Cryptocurrencies: A New Form of Securities?

This comment discusses when cryptocurrencies will be considered securities, the resulting prospectus requirement, and some practical implications of non-compliance with securities laws.

A growing way start-up businesses are raising capital from investors is through the utilization of cryptocurrencies in initial coin offerings (“ICOs”) and initial token offerings (“ITOs”). An issue with these capital-raising ventures has been uncertainty about whether the coins/tokens being offered are securities. If so, they would be subject to securities regulation. The ambiguity surrounding these offerings triggered investor protection concerns, and on August 24, 2017, the Canadian Securities Administrators (“CSA”) issued Staff Notice 46-3071 (“the Notice”) to address this issue. At the time the Notice was released, every jurisdiction in Canada, except Saskatchewan, published it. The Financial and Consumer Affairs Authority of Saskatchewan was delayed due to a by-election, but published the Notice on September 8, 2017.2

ICOs/ITOs are being used to raise capital from investors through the internet for a variety of projects.3 These capital-raising ventures are similar to initial public offerings in the sense that the coins/tokens are comparable to company shares, and they have fluctuating value based on the management of the capital raised.4 Further, the coins/tokens acquired may also be traded on cryptocurrency exchanges where secondary transactions can take place.5 The Notice states that cryptocurrency exchanges, which are similar to stock exchanges, pose additional problems:

Allowing coins/tokens that are securities issued as part of an ICO/ITO to trade on these cryptocurrency exchanges may also place the business issuing the coins/tokens offside securities laws. For example, the resale of coins/tokens that are securities will be subject to restrictions on secondary trading.6

With these issues in mind, the Notice provides guidance to financial technology companies, investors, and advisors in regard to ICOs/ITOs, cryptocurrency exchanges, and investment funds. This comment focuses on when coins/tokens will be considered securities, the resulting prospectus requirement, and some practical implications of non-compliance with securities laws.

Prior to the Notice, companies conducting ICOs/ITOs tried to assert the coins/tokens being offered were not securities in their terms and conditions of purchase. Two recent examples include:

i.          DIMCOIN Foundation’s Terms and Conditions, stating “[t]hough DIM TOKENs are similar to securities, they are not and shall not be considered as such”;7 and

ii.         The Equibit Group’s Terms and Conditions, stating, “[t]his document is not a solicitation for investment and does not pertain in any way to an offering of securities in any jurisdiction.”8

However, the terms and conditions of an ICO/ITO are not determinative as to whether a security is being offered. The Notice states the CSA is aware companies are marketing coins/tokens as software products not subject to securities law.9 Notwithstanding these terms and conditions, the determination as to whether the coins/tokens are securities is a matter of substance, not form.10

The Notice lays out a four-pronged test to determine if the coin/token is an investment contract and therefore a security.11 The test is articulated as follows:

[D]oes the ICO/ITO involve:

1.         An investment of money

2.         In a common enterprise

3.         With the expectation of profit

4.         To come significantly from the efforts of others.12

The CSA states it has reviewed a number of offerings and, in many instances, it has found the coins/tokens in question constitute securities based on the existence of an investment contract.13 However, not every coin/token distributed will be considered a security. For example, securities laws may not be involved when an individual purchases coins/tokens to play video games on a platform.14 Simply put, if the cryptocurrency’s value is tied to the future profits or success of the company, it will likely be considered a security.15 Businesses found to be issuing securities will need to comply with fundamental securities law obligations, including the prospectus or exemption requirements.

Prospectus requirements, or the need to rely on a prospectus exemption, arise under Canadian securities law when a Canadian issuer sells securities to investors in Canada.16 Therefore, if the coins/tokens being offered during an ICO/ITO are considered securities, the prospectus requirement, or the need to rely on an exemption, will be engaged. The CSA anticipates businesses selling coins/tokens will likely do so under the accredited investor prospectus exemption or, for retail investors, the offering memorandum prospectus exemption.17

For businesses that have already completed ICOs/ITOs, a common practice has been to publish a document referred to as a whitepaper, and the Notice explicitly compares these documents against the prospectus requirement.18 Whitepapers typically contain information as to the fundraising goal, the business, the project for which the capital is being raised, how many coins/tokens management will retain, and the duration of the offering.19 These documents are clearly a form of investor disclosure. However, it is important to note that securities laws contain specific disclosure requirements and investors must be provided with a document that complies with these specific requirements.20 Moreover, securities may only be sold after a prospectus has been sent to a securities regulatory authority and receipt of such has been obtained by the business.21 This means that while whitepapers are a form of disclosure to investors, businesses involved in ICOs/ITOs cannot rely on their whitepaper to satisfy the prospectus requirement.

There are also practical implications for businesses or individuals involved in ICOs/ITOs to contemplate, specifically if their offerings are considered securities as per the four-pronged test, but those offerings do not comply with securities laws. In these situations, investors may have the right to withdraw from the transaction and/or pursue damages against persons or companies who conducted the transaction in breach of securities laws.22 These potential remedies could become an issue for companies who have already issued coins/tokens considered securities without complying with the prospectus requirement or other securities law obligations. It remains to be seen what will happen in these instances. Regardless, businesses conducting ICOs/ITOs in the future would be well-served to utilize the CSA’s guidance in considering whether their offerings are securities, and to contemplate any resulting securities law obligations.

* JD Candidate (University of Saskatchewan). Any errors are mine.

1 “CSA Staff Notice 46-307 Cryptocurrency Offerings”, OSC CSA Notice, 40 OSCB 7231 (Montreal: CSA, 24 August 2017) [Notice].

2 “Securities—CSA Staff Notice 46-307 Cryptocurrency Offerings” (8 September 2017), online: <>, archived: <>.

3 Notice, supra note 1 at 7232.

4 Ibid.

5 Ibid.

6 Ibid.

7 DIMCOIN Foundation, “Terms and Conditions” (26 May 2017), online: <> select: “Terms & Conditions”, archived: <> at 1.

8 Equibit Group, “Terms and Conditions” (2017), online: <>, archived: <>, at 1.

9 Supra note 1 at 7233.

10 Ibid.

11 Ibid. See also Pacific Coast Coin Exchange of Canada v Ontario (Securities Commission), [1978] 2 SCR 112, 80 DLR (3d) 529 (containing a more complete discussion as to when an investment contract constitutes a security).

12 Ibid at 7233.

13 Ibid.

14 Ibid.

15 Ibid.

16 Rob Lando, “When Do Canada’s Prospectus Requirements Apply?” (8 November 2013) Rob Lando (blog), online: <>, archived: <>. See also The Securities Act, 1988, SS 1988-89, c S-42.2, s 58 (which provides for the prospectus requirement in Saskatchewan).

17 Notice, supra note 1 at 7233.

18 Ibid.

19 Ibid.

20 Ibid.

21 Ibid at 7231.

22 Ibid at 7233.

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