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Unraveling the Government of Canada's Report on Crypto Law


Hand holding a phone with a balance of Bitcoin

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Introduction

In 2022, the House of Commons Committee in Canada embarked on a groundbreaking study to explore the vast potential of blockchain technology across various sectors, including on Canadian crypto law. The study aimed to assess the current status of blockchain, crypto adoption, and crypto law in the country, engaging in extensive consultations, gathering insights from 31 expert witnesses, and analyzing six briefs. The findings shed light on the manifold benefits and challenges associated with blockchain technology and crypto law, with particular emphasis on the need for robust regulatory frameworks. In this comprehensive analysis, we delve into the implications of the study's revelations, with a focus on the legal aspects surrounding cryptocurrencies and blockchain technology in Canada.


Blockchain Technology and Its Evolution

Originating from Satoshi Nakamoto's seminal 2008 paper, blockchain technology emerged as a distributed ledger system. It operates on a network where every node possesses a copy of the ledger and validates information through consensus mechanisms. The addition of encrypted data blocks ensures data integrity and eliminates retroactive alterations, all without the need for a central authority. Blockchain networks can be open/permissionless (e.g., Bitcoin, Ethereum) or private/permissioned, with restricted access to certain nodes. Although often confused with blockchain technology, cryptocurrencies represent digital currencies that utilize blockchain as their underlying infrastructure.


Cryptocurrencies and Their Applications

Blockchain technology and cryptocurrencies are intrinsically linked, as blockchain serves as a digital ledger enabling secure electronic transfers and storage of value. Modeled after Bitcoin's blockchain, most cryptocurrencies facilitate transactions and validate the ledger using cryptographic keys to ensure secure ownership verification. While Bitcoin uses a proof-of-work consensus mechanism, where nodes compete to validate transactions through computational problems, Ethereum has transitioned to a proof-of-stake model. Together, blockchain and cryptocurrencies form the core of Web 3, the third phase of the internet, empowering individuals with ownership of digital assets and online privacy.


Characteristics and Challenges of Blockchain Technology

Blockchain networks boast four key characteristics: transparency, traceability, immutability, and disintermediation, allowing for peer-to-peer transactions without intermediary involvement. These features provide data decentralization, enhanced security, and proven business solutions. However, blockchain technology faces several challenges, including concerns over energy consumption, limited scalability, high transaction fees, lack of standardized regulations, and the ongoing development of regulatory frameworks.


Diverse Applications of Blockchain Technology

Blockchain's applications can be broadly categorized into two groups: those related to cryptocurrencies and those in various sectors beyond finance. Expert witnesses cautioned against assuming that the most valuable applications of blockchain technology are already known, likening the early days of blockchain to the nascent stages of the internet. Cryptocurrencies, created using blockchain technology, include cryptocurrencies themselves, cyber-indexed tokens (e.g., NFTs), and utility tokens serving specific purposes.

Beyond cryptocurrencies, blockchain technology finds application in diverse non-cryptocurrency fields, such as efficient and transparent supply chains, pharmaceutical provenance, food security, tracking CO2 emissions, and improving carbon credit systems. Blockchain also enables automated revenue distribution in cultural industries and enhances fraud detection in music royalty distribution. The advent of non-fungible tokens (NFTs) has created entirely new digital-native industries centered around unique asset ownership.


Financial Applications and Canada's Role in the Blockchain Industry

The financial sector significantly benefits from blockchain technology, with cryptocurrencies serving as viable investment opportunities and "smart contracts" driving the growth of decentralized finance (DeFi). Blockchain enables fractionalized ownership of assets like real estate, fosters financial inclusion for underserved populations, and facilitates quicker cross-border transactions with reduced settlement times. Canada stands as an innovative leader in the blockchain industry, with substantial contributions to projects like Ethereum. However, expert witnesses warned of potential talent and entrepreneurship loss due to the lack of regulatory clarity and support, which might impede the country's progress in this rapidly evolving field.


Economic Impact and Regulatory Landscape of Crypto Law in Canada

Blockchain's economic impact in Canada is evident, with billions invested in the sector. While the number of businesses adopting blockchain technology remains relatively low, it is steadily increasing, providing employment to around 16,000 individuals and offering competitive salaries. Despite its potential, the industry faces regulatory challenges at both federal and provincial levels. Regulators focus on cryptocurrency trading platforms and related financial services to safeguard consumers and combat money laundering concerns. The taxation of cryptocurrencies involves considering them as commodities, resulting in capital gains or losses. Provincial securities regulators view many crypto assets as securities subject to securities legislation. The regulatory sandbox program offers temporary relief to firms to comply with regulations.


Canada's Approach to Regulating Cryptocurrency Trading Platforms

Canada hosts approximately 11 Canadian-based cryptocurrency trading platforms catering to Canadians and at least 15 foreign platforms serving the country. In the aftermath of the collapse of QuadrigaCX in 2019, Canadian regulators adopted a more robust approach to regulating these platforms to protect consumers. Witness testimonies highlighted the stringent regulatory requirements that platforms must adhere to, including the implementation of cold storage for client assets. Some platforms are registered with Canadian securities regulators and the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), with robust anti-money laundering and compliance programs. Cryptocurrency custodians play a crucial role in risk mitigation and securing assets for institutions and investors.


Canada's Competitive Advantage in Cryptocurrency Mining

Canada boasts a competitive advantage in cryptocurrency mining, driven by factors such as the rule of law, infrastructure, a well-educated workforce, natural cooling systems, and access to clean, renewable energy. Mining operations provide significant value to the Canadian economy and contribute to smaller population centers. However, concerns arise over high energy consumption, comparable to that of entire countries, leading some utilities to restrict new connections. Witnesses highlighted the need for innovations in renewable energy sources and alternative consensus mechanisms to mitigate environmental impacts and support the power grid.


Overcoming Challenges and Embracing Opportunities

While the blockchain industry has witnessed remarkable growth and potential, it has also faced significant challenges, with high-profile fraud cases like FTX. Expert witnesses emphasized the importance of differentiating technology from bad actors and the need for effective regulations to protect consumers from potential risks associated with cryptocurrencies. Nonetheless, the majority of experts remain optimistic about the transformative potential of blockchain technology.


Promoting Regulatory Clarity and Government Support of Crypto Law

To foster the growth of the blockchain industry in Canada, regulatory clarity is paramount. A lack of standardized regulations and jurisdictional oversight has led some firms to relocate to other countries, affecting talent retention and consumer protection. Expert witnesses recommended the development of a digital asset taxonomy and differentiated regulations, with the European Union's (EU) comprehensive MiCA regulations cited as a potential model.


To address the lack of regulatory clarity, witnesses called for increased government engagement with the blockchain industry and the establishment of a national strategy. Stablecoins received particular attention, with recommendations for a comprehensive regulatory regime. Witnesses also highlighted the potential of Central Bank Digital Currencies (CBDCs) and their benefits in blockchain-based transactions.


Furthermore, witnesses emphasized the importance of government support in research, commercialization, and education within the blockchain industry. They proposed targeted investments to bolster research and commercialization efforts, drawing parallels with the government's successful support of artificial intelligence research. Education was identified as a critical aspect to enhance public understanding of blockchain technology and protect consumers from fraud. Blockchain education, beginning at the elementary school level, was considered essential to nurture talent and create a competitive workforce within the global industry.


List of Recommendations

In response to the information gathered by the Government of Canada, they released the following sixteen recommendations:

  1. That the Government of Canada recognize blockchain as an emerging industry in Canada, with significant long-term economic and job creation opportunities.

  2. That the government of Canada should, in its efforts to improve consumer protection and regulatory clarity to the emerging and innovative field of digital assets, be guided by the principle that individuals’ right to self custody should be protected and that ease of access to safe and reliable on and off ramps should be defended and promoted.

  3. That the Government of Canada, following consultation with the provinces and stakeholders, establish a national blockchain strategy that clarifies the government’s policy direction and regulatory approach, and demonstrates support for the industry.

  4. That the Government of Canada, with a view to adopting a national blockchain and distributed ledger strategy call on a group of experts, entrepreneurs, academics and investors, as well as people in the artificial intelligence industry cluster, to support its analysis and understanding and help it determine best steps; and give the group a mandate to set up a platform for information exchange and monitoring; carry out analyses to identify the most promising or high-risk areas for disruption; advise the government on promising initiatives; and support the government in implementing selected initiatives.

  5. That the Government of Canada pursue opportunities for international cooperation in the development of blockchain regulations and policies, including with our major trading partners.

  6. That the Government of Canada conduct innovative pilot projects using distributed ledgers to help strengthen the ecosystem and recognize up-and-coming businesses.

  7. That the Government of Canada create a sandbox where entrepreneurs can test technologies unhindered by as yet unadopted regulations.

  8. That the Government of Canada adopt a distinct regulatory approach to stablecoins that reflects the difference between these products and other cryptocurrencies, and account for the unique regulatory challenges they present.

  9. That the Government of Canada adopt regulatory changes to promote the establishment of federally regulated cryptocurrency custodians to meet the demand for cold storage services from Canadian cryptocurrency firms.

  10. That the Government of Canada adopt measures for access to banking and insurance services for blockchain firms, including through Crown corporations.

  11. That the Government of Canada establish a public awareness campaign, in consultation with the provinces and the industry, to educate the public about risks related to cryptocurrencies and the benefits of accessing cryptocurrency markets through regulated Canadian entities.

  12. That the Government of Canada draw on the previous report on SMEs and launch a strategic initiative to develop skills and talent and support research.

  13. That the Government of Canada investigate ways to promote the adoption of blockchain technology in supply chains.

  14. That the Government of Canada, in collaboration with the Commissioner of Canada Elections, undertake a study on the new opportunities this technology presents for electronic voting, consultation, and the modernization of our democratic institutions.

  15. That the government of Canada should investigate equity between provinces in the application of the Excise Tax Act to mining activities to ensure fair taxation.

  16. That the government of Canada, in order to foster a competitive digital asset mining environment and in order to continue to attract investments, should maintain that digital asset mining constitutes a commercial activity in Canada; and as such adopt a neutral and equitable position towards this new and growing industry.

Conclusion

The findings from the House of Commons Committee's study demonstrate that blockchain technology and cryptocurrencies possess immense potential to revolutionize various sectors and boost economic growth in Canada. Despite facing challenges such as regulatory clarity, high energy consumption, and concerns over criminal activity, the blockchain industry in Canada continues to thrive. With recommendations for regulatory clarity, government support, and strategic initiatives, the country can become a global leader in this transformative technology, unleashing countless opportunities for innovation and prosperity in the years to come. We provide advice on all things related to blockchain and cryptocurrencies. We offer flat fees to provide you and your business with certainty. Contact us today to learn more about how we can assist you.



This article is intended for informational purposes only and should not be considered as legal advice and does not establish an attorney-client relationship. Consulting with a qualified legal professional is recommended for specific legal concerns and requirements related to your business.



© 2023 Andrew Roy

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