grasses. In August, the federal government opted to delay the release of its regulations for cryptocurrency and blockchain companies until after the elections.

The question is: what happens if Bitcoin and friends once again start to surge? Ironically, this may not happen until institutional investors have more clarity on regulations, something that at least part of the crypto community may balk at.

“We inhabit a 1990s world in internet terms,” said Jeff Dennis, Fasken Martineau’s entrepreneur-in-residence. “Nobody really knows where this is going.”