Without a new direction, crypto isn't going anywhere new
There is already a crypto strategy in the making, and it's following a familiar pattern
Cryptocurrency is either the future of finance or a ticking time bomb, depending on whom you ask. When you consider how inefficient and path-dependent our traditional financial system is, crypto is a chance to start fresh and fix things. Faster and cheaper payments. More financial inclusion. A degree of independence from the state, if you’re into that sort of thing. Or, if you prefer to indulge in other forms of neuroticism, it’s also a chance for criminals to launder money, terrorists to finance their work, and scammers to steal from people.
Whether aroused by the dollar signs of financial innovation, or panicked by the erosion of financial integrity, there’s one thing on which people in the mainstream seem to agree: the government should do something. Michelle Rempel Garner, a Conservative MP, recently tabled a bill to encourage the growth of the crypto sector. She called on the Minister of Finance to listen to the “innovators” and “practitioners,” who know which policies they need for growth and which they don’t. Meanwhile, the former second-in-command at the Bank of Canada, Carolyn Wilkins, took to the pages of the Financial Post to argue why Canada needs to make cryptocurrency “as safe as our financial system.” Don’t neglect safety and soundness, in other words, by giving innovators a blank cheque.
Do something, but do what? While everyone is calling on the government to act, the government is already acting. There is already a crypto strategy in the making, and it’s following a familiar pattern.
There is no wild west in our crypto land
Today, crypto is subject to emerging function-based oversight. Some crypto companies are regulated under money laundering and terrorist financing law. Others must register with securities regulators. And if cryptocurrency ever becomes a common payment method, it will likely be regulated as a payment service or a payment system, although the federal government would have to give itself power under the Retail Payment Activities Act and lightly amend the Payment Clearing and Settlement Act.
In 2014, Canada amended the Proceeds of Crime (Money Laundering) and Terrorist Financing Act to apply to crypto. Any company that lets its customers exchange or transfer crypto is a money services business and needs to register with our financial intelligence unit, FINTRAC. MSBs are required to do know-your-client checks, keep records, and report large and suspicious transactions.
Though being an MSB comes with special legal requirements, the requirements are light. For example, they wouldn’t have been enough to stop Quadriga—the infamous Canadian crypto platform—from losing almost $200 million of customer money. The PCMLTFA and FINTRAC don’t protect Canadians who buy and sell crypto. They just try to stop the flow of dirty money. Expecting them to do more is like expecting someone to build a 26-storey condo with only a hammer.
That’s why crypto platforms have also come under the oversight of securities regulators. Last year, the Canadian Securities Administrator and the Investment Industry Regulatory Organization of Canada outlined the regulatory requirements for crypto platforms and issued guidance on how they can be adopted by securities regulators. Not long after, the Ontario Securities Commission issued a stern warning to crypto platforms to comply with securities law. Since then, a handful of cryptocurrency platforms have registered with the OSC to get on the right side of the law.
Still, cryptocurrency is more than a security. It’s also a way to buy and sell goods and services, challenging the traditional monetary and payment systems our economy runs on. A time may come when you’ll be able to pay and be paid in something other than Canadian dollars. Perhaps it’s a cryptocurrency like bitcoin, or a stablecoin backed by fiat.
That’s why the federal government is hedging against a world in which crypto payments are the norm. Passed in 2021, the RPAA gives the federal government the room to oversee payment service providers who deal in crypto. Whether it takes the room is another story. What’s more, although I’ve seen no evidence that the federal government is going to give the Bank of Canada the power to oversee crypto payment systems under the PCSA, I’d bet you a non-trivial sum of crypto they’re thinking about it.
Even our banking regulator—the Office of the Superintendent of Financial Institutions—is jumping into the mix. OSFI isn’t giving crypto companies banking licenses, but it’s thinking about how to manage the risk crypto poses to the financial system. Last year, OSFI asked banks about how to classify different crypto assets, what the risks are, and how they should be managed.
Crypto land is no longer a wild west. The emerging strategy is to regulate crypto so that it’s more like the traditional financial system. When crypto is a security, regulate it as a security. When it’s a way to move money around, regulate it as a money services business. If it becomes a common way to buy and sell things, regulate it as a payment service provider or a payment system. And insofar as it’s a risk on a bank’s balance sheet, manage it like other risks on a bank’s balance sheet.
Maybe regulating crypto so that it’s more like the traditional financial system is the right approach. Or maybe it isn’t, since business as usual means business as usual.
Don’t forget the reason people get so excited about crypto is that it’s radically different from the traditional financial system, starting with its governance and the distributive implications. Take it from Will Wilkinson, if not from me: “architecture that can coordinate economic activity in a way that makes the firm superfluous, deconcentrates ownership and control over vital networks, and broadly distributes economic surplus to network participants according to transparent, fair and relatively fixed rules, is the killer app.”
Making crypto more like the traditional financial system is going to limit the possibilities of being radically different. Crypto isn’t going to be decentralized if policymakers insist on centralizing it “to get some comfort from a regulatory and supervisory standpoint.” Crypto isn’t going to be the future of anything if policymakers make it less cost-effective than the traditional financial system. Crypto isn’t even going to be the present of anything if financial institutions continue refusing to give bank accounts to crypto businesses.
Some crypto possibilities should be limited, but some crypto possibilities should be created. So far, however, the Canadian strategy is heavier on the former than the latter. Limit the possibility of money laundering and terrorist financing? That’s the PCMLTFA. Limit the possibility of defrauding investors? Securities regulators are coming to the rescue. Limit the possibility of a payments wallet being cleared out or a payment system blowing up? The RPAA and PCSA are there when we need them. Limit the possibility of Canada being unable to administer its own monetary policy? The Bank of Canada is on the job. Limit the possibility of risks materializing on the financial sector’s balance sheet? Don’t worry: OSFI has been consulting.
By limiting possibilities more than creating them, all the government is doing is making crypto more attractive than a ticking time bomb. This will do something to support the growth of crypto. Something not too hot. Something not too cold. Something barely tepid, like a cup of coffee that’s been out for a little too long. It’s like Goldilocks is doing public policy, but she’s risk averse. It’s worse to get a scorched tongue than it is to eat a disappointing bowl of porridge. This is the Canadian way.
I’m not going to pretend I know what the answer is. I don’t know what society’s preferences are for a financial system with radically different governance and distributive effects. I also don’t know what society’s risk-appetite is for the experimentation necessary to bring a new financial system to life.
What I do know, however, is that we need to get comfortable with a bit more risk if we want a bit more reward.