Consumer protection is the oft-cited raison d'être of regulators in Canada (and abroad). Central to this idea is that the government exercises its authority to reduce the risk of loss for a consumer. Consumer protection and risk of loss are intimately tied, and in the case of Canadian regulators position on the cryptocurrency field, risk of loss is central. But the tradeoffs inherent in this idea are rarely explored when risk of loss/consumer protection is discussed.

Risk of loss must be one of two things: i) losing out on risk of gain, or; ii) gaining a loss. But before explaining the previous sentence, I'd like to give an example of what this means in a context that's more understandable than financial products.

A Grocery Store And Consumer Protection

Grocery stores in Canada are almost completely unregulated in the sense that their core business of retailing groceries is not subject to a special regulatory regime. There's food-handling laws for preparing the food, and there's some laws that affect all businesses like the Competition Act, but on the whole, there's almost no regulation. Many people are surprised to find out that the rules applicable to a grocery store selling food are far more relaxed than that of a company selling an investment product or selling foreign currencies. So it's easy to imagine a world in which the government reacts to this Wild West of groceries by reining in grocery stores through consumer protection laws.

One way that the government might try to reduce the risk to consumers is to mandate quality standards for fruits and vegetables, say by requiring them to be free of pesticides and for the retailer to have carefully evaluated which suppliers they're using and making sure they understand where the farms are located, who's doing the packaging, certifying that they're free of human trafficking, and subject to minimum labour standards. Retailers could be required to analyse whether their products might be making consumers sick through contamination or food poisoning. They might be required to ask customers whether they really need that food, or make sure they're eating healthy products.

There's no end to the number of ways people could dream up to imagine how to reduce the risk of loss of grocery store customers. And it would be easy to see how this would be consumer protection. But it's equally easy to see that this would immediately result in many products being pulled from the shelves and a big escalation in prices. It's quite possible there'd be a shift to people importing food directly from abroad or switching to foreign-owned online retailers like Amazon. What we can be quite sure of is that this would not be consequence-free and there would be serious costs imposed by introducing consumer protection rules. It's also reasonable to think that these rules would actually work in the sense that there really would be less risk of loss to customers of grocery stores. Perhaps foods that will soon expire could be removed more quickly from shelves preventing customers from suffering the loss of rotting produce, but the produce would still rot and the grocery store would bear the cost of that, which will ultimately require them to raise prices because grocery stores operate in a competitive environment (as do all businesses in Canada, other than government monopologies or companies that are a part of restricted markets due to laws).

Grocery stores sound like a very obvious target for consumer protection because of their tremendous impact on Canadians, the chance of injury due to bad food, the national importance of healthy eating, and so many other rationales that could be dreamed up. But there are great reasons why there are is no Grocery Store Act in Canada. In fact, there's only one law in Canada that even mentions the term grocery and it's a Quebec law about selling alcohol (and there are no laws that mention similar words). This is sensible, and it's how Canada generally works. It's a recognition that special purpose laws that regulate an industry in the name of consumer protection can and do result in costs imposed on customers. These costs come in two forms: losing out on risk of gain, and gaining a loss.

Losing Out On Risk Of Gain

One way to reduce risk of loss is to reduce the risk overall, but this always reduces the risk of gains. For example, investment advisors in Canada need to find out what their clients' risk tolerance is and goals are, and then recommend investments that match that risk profile. It's not that advisors recommend amazing and safe investments to some people and risky bad ones to others, it's that there's a tradeoff between risk and reward. If someone wants low risk of loss, they're all but guaranteed to have low risk of gain. This is a foundational concept in investing, and is even expressed in legal requirements for investment dealers. It makes sense and it's backed up by abundant historical and theoretical evidence.

In some cases, the loss of the gain that could come from a risk may mean that the overall transaction is transformed into a guaranteed loss. For example, investing in government bonds that pay a low interest rate but are very safe may result in a guaranteed loss of the rate of inflation exceeds the rate of return on the bonds. There are of course reasons why someoen might want to lock in a loss using government bonds, but for the typical everyday Canadian, this is probably not a good idea. The safety level is so high that, counterintuitively, a loss is nearly guaranteed!

In my grocery store example above, the loss of risk of gain is that consumers would lose out on many products that they might like.

Gaining A Loss

Losing a risk factor may result in a loss of something else, such as less product availability or higher prices. For example, imagine that a law was passed that required all companies in Canada to automatically issue 10 year unlimited warranties for all retail products that are sold to consumers. Almost immediately, prices would increase to cover the huge increase in costs that sellers of goods would suffer. Low-end products might be entirely removed from the market. Reliable high-end products might be less impacted. Although the effects of such a law wouldn't be easy to estimate, it's very reasonable to expect higher prices. Most laws that increase costs for businesses result in higher costs for the customers of those businesses, although in some cases this loss is not in money terms, it's in the types of products available.

Removing risk is often accompanied by gaining a loss.

In my grocery store example above, the gaining of loss would be the higher prices that result.

Seemingly Cost-Free Rules

Risk of loss is not necessarily in the consumer's interest. In Canada, the legal system very often reflects this obvious idea. But in some sectors of the economy, arguments without evidence or without regard to the wider consequences of actions, has resulted in laws that don't reflect the general structure of Canada. Whether or not these laws make sense, it's important for regulators to explain that the government cannot, in almost every situation, reduce the risk of loss for free.

I'm not saying it's impossible to find an example where it is true that the government can actually reduce risk of loss without any costs, but these examples are rare. The closest thing that comes to mind recently is the move to ban some kinds of charges on mutual funds that are paid when the customer goes to sell the mutual fund, which is a practice that's very costly for consumers and probably only exists because mutual fund dealers can't get away from the juicy profits that this practice brings them. I'm a fan of this rule, and the result will likely be a switch to more efficient ETF products that don't have high commissions for salespeople. But I wouldn't be surprised if someone who works in that industry could explain that there are consequences to even this seemingly beneficial rule. Complex rules often have complex consequences that aren't known to people who are outside the indsutry. But it also may be the case that this new rule was only necessary because of previous rules that created the problem in the first place, or stopped companies from competing in the market for mutual funds without these high fees. Laws are complicated! The effects can sometimes only be felt years later. In the case of mutual fund fees, perhaps the cost might be consolidation of the market and a shift to larger securities dealers which ends up causing higher prices years from now.

Conclusion

It is very often the case when it comes to laws that there's no free lunch. Consumer protection often has costs, and sometimes those costs are hard to see because they show up in subtle ways, whether as less product choice, less competition, higher prices, or some other impact on the consumer. Only careful analysis of all of the costs, backed by expert knowledge, can provide a reasonable assessment of costs, but even then, some may be missed. In the context of Canadian regulation of the cryptocurrency field, these costs may be hard to spot, particularly because it's not known whether today's cryptocurrency industry is as large and sophisticated as it will ever become, or if we're still in the early days of something that could become much bigger. Perhaps increasing consumer protection rules might cause a loss of future opportunities, rather than of any current ones, which would be the sort of loss that's almost impossible to estimate let alone see coming.