Government promises safety from the rough and tumble reality of life. This post is about the balance between protection and reward, and what that means in a globalized world in which Canadian services businesses are increasingly meeting with the opportunities & competition that manufacturers faced decades ago. Specifically, this post is in the context of moves to increase regulatory requirements for Canadian businesses in the cryptocurrency industry, but the issues aren't specific to cryptocurrency or blockchain technology.
Centuries ago, the government promise of safety meant protection from invasion by neighbouring warlords. Today, it means protection from all manner of harms. In Canada, the public demands safety at every turn and the government obliges. It does so by creating new rules and writing them down in uncountable laws, proclamations, guidance, and instructions. The Canadian public is always hopeful that if only one more rule could be created, they will be protected. And yes despite creating millions of rules, our government and its legal system have not eliminated frauds, scams, and cheating. Virtually everyone in Canada has been defrauded by someone. Sometimes the losses are life changing, and the stories are often heart breaking. I hear them from the people who regularly call me to see if a lawyer has the answer to what the government and basic decency failed to prevent. The answer is usually no.
Could one more law finally make people safe? No. Because criminals don’t follow laws. But setting aside criminals, the answer is still no. Because life is about risk. The least risky career is to work for the government as a civil servant with an inflation-indexed pension and yet many people choose to engage in far riskier business activities because if they succeed there is great reward. On average, the public sector in Canada pays around 20% more than private. Yet people still start businesses and go to work for startups. The public invests in stocks because they have risk, not in spite of it, because if they didn’t have risk, there would be no reward. The two are opposite sides of the same coin. Opportunities with enormous reward and low risk are rare, and they’re so rare that it’s often an indicator of a scam of some kind. Frauds promise disproportionate risk/reward ratios. Reality doesn’t.
Laws may change the risk/reward calculation. But the general result is to reduce reward and risk in proportion, and to do so at a cost that lessens the overall reward:risk ratio because laws aren’t free to create, implement, follow, or administer. Someone must pay. And that cost is often not seen. Because if it was truly the case that laws could eliminate risk while leaving all the reward to the public we would be living in a utopia. Unfortunately, despite centuries of rule making, risk still exists. And it’s a necessary part of life. We want entrepreneurs to take risks to create new products like Netflix, iPhones and your favourite coffee shop’s perfect blend of coffee. A life without risk is one of boring monotony in which nothing changes and everyone is impoverished because from the taking of risk comes great improvements.
Canada could eliminate risks substantially from new technologies by simply banning them. That happens sometimes. But most people would instead argue that “regulation” is needed. Almost all regulation is actually social - how people deal with one another - rather than legal in nature. Most people can’t know even a tiny percentage of the laws that have been created and it doesn’t matter anyway because they don’t follow the law they follow their conscience. Virtually every business dispute in Canada is not dealt with by recourse to the courts. Virtually every dispute between people is settled through discussion, argument, and agreement.
People in Canada do not, as a rule, resolve their disputes using courts or a rule designed by a legislature. But we certainly have a lot of laws and they are important in the public imagination if not in reality. When people in Canada (and particularly people in government and academia) hear of a new thing they ask: what should the law be? How can the government set the parameters? How can it be controlled or stopped? How can the risks be managed to reduce the chance of bad things happening? Never mind that the most impactful technologies don’t have rules at all. For example, almost all teenagers in Canada now have an Internet connected device with Facebook, Twitter, Instagram, TikTok or any number of foreign owned services that they interact with every day with almost no oversight by Canadian lawmakers. There's no law stopping people from driving as much as they'd like even though brake dust, air pollution, children being hit crossing the street, and carbon dioxide are major threats to the health of Canadians. Obesity is a major killer. Examples abound. But there’s no fact or book for people to read that will stop the question: how can legal rules make us safer? And there is certainly truth to the idea that our modern world of laws has reduced many risks. Laws can and do reduce risk. Just not for free (and sometimes with costs greater than the benefits).
What’s asked less often than what rule can be passed is: what will be the cost? And in a world in which Canadians compete with 7+ billion other smart, motivated people, the question should always be: what will we lose to others by making a rule? Many countries ban or censor the Internet to stop perceived harms but they inevitably lose out on scientific progress, new technologies, and new ideas that can make their countries more prosperous. Very few of the richest countries in the world ban the Internet because the costs are so high. To take this down to the level of daily reality, we should consider what restrictive rules will cost Canada’s businesses or people. That’s a trite comment that few would disagree with, and it’s become increasingly common in Canada for regulators to create “regulatory impact assessments” (or at least, go through the motions of doing it) to look at whether the costs outweigh the benefits. Because banning or restricting always has a cost. But the cost can be very subtle, such as a lessening of Canada’s global competitiveness by creating a special walled off market in Canada that has rules not followed elsewhere.
If Canada made a law requiring all food to be organic we would surely have more healthy food but at a high cost to Canadians and probably a substantial lessening in farm incomes. Similarly, if we create any regulatory regime that creates a special system for Canada that’s different from the global mainstream, there’s a risk that Canadian companies will be cut out of the world economy and Canadians will become poorer as a result. We generally try to standardize our exports to meet world standards and not prohibit business activities commonly engaged in internationally. And when that happens properly, Canadians benefit enormously by being able to sell to the world, rather than just our own domestic market. This is a subtle type of risk that is actually created by the effort to reduce risk, because the local rules to make Canadians “safer” (usually the rationale) reduces the chance that Canadians will become richer through a direct lessening of trade or reduced opportunities for working with other companies around the world. We are not an island.
In my legal niche, I work very closely with brilliant entrepreneurs who take big risks and are typically trying to create new services and products rather than just rehash what has already existed. These are the kinds of things that make everyone more prosperous, because even failed experiments have lessons that help society head towards the right answer. And the cryptocurrency space in particular has a high degree of failure but also great rewards for those who can figure out what people want and how they want it. And especially so when it comes to international exports as the world market for cryptocurrency products and services is on the order of 100x larger than the domestic market.
The world of startups is not all upside, even without considering just failing to meet market demands. Less positively, the nature of making new products and services often entails not operating to the "highest standards" and scrupulously following every best practice because those emerge as product of scale and stability. "Don't boil the ocean" is a mantra of many companies that are trying to do something interesting. Later, other large companies will standardize and operationalize. But few great products have emerged from the minds of accountants, regulatory lawyers and bureacrats. My legal advice is rarely "innovation" in the useful sense of the word. Proper paperwork is important but must not be confused with innovation.
Cryptocurrency is famously risky. If there’s one thing the public has heard about Bitcoin it’s that it’s volatile, risky, and has made fortunes for some. These attributes are all linked. And there’s no version of this that eliminates the risk but keeps the reward. There are opportunities for lessening frauds, but those are not specific to cryptocurrency. Fraud, scams and market manipulation are common in all countries and industries. Canada’s grocery stores teamed up for 14 years in the 2000s to successfully conspire against the public to raise the price of bread (in contravention of Canada’s clear laws against conspiracies). No one has gone to jail yet for cheating virtually everyone in Canada on the price o a basic food product. If I were to list out the frauds and schemes of just Canada’s major companies this blog post would become a book. That’s bad. It’s actually much more bad than most people are aware of. But it may also be true that these problems are worse in the cryptocurrency industry than for others because of the newness of it, real profits made by some, and in part the restrictions imposed on it by banks, regulators and others who are not keen on it (which forces some activities underground or forces companies to offer services in unusual ways). But does the high risk and the perhaps higher risk of white collar crime justify restrictions to make people safer?
There are of course already many restrictions on businesses in Canada. Fraud is prohibited in many ways. There are criminals laws that cover just about any kind of conduct that Canadians would consider to be “crime” (and many other prohibitions that people would not consider to be crime such as the relatively recently repealed criminal offences for pretending to practice witchcraft, publishing “crime comics”, and selling marijuana). There are also many consumer protection laws, common law rules, and many other rules that are applicable in general to business. There is no shortage of law to apply. But is more needed? Is it possible to reduce the risk while keeping the reward, or reducing the risk appropriately? What’s appropriate for one person is inappropriate for another, but most lawyers believe that rules can be made that keep most of the reward while eliminating a substantial part of the risk. That assumption, or similarly phrased ones, are the basis of the regulatory state that now has special rules for many industries. Cryptocurrency entered that phase in 2015 with the money services business regime being applied at the federal level, and is now entering a new phase of even more special regulation.
Canada’s securities regulators proposed an interpretation this week to bring cryptocurrency dealing into the fold of securities laws by having the business be absorbed into the category of companies that deal in stocks, bonds, etc. (This issue is actually more complicated than this brief summary.) Is cryptocurrency like stocks? Not usually. They’re a fundamentally different thing that was not created in order to compete with stocks, and probably when Bitcoin was first created the creator(s) would’t have even understood the analogy - they probably thought their invention might compete with other payment methods, not investments. But it’s true that many people have speculated on the price and hoped that it would go up. But is it more like beanie babies (or other fad speculations) or is it more like TD bank stock? Or is it more like gambling? Or is it more like an alternative money? Or is it more like a payment system? Or does it have properties of all of these, depending on the nature of the product? The latter is the (unsatisfying) lawyer answer. But is it enough like stocks that stock trading companies and their regulators are the right people to run this? Will they be the right stewards of risk & reward?
I don’t have the answer to the cliffhanger questions above, but I do know that the rest of the world is not following that line of thought. And if Canada takes the lead on treating it like this, we will not create the global champions of tomorrow that will create wealth in Canada. Inevitably, Canadians will still be involved in the global market, but not through the securities approach. They will go offshore or move to other countries. Closing the doors to Canada's markets won’t make Canada richer. Canada already sends legions of new graduates from our top science and engineering schools to the United States, and Canadian startups are frequently snapped up by foreign companies that can provide a more competitive home for their innovations. More than half of all graduates of Canada's top engineering school, Waterloo, who will create the software of tomorrow move to the United States every year, to make that software for US companies. That's the playing field.
Applying a very high regulatory burden to any business may genuinely reduce risk for customers. This article is not to suggest that risk can’t be eliminated. They can. But not for free. And if too many risks are eliminated, the costs will be very high, and the rewards will be greatly diminished. And they will be diminished at a higher rate than the risk will be reduced because it’s not free to administer the rules that reduce risk. For example, lawyers aren’t free. They’re often very expensive, and a common role for lawyers is to help people navigate the forms and bureaucracy that are required to do business at all. Although I’m a lawyer, I don’t support creating new rules so that law offices can have nicer artwork in their conference rooms or to help lawyers gain more power in society. Generally, we should be working to streamline systems to reorient Canada for the 21st century in which everyone competes with everyone, rather than just the company down the street. Canada is not an island.
Securities laws are one of the most complicated regimes in Canada. They’re designed to deal with many subjects, but an important one is the long history of frauds and scams in the investment/financial industry. There are good reasons for many of the rules. Canada continues to have very high rates of crimes committed in financial markets, as a look at any of the enforcement actions by provincial securities regulators or IIROC shows. There is also, despite clear rules to the contrary, a lot of insider trading in Canada (sometimes even involving the same lawyers who help to navigate the gauntlet of law). Clearly the laws have not eliminated all the risks. But they have certainly greatly lessened many risks. Is it worth it? Perhaps. But we should be very hesitant about trying to bring other industries into this fold, because as it stands, only a tiny percentage of the Canadian economy is supervised under this system. Could we reduce other risks by bringing more companies and activities under this risk reduction framework? Maybe. But there’s a very good reason why that isn’t done: it’s too expensive and Canadian business would grind to a halt. There would also be a steep drop in the availability of products and services.
The logic of why we don’t apply securities rules to everything is the same as that for why “know your client” rules (and other AML rules) are not required of all businesses. It would undoubtedly help to reduce corrupt foreign officials buying products and services from Canadian companies, and it would probably lessen organized crime in Canada, but the idea of having to present identification to buy a pizza in Canada is one that many people would find puzzling. And every new rule brings with it new opportunities for abuse. Like how police are routinely sanctioned in Canada for unlawfully accessing police databases to stalk women, using the information that was obtained to help keep them safe from others. Bad people are out there and they will take advantage of whatever they can (which is often the reason for regulation in the first place!). Collecting everyone’s identities for every transaction is great for stopping crime but brings with it many costs that are difficult for people to anticipate, and especially so for most regular people because they’re not familiar with the mindset of criminals and their constant search for new ways to abuse the Canadian public.
Securities are a high standard. Most lawyers would probably agree that securities laws are one of the most challenging legal regimes in Canada for companies to do business under and most companies that do this employ a number of specialized professionals to help them with the paperwork required. It’s not very amenable to startups and it’s not very amenable to rapid changes (because the rules change slowly and regulators have a reflexive instinct against change). The balance that’s been struck in the economy at large, in which only a narrow slice of the economy is covered by securities laws, is the one that tries to mitigate important risks without sabotaging the entire economy. Adding cryptocurrency into this framework is an idea that is “common sense” to those who see risks and want to stop them, but the costs will be high and are difficult to anticipate. Probably one key impact will be that Canada becomes even less significant globally because our companies in this area will not be competing internationally and will not be following international approaches, because they will have their own special market that is separated from the global economy by securities laws applicable to local players.
The actual notice this week that was alluded to above doesn’t bring all cryptocurrency activities under the securities rubric, and the regulators have taken care to say that this is not a legal change at all, just a matter of interpretation. But interpretations are not neutral and picking one stance instead of another creates costs in the same way as a new rule because most businesses respect the government’s thinking and will seek to abide by it. And for those who don’t, the government has deep pockets to litigate and investors are often wary of funding defences against government positions. Interpretations and statements also set the tone for entrepeneurs who can choose where to do business in the world (and who already frequently choose other countries due to other factors).
Ultimately, the law is the law and courts will hopefully decide the issue of the application of securities laws to cryptocurrency sales. Court decisions provide certainy in a way that intepretative notices don't (and which may be more important than any particular rule to businesses). On this particular guidance, I believe that the government has gone too far in the direction of trying to provide safety without respect to the costs imposed (because the costs are not really their problem, while the demands for safety are). A key motivator of the recent guidance is a spectacular fraud committed a few years ago but that fraud was illegal at the time without any change of interpretation or new rule. Fraud is illegal and has been for a long time. And there are also many other rules that can be thrown against a "company" that acts like that one did, both by the government (regulators) and private litigants. I expect if this guidance continues on the path it’s going on, Canada’s statute internationally in cryptocurrency will probably be diminished and more of our brilliant (non-criminal) minds will move to greener pastures. Canadian buyers and sellers of cryptocurrency will bear the higher prices or do business with foreign companies that don’t follow the rules here (because the Internet enables this and isn't going away). Reduced innovation as companies attempt to follow prescriptions by regulators interested first and foremost with safety and risk, rather than creativity and reward, will mean Canadian consumers and businesses will lose out on innovations in one of the biggest technological developments since the Internet: the global, trillion dollar market for blockchain technologies.
As with all of my blog posts, this one does not represent the opinions of my clients, who sometimes take very different positions on these issues. I also frequently provide advice to clients that is consistent with Canadian law but not consistent with my personal views, as that is the proper role of a lawyer. My clients do not vet these posts and may not even be aware of them. I hope you enjoyed reading this article that is slightly more philosophical than my usual Canadian law posts. I've been writing about these issues for many years and you can read some of my other takes on issues in the industry here.