Overview
Crypto-assets1 , which are forms of digital currency that operate on a decentralized network, are known to be theoretically immune to government interference and manipulation, as these digital assets operate on systems that are “decentralized”. This concept of decentralized control runs antithesis to traditional financial systems, which rely on the use of centralized intermediaries. Unlike traditional currency, crypto-assets can be transferred from peer to peer, without the need to be relinquished to an intermediary party, such as a bank or a government.
Decentralized finance, or “
Decentralized Applications
Non-Fungible Tokens
Non-fungible tokens (“NFTs“) are unique and non-interchangeable units of data that are stored using blockchain technology. NFTs can be bought and sold like any other piece of property, but which have no tangible form of their own. NFTs can be anything digital such as artwork, digital collectibles, music, and items in video games. In some cases, NFTs are fetching huge prices in auctions due to hype amongst investors. However, on a more practical level, NFTs can contribute to the growth of
Risks
Technological
The presence of cyber security threats and hackers have the potential to compromise the functionality of the complete blockchain platform given that the public blockchain infrastructure is not infallible. In the event that hackers find a vulnerability in a smart contract or other aspects of a
Compliance/legal
To date, much of the guidance provided by regulators on digital assets has focused on areas such as initial coin offerings, and not necessarily on
While in theory, crypto-assets, such as Bitcoin, can be used all over the world, most vendors are not set up to accept them, and many
Asset
The crypto market is extremely risky, as well as speculative. The market risks are idiosyncratic as cryptoassets trade only on demand and are often heavily influenced by unexpected outside factors such as social media. Because of crypto’s innately volatile character, unexpected changes in market sentiment can lead to sharp and sudden moves in price from hundreds to thousands of dollars, causing associated liquidity risks. This can lead to catastrophic “bank runs”, significantly reducing the value of crypto-asset tokens. An
Why
CTPs
As mentioned, a defining feature of
CCBs
Similarly to CTPs, a self-executing smart contract that is entered on a blockchain is perceived to be intermediary-less. Take the example of a contingent convertible bond (a “CCB“), a fixed-income instrument that is convertible into equity if a pre-specified trigger event occurs. Theoretically, the terms of a CCB could be translated into computer code as a smart contract. The smart contract would then be recorded on some type of distributed ledger, and the contract’s code would work to automatically make interest payments from the issuer to the holder. The payments would be made in some form of virtual currency, and if the holder wished to trade the smart CCB, the distributed ledger would be updated to reflect the new holder of the smart CCB. The code would then automatically order that interest payments be made to the new holder, while the smart contract would check the information sources to determine whether a trigger event has occurred. Upon receiving information that a trigger event has occurred, the distributed ledger would immediately reflect that the holder no longer has any ownership interest in the smart CCB, but instead has an ownership interest in the equity of the issuer. By design, humans would have no real opportunity to interrupt the performance of a conversion. However, coders are still needed to write the underlying code and parties need to maintain the ledger in which the code operates.
Unfortunately, smart contracts are not able to consider parties who wish to negotiate after the smart contract has been written. Additionally, a smart contract may not be able to contemplate every possible scenario to determine whether or not the contract has been fulfilled. Before smart contracts can be relied upon fully, there would likely need to be an intermediary that is able to adjudicate scenarios regarding an event that has not been contemplated for in the code, or alternatively, allow for the parties to negotiate further. As an example, one can consider how much worse financial collapses like the subprime mortgage crisis of 2008 would have been if there was no ability for counterparties to negotiate outside of the default scenarios previously negotiated into contracts.
Whether it is CTPs, coders, or private parties such as adjudicators, it is clear that intermediaries still exist in the
What regulation exists today?
Currently in
The willingness of Canadian regulators to take action on CTPs is likely a recognition of the fact that the majority of crypto-asset transactions in
In
With regard to NFTs, the CSA and/or IIROC have yet to comment on this particular asset class.
What regulations can be used in the future?
The central issue with regulating intermediaries involved with crypto-assets is that
Regulation could begin first at the innovation process, where governmental authorities could pre-approve the technology and algorithms being proposed by working with and vetting the coders/developers designing the technology. Coders themselves could also be licensed or have to register with a governing body. As these crypto-technologies rely on self-executing financial algorithms, there would need to be checks in place to understand the algorithms and the intended results. By participating in the innovation process, regulators would have a head start as new crypto-technologies are introduced, rather than reacting after the technology has already been brought to market. Once the technology is pre-approved and tested on the market, regulators would be able to monitor the ledgers which host the technology and also continue to test and monitor the underlying algorithm to lessen operational risk.
By working with developers as technology advances, regulators may be able to mandate certain measures in the technology itself such as an “audit trail” to document the decision making process of the algorithm, a “black-box recorder” to capture input data streams, and data storage requirements. Any future Canadian regulatory measures will still likely be stymied by jurisdictional issues. Many CTPs, DApps or coders could operate in foreign jurisdictions with no regulation and would, therefore, be outside the reach of Canadian regulators. Whatever approach is taken, it must also be cross-jurisdictional in nature to be truly effective.
Until governmental authorities get a handle on
What does the future hold?
Moving forward, we await to see what steps Canadian regulators will take with respect to the regulation of DApps, NFTs, and coders of blockchain, which will have to include working across jurisdictions to ensure that parties are not able to easily skirt Canadian regulations. The
Footnote
1. Includes cryptocurrency, utility tokens, security tokens, and non-fungible tokens
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Mr
Suite 3000, P.O. Box 95
ON M5K 1G8
Tel: 4168649700
Fax: 4169418852
E-mail: kgreen@foglers.com
URL: www.foglers.com/
© Mondaq Ltd, 2021 – Tel. +44 (0)20 8544 8300 – http://www.mondaq.com, source
This news is republished from another source. You can check the original article here
Be the first to comment