Canada’s KYC/AML Rules for New Crypto Regulations “Virtual Currency”

June 13, 2018


On June 9th, 2018, Canada has published draft anti-money laundering (AML) legislation amendments that apply to companies dealing in virtual currencies like bitcoin on blockchain technology. Here is a recap in this article and the links to the draft amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) and its enacted regulations for further exploration.

The new regulations will treat crypto exchanges and payment processors as money service businesses (MSB), which requires them to report large transactions — those over $10,000 Canadian dollars ($7700 USD) — and a new Know Your Customer (KYC) threshold set at transactions of $1000 CAD ($770 USD). The draft also contains a cost-benefit analysis, which reveals the regulations would cost about $61 CAD mln ($47 mln USD) over the next 10 years.

—- More Updates from our legal sources:

Key Takeaways —

  • Determining whether securities laws apply to an offering of tokens is dependent on the economic realities of the offering as a whole. Emphasis should be placed on substance over form when making the determination.
  • Multiple step token offerings can be subject to securities laws. If a token delivered at a second or later step maintains security-like attributes, the CSA may consider it to be a security.

Summary and Background  — The Staff Notice provides additional guidance on the Canadian regulatory approach to cryptocurrency offerings and funds and offerings and follows Staff ongoing engagement with numerous industry participants. Cryptocurrency offerings are often similar to initial public offerings of shares or equity. This resemblance is because the offering can involve the distribution of an investment contract, and/or the offering and/or the tokens issued under the offering are otherwise securities. Cryptocurrency offerings that involve the sale of securities will be subject to securities laws.

When an Offering of Tokens May or May Not Involve an Offering of Securities — In this Staff Notice, the CSA expanded on the applicability of securities laws, specifically with regards to the determination of whether or not an investment contract exists in the context of token offerings. The CSA emphasized the focus on substance over form in the analysis, stating that an assessment should be made on both the technical characteristics of the token itself and the economic realities of the offering as a whole. Further, when interpreting the term “investment contract,” consideration should be given as to whether the offering involves an investment of money, in a common enterprise, with the expectation of profit to come significantly from the efforts of others.

On the topic of “utility tokens,” the Staff Notice provides that the fact that a token has a utility is not, in and of itself, determinative as to whether an offering involves the distribution of a security. In fact, the CSA highlighted that the majority of “utility token” offerings that it had reviewed have involved the distribution of a security, usually an investment contract.

The Staff Notice also discusses tokens that are reasonably expected or marketed to trade on one or more crypto-asset trading platforms. Such instances can give rise to implications on the presence of elements of an investment contract, due to the fact that purchasers may purchase tokens with an expectation to resell for profit. When determining whether tokens are reasonably expected to trade in the secondary market, formal and informal representations made by the issuer will need to be considered, along with third party representations that have been endorsed by the issuer or management.

Offerings of Tokens That Are Structured in Multiple Steps.  The CSA further addresses token offerings structured in multiple steps. These offerings generally proceed as follows:

  • The purchaser agrees to contribute money in exchange for a right to receive tokens at a future date. While no token is delivered at the time of purchase, there is generally a distribution of a security in the form of the right to a future token, which is usually made under a prospectus exemption.
  • The issuer then delivers the token after having represented that the online platform is built or the goods or services are available, and the token is functional.

Securities laws are applicable in these multiple step offerings. The Staff Notice specifically notes that a “utility token” delivered at a second or later step may still be considered a security if it continues to have a number of security-like attributes. Additionally, since the distribution of a security is subject to the prospectus requirement, issuers must ensure their compliance with the relevant National Instrument requirements. If the distribution of the security at the first step is made without complying with the requirements, the issuer will remain in default of the requirements, even if subsequent steps may have occurred.

The Upshot   In issuing the Staff Notice, the CSA provides greater clarity into the current securities law implications for token offerings. The CSA intends to continue taking regulatory action to prevent securities law violations in the context of coin and token offerings. Businesses should, therefore, consider and seek advice regarding the applicability of securities laws when dealing with the evolving cryptocurrency industry.

Many businesses already have in place the required elements of an anti-money laundering (AML) compliance regime, including:

  • The appointment of a Compliance Officer;
  • Written policies and procedures;
  • A documented risk assessment;
  • Training; and
  • Effectiveness testing (like an audit, but for compliance).

In addition, many have been voluntarily reporting suspicious activity to the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), the body under which they expect to be regulated for AML. The proposed amendments would formalize compliance program requirements, as well as create new requirements specific to businesses “dealing in virtual currency” (which would now be considered MSBs). While “dealing in virtual currency” itself is not defined, the text of the regulations implies that it will include exchanging, sending, and receiving virtual currency on behalf of other people or entities. Here is a great recap video on video on Canada’s AML Rules for “Virtual Currency” from Outlier AML Anti Money Laundering Consulting here:

FAQ note of Interest / diving into the definitions and the grey areas: 

1. Do the definitions capture unintended parties?  “We were surprised to see that there were not specific carve-outs for certain types of tokens, including securities, and tokens intended specifically for gaming. The definition, as it’s currently written seems capable of encompassing both tokenized security offerings and gaming tokens.” In addition, the second part of the definition that includes “information that enables a person or entity to have access to a digital currency referred to in paragraph (a).” has the potential to open the definition even more broadly. For instance, if I have stored a copy of a seed phrase or a hardware device with a vault service – have they received virtual currency? Are they sending virtual currency to me if the contents of my vault are couriered to me?

2. What about peer-to-peer, decentralized applications, and smart contracts? “The amendments as they are presented appear to take the view that transactions have intermediaries. There are no specific carve-outs for peer-to-peer transactions (though we expect that previous guidance could be applied here), decentralized applications, and smart contracts. This may be a particularly contentious issue in the case of an exchange from one “virtual currency” to another – especially where such an exchange is initiated or completed without any human intervention.” Source visit: Outlier Blog – AML . You can connect with us on Twitter.