What Canadian Advisors Should Know About Crypto
Interest in crypto from clients is not going away anytime soon, and regulators are recognizing this, building frameworks for regulation and enforcement in the space. In Canada, we’ve seen rules emerge for exchanges, and more recently, exemptions for dealers.
Specific rules for Canadian advisers may be next. In the meantime, we can check which way the wind is blowing and establish some guidelines. In the US, Morningstar’s Jasmin Sethi found that recent developments provide clues in the absence of formal regulations: “I call them ‘hooks’ – guidance and precedents that, while not set law, could mean advisers will be under regulatory scrutiny.”
In Canada, it currently looks something like this:
Before coming to the attention of the authorities, it is worth considering the risks behind any notorious crypto-asset. “Cryptocurrencies are highly speculative and subject to extreme volatility,” says Sethi, “They are particularly dangerous for participants approaching retirement or those who choose to allocate a large portion of their accounts to them.” The Canadian Securities Administrators (CSA) identify four key dangers:
- Volatility: Social media hype and marketing campaigns can cause wild swings in cryptocurrencies, and there are usually few trading restrictions.
- Liquidity: There is a real possibility that crypto trading platforms (CTPs) do not have enough funds to cover your order. “There are also no guarantees that demand for any given crypto-asset will continue,” the CSA letter said.
- Online risk: Crypto can be anywhere and interact with all kinds of intermediaries. Great for innovation, but a headache for maintenance issues. Take Celcius, which “paused” investor withdrawals. Morningstar’s James Gard recently found that the company’s custody arrangement gave the company title to assets to be used “as it sees fit”.
- Technical and cyber security risks: We’ve heard about the hacks, but crypto is also prone to programming vulnerabilities. Even coins designed to be stable collapse when everyone runs for the door at once.
Regulators have begun to respond to the risks surrounding crypto, and perhaps the fastest is Revenue Canada with its guidance that all transactions involving cryptocurrency are generally treated as business income or as capital gains.
For investors, “buying a cryptocurrency with the intention of selling it for a profit can be treated as business income, even if it is an isolated event,” the CRA says, “because it can be considered an adventure or concern in the nature of the trade. .”
An adviser acting on behalf of a client might argue that it was not “a fairy tale”, but they want to make sure they are not an extension of a client’s business. Holding a wallet opens a door to crypto deposits from anyone with the wallet address, and transactions are permanent.
Another thing to look for is how Canadian tax law applies to altcoins. Often, to buy altcoins, fiat currency must be converted to regular crypto like Bitcoin or Ethereum. This crypto-to-crypto transaction sets out rules that require additional steps in reporting.
“Generally, when you dispose of one type of cryptocurrency to obtain another cryptocurrency, the exchange transaction rules apply,” the CRA brief says, “You must convert the value of the cryptocurrency you received into Canadian dollars. This transaction is considered a disposition and you must report it on your tax return. Report the resulting gain or loss as either business income (or loss) or capital gain (or loss).”
A good alternative to the complexity of “holding” crypto is to simply buy a fund, of course. In exchange for a fee, acquiring an interest in crypto is as easy as buying an ETF. Another advantage is that the treasures become much more familiar.
When it comes to official regulation around crypto trading, start by considering existing legislation, as the CSA did in 2019: “If cryptoassets that are securities or derivatives are traded on a platform, such platform will be subject to securities legislation.” and clarified in 2020, “In some cases, cryptoassets are clearly a security, such as a tokenized security that has rights traditionally associated with ordinary shares, such as voting rights and the right to receive dividends. In other cases, cryptoassets are a derivative, such as a token that provides an opportunity to acquire an asset in the future.”
Crypto trading platforms appear to have been the primary target of regulators so far, and while they do not specifically address the activities of advisers, we get a clear understanding of what is covered by securities law, and that is “a contractual right or requirement of a underlying crypto.resource”. The CSA and the Investment Industry Regulatory Organization of Canada (IIROC) have since outlined a regulatory framework specific to crypto-asset trading platforms (CTPs). Platforms are now required to register, and so far provincial regulators seem to be taking it seriously.
To address custody issues specific to crypto, IIROC has granted exemptions to dealer rules, which saw Fidelity first in line to offer crypto trading and custody to institutional clients. IIROC has also provided guidance on advertising and social media around crypto, advising on activities that could attract scrutiny, which includes posting statements that could be considered false or misleading. Other behaviors mentioned that are sure to raise some red flags include the use of gambling-style contests or promotions that involve bonuses. These concerns from regulators can help counselors become aware of the environment in which clients find themselves when they come to seek guidance.
“Cryptocurrencies are a tempting opportunity for people trying to get rich quick. They hear stories of people making large sums of money and hope to replicate that success, with little understanding of the risks involved,” Sethi says, “Apart from the attractiveness of cryptocurrency, it is also less likely that customers have sufficient knowledge about these investments. than they do about traditional asset classes. Evaluating cryptocurrency investments is difficult even for expert investors. Advisers need to take the time to ensure their clients are fully informed about the asset and the risks involved rather than allowing them to naively accept the risks.”
Giving crypto advice is no easy task. There is another world of influences and technical factors to consider, which must be compatible with the client’s goals. “It is important for advisors to look at each client’s circumstances, risk and wealth to determine appropriate allocations and be sure they fully understand the risks of this asset class,” says Sethi, “That said, crypto can be off interest and use to clients who want to allocate a small portion of their portfolios at the right level,” and advisors have a critical role to play in helping clients make the right allocation decisions and determine the best way to invest. Before next question from a client about crypto, consider subscribing to cryptocurrency news and discussions or improve your understanding of the opportunities and risks surrounding this evolving asset class.
