How Canada will regulate bitcoin

New federal regime for cryptocurrencies comes into further focus

This past week, two sources of information became available indicating how the Canadian government will increase its regulation and oversight of virtual currencies, including bitcoin. Through a combination of legislative and regulatory changes, Parliament and the Financial Reports Analysis Centre of Canada—Canada’s financial intelligence unit—will wrap “dealers” in virtual currencies into the current money services business regime. Conceptually, this is somewhat similar to the approach taken to exchange functions by the Financial Crimes Enforcement Network in the United States. The federal government has clarified things somewhat but, at the same time, left us with many unanswered questions. We will have to wait for further regulatory guidance to see how the whole regime in Canada plays out, but I think things are looking very positive for FIU regulation of cryptocurrencies in Canada.

The Current Structure & Canada’s Economic Action Plan

FinTRAC is an independent agency that acts as Canada’s FIU to enforce the Financial Action Task Force’s 40 Recommendations. It does this primarily through the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the PCMLTFA) and Regulations (the Regulations). I have previously written about FinTRAC, its FATF-mandated role, and the PCMLTFA and the Regulations. As explained in the earlier post, FinTRAC has thus far taken the view that bitcoins are not “funds” within the meaning of the PCMLTFA and the Regulations. That means that FinTRAC will not regulate many bitcoin exchange functions under the MSB rules in Canada.

Note that this does not mean that FinTRAC will never regulate bitcoin exchanges or other bitcoin business models under the current rules, depending on their business lines and functions, nor does it mean that persons transacting in bitcoin in Canada aren’t subject to regulation. For example, taxpayers earning income from source in Canada will pay tax on that income, subject to the normal inclusion and deduction rules. People transacting in bitcoin in Canada are also subject to the anti-money laundering provisions of the Criminal Code. And bitcoin-denominated products bundled as funds and other investment products will be subject to provincial securities rules. (If certainty on that last point was needed, which I don’t think it was, the Ontario Securities Commission recently made very clear that the Securities Act applies to funds denominated in bitcoin. One company, in particular, has been very public in marketing “bitcoin investments” in Canada. The OSC is now reviewing the company’s continuous disclosure record and delving into just about every area of modern Canadian securities law in that review, including marketing, accounting, disclosure requirements, and registration issues.) Still, FinTRAC had taken a relatively hands-off approach to many bitcoin exchange business lines because of its interpretation of the PCMLTFA and the Regulations. Certain participants in the bitcoin economy have responded by coming to Canada and setting up new businesses here.

Last month, the federal government introduced its 2014 budget plan to Parliament. I blogged on the budget as it affects bitcoin. Dubbed Canada’s Economic Action Plan, the budget calls virtual currencies “emerging risks” in the fight against money laundering and terrorist financing. The budget proposed to introduce AML and CTF regulations for virtual currencies, including bitcoin. The budget plan seemed to indicate that only regulations would be changed, possibly without new legislation being passed by Parliament.

We now know that both new legislation and regulations are on the agenda. And we basically know how the federal government plans to strengthen its bitcoin oversight.

Latest Pronouncements

The first indication the government provided this past week was the budget implementation act. That entire document is a few hundred pages long and can be viewed here. The particularly relevant provisions affecting bitcoin are distilled into a shorter extract here. This is a government bill—styled the Economic Action Plan 2014 Act, No. 1—that essentially sets out the legislative details of the government’s budget plan.

The implementation act establishes that virtual currencies are to be regulated as part of the MSB regime. See pages 4-5 of the extract (pages 163-164 of the entire document). Part I of the PCMLTFA addresses record keeping, identity verification, suspicious transaction reporting, and registration requirements. Section 5 addresses those persons and entities to which Part I applies, and the proposed replacement to s. 5(h) of the PCMLTFA now includes “dealing in virtual currencies, as defined in the regulations.” Note that a “dealer” in virtual currencies is caught by section 5 whether it has a place of business in Canada (subsection (h)) or it doesn’t but provides the service to Canadian customers and the service is “directed at” Canadian customers (new subsection (h.1)). Also note that subsection 1(1) of the Regulations provides that “money services business” includes persons or entities referred to in subsection 5(h) of the PCMLTFA; that will doubtless be changed to include new subsection 5(h.1).

So virtual currencies will be included under the PCMLTFA and the Regulations, and we see they’ll be covered by the MSB rules and that those rules are aimed at “dealing in virtual currencies.” That already answers a number of questions that were outstanding from the budget announcement.

We also saw some interesting thoughts in the remarks of federal Department of Finance officials this past week before the Senate Standing Committee on Banking, Trade and Commerce. That committee is engaged in a study of digital currency; it will be studying for more than a year and report out sometime in 2015. This past Wednesday, David Murchison, the Director of the Financial Sector Division made some brief but telling remarks about what the Finance Department is doing as part of the budget’s implementation agenda. Mr. Murchison referred to the legislative and regulatory changes targeting those “in the business of dealing in virtual currencies.” He then said: “We would aim, in these regulations, to cover virtual currency exchanges, but not individuals or businesses. We think that this approach will allow for financial innovation, which we see to be one of the interesting markers behind this. Again, there will be an opportunity for public consultation on both these initiatives.” Mr. Murchison also stated that Finance is undertaking a consultation on Canadian payment system oversight and that virtual currencies will be included in that consultation.

You can listen to all of the hearings before the committee live or archived on its home page. Mr. Murchison’s and his colleagues’ presentations are here.

Two things are clear from the comments from Finance. First, the Department of Finance is targeting virtual currency (including bitcoin) exchanges and “not individuals or businesses,” limiting the scope of the MSB rules still further, which seems positive. Second, financial innovation appears to be important to the government—indeed, references to the positive attributes and innovation of bitcoin ran throughout the evidence from Finance and the senators’ questions—so Canada is not out to throttle this nascent industry.

One side note: The committee’s deliberations will be going on for some time, so there will be plenty of time to comment later, but generally I was very impressed at the way the senators are approaching this issue. It’s obviously a new area to many of them, and I think they’ve already asked many clear, helpful, and penetrating questions. I look forward to seeing more evidence get in front of this body.

Where Does This Leave Us?

The implementation bill and the committee testimony give rise to at least as many questions as they answer. For example, what are “virtual currencies?” The focus of the Senate hearings was clearly on bitcoin, so surely bitcoin will be included. A good bet is that it will include currencies that are both decentralized and convertible, but we will have to wait and see. Another example is the line between exchanges as “dealers” and other businesses. What will the definition be of those in the business of dealing in virtual currencies? Mr. Murchison said they’re targeting exchanges and not “individuals or businesses.” Clearly businesses can be exchanges, so that just punts the question over to the definition of “exchange.” Will a miner selling bitcoin post-mine be an exchange? Are arbitrageurs among bitcoin exchanges in the business of dealing in virtual currency? Are so-called bitcoin ATMs exchanges? Again, we will have to wait for the consultation process and further guidance from the Department of Finance for answers.

Generally, I think the past week has been good for bitcoin in Canada. We have a great deal more clarity in terms of what will be expected from certain cryptocurrency businesses in Canada, notably exchanges. We know that the government will cover exchanges under the MSB rules. That proposed regulation, thus far, seems appropriate. We will have to continue to watch to see how narrowly tailored it is. If we get to a set of reasonable definitions in the Regulations, we may well still have a very welcoming regime for bitcoin and other cryptocurrencies in Canada.