The crypto hype is down, but crypto scams are spreading

Although the mass euphoria surrounding all things crypto has subsided, one facet of the cryptocurrency space is still flourishing: fraud and unregulated activity.

Canadian authorities are reporting record levels of fraud, as securities regulators try to crack down on illegal trading related to crypto-assets.

The Banking and Investments Ombudsman recently reported that fraud-related cases tripled in the fourth quarter of 2022, mainly as a result of complaints involving crypto-investments.

The Canadian Anti-Fraud Centre, meanwhile, reported a “swimming” $530 million in fraud losses last year, a year-over-year increase of nearly 40 percent, with crypto fraud the biggest culprit.

And every few weeks, the Ontario Securities Commission releases a new list of companies that could pose a risk to investors — mostly crypto firms that aren’t registered to operate in the province.

“The regulator has to constantly play dumb,” said Ryan Clements, a fintech expert at the University of Calgary.

Even within the more legitimate side of the industry, compliance with Canadian securities regulations is an issue.

Last month, the Canadian Securities Administrators announced that they were tightening the rules for crypto exchanges operating in Canada.

CSA cited the recent collapse of a number of trading platforms, including FTX, then one of the world’s largest. These incidents “highlight the significant investor protection risks for Canadian investors when trading cryptoassets,” the CSA said.

It gave non-compliant firms until March 24 to sign an undertaking indicating they plan to follow the rules while they are in the process of registering. These rules include new prohibitions designed to protect investors from the lapses that led to the FTX failure.

Ethan Lou: Irony: An exchange for bankrupt crypto exchanges – to trade your lost coin claims

For example, crypto-assets cannot be used to determine a platform’s working capital requirements. In the case of FTX, a cryptocurrency created by the firm was allegedly used as collateral to borrow billions of dollars, eventually leading to a solvency crisis.

The CSA also introduces restrictions on how private customers trade with credit or leverage. And there are new restrictions on the use of stablecoins, which are usually pegged to a currency like the US dollar. Although they are supposed to be a relatively safe haven within the crypto space, stablecoins have recently attracted scrutiny from US regulators who are concerned that they pose a liquidity risk.

So far, the measures taken by Canadian regulators have struck a pretty good balance between encouraging innovation and protecting investors, said James Kosa, a partner focused on information technology at law firm WeirFoulds.

“They have been shockingly nimble, given the challenges of regulating securities in a country with 13 regulators,” Kosa said.

“They try very hard to treat the good as good and the bad as bad.”

After all, Canadian regulators had a bit of a head start. The 2019 bankruptcy of cryptocurrency exchange QuadrigaCX proved to be an early catalyst for regulatory change. About $170 million of client money effectively disappeared when Quadriga’s founder died, in what would turn out to be something of a preview of the FTX debacle. In both cases, misuse of client money and lax accounting were among the critical misdeeds.

Canadian regulators responded with a set of controls on the types of coins that can be traded, restrictions on margins and derivatives and the use of qualified custodians to hold client funds.

So far, 11 crypto asset trading platforms have registered to operate in Canada. But that doesn’t stop Canadian investors from accessing those who don’t. For example, there is evidence that some Canadian investors had access to the unregulated FTX platform, which was domiciled in the Bahamas.

And while the cryptocurrency bubble has effectively popped, many mainstream investors are still attracted to the space, Prof Clements said. “The crypto story is something bigger than just chasing returns. There is an ethos attached to the crypto ecosystem, like decentralization and peer-to-peer systems, and these are still compelling narratives.”

The strength of that narrative, combined with crypto’s complexity, also seems to make it a haven for fraudsters. Despite regulators’ best efforts, it’s normal for the law to delay an emerging technology by at least a few years, Kosa said.

“The legitimate side will eventually mature into something that investors can trust and invest in.”