Recent staff notices by the Canadian Securities Administrators (the CSA) have used a “crypto contracts” term, but the meaning of this term has not been entirely clear. Probably “crypto contracts” are not meant to be smart contracts as such term is generally understood, so to a certain extent “crypto contracts” meaning has remained somewhat cryptic.
Initially, a reference to crypto contracts was used in the CSA Staff Notice 21–329 Guidance for Crypto-Asset Trading Platforms: Compliance With Regulatory Requirements (CSA SN 21–329). In defining crypto contracts, CSA SN 21–329 refers to “instruments or contracts involving crypto assets, as indicated in CSA Staff Notice 21–327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto-Assets (CSA SN 21–327)”. However, CSA SN 21–327 itself does not include a particular reference to specific instruments or contracts involving crypto assets. CSA SN 21–327 also does not determine whether a “crypto contract” is a security or not, but refers to a particular set of circumstances under which platforms facilitating transactions in crypto assets (CTPs) could be subject to the securities legislation. Rather, CSA SN 21–327 appears to refer to two broad categories: (a) arrangements providing a contractual right or claim to an underlying crypto asset and (b) contracts or instruments for the purchase, sale or delivery of a crypto asset resulting in and being settled by an immediate delivery of an underlying crypto asset (provided that such crypto asset is not a security or a derivative). This seems to mean that if a CTP has arrangements in the category (a), it is likely that such CTP would be subject to the securities legislation. This would also probably mean that those arrangements are also likely to be considered securities. If a CTP transacts in crypto assets from category (b) only and provides for immediate delivery and settlement of the transactions, it is possible that such CTP would avoid being subjected to the securities legislation requirements (subject to many conditions and qualifications as usual). However, this is a different story.
Recent decisions by the Ontario Securities Commission in Mek Global Limited (Re), (2022 ONCMT 15) (Re MEK Global Limited) and Re Polo Digital Assets, Ltd (Re), (2022 ONCMT 32) (Re Polo Digital Assets) shed some light on “crypto contracts” definition. These cases suggest that where CTPs provide their customers with a contractual right or claim to an underlying crypto asset (a Crypto Contract), such Crypto Contract could be regarded as a security. This view is explained in more detail in Re Polo Digital Assets, Ltd (2022 ONCMT 32), in which it was reasoned that a Crypto Contract is a security where investors on a CTP are dependent on the actions, custody arrangements and solvency of such CTP, the investors are engaged in the common enterprise with CTP and are dependent on the CTP‘s significant efforts for the failure or success of their investment. A CTP is considered to be selling a Crypto Contract when an investor deposits crypto assets on the platform, trades crypto assets for other crypto assets. Such sale of a Crypto Contract constitutes “a disposition of a security for valuable consideration”, and if the CTP is in the business of trading securities, the CTP will be subject to the dealer registration requirement. In addition, a Crypto Contract sale would require a prospectus or distribution in reliance on applicable prospectus exemption. In Re Polo Digital Assets, Ltd., the OSC also included a list of actions that were regarded as acts in furtherance of trading:
(a) creating and maintaining a securities trading market on the platform,
(b) carrying out trade matching functions,
© creating and maintaining means for investors to create and fund accounts on the platform, providing information to investors to assist them in accessing and trading on the platform,
(d) promoting the platform, and
(e) offering the platform through which investors trade on the platform.
The list appears to suggest that potentially any interaction between a CTP and an investor resulting in a transaction in a crypto asset could potentially be regarded as a transaction in a security when an investor is dependent on the CTP.
Next Steps
The decisions in Re MEK Global Limited and Re Polo Digital Assets are helpful in getting a better understanding of how the securities regulators would approach the definition of a “crypto contract”. This also mean that almost anything can be a security, although determination of whether an arrangement is a crypto contract and/or a security would require looking at many factors and details. In this context, CTPs are suggested to look carefully at their terms of service, internal operations and each individual digital (crypto) asset and determine whether their trading arrangement with a user would constitute a security and whether they are actually facilitating trades in securities and/or derivatives.
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