Recommendation 1
That the government prioritizes establishing a clear regulatory framework for fiat-backed stablecoins.
Recommendation 2
That the government implement a comprehensive strategy to support blockchain and Web3 startups, promote financial innovation, and strengthen Canada’s blockchain ecosystem.
Recommendation 3
That the government begin allowing crypto assets and continue allowing crypto-backed assets to qualify as investments for registered savings plans.
Recommendation 4
That the government prioritize addressing custody in the development of digital asset policy and implement a harmonized regulatory framework to develop the domestic custodian ecosystem.
The Canadian Web3 Council (CW3) is dedicated to growing Canada’s blockchain ecosystem. Our diverse membership, comprised of industry leaders and ambitious upstarts operating across more than 100 countries, brings a wealth of global perspectives to fuel local innovation and growth.
Recommendation 1: That the government prioritizes establishing a clear regulatory framework for fiat-backed stablecoins.
A digital economy demands a versatile, widely-accepted digital currency that serves as a frictionless payment method, collateral, and settlement asset on a shared ledger. Fiat-backed stablecoins can ably perform these functions while offering enhanced payment efficiency and reducing transaction costs.
Yet the current regulatory approach, which treats all stablecoins as securities and/or derivatives, is out of step with international trends. A fit-for-purpose regulatory framework would enable innovation in the payments sector, provide clarity for businesses and consumers, align Canada with global regulatory best practices, and enhance Canada’s competitiveness in the digital economy.
To implement this framework effectively, the government should first establish a clear definition of fiat-backed stablecoins, distinguishing them from other types of digital assets and cryptocurrencies and emphasizing their function as a digital representation of fiat currency, be fully redeemable and backed 1:1 by high quality and liquid reserve assets held in regulated financial institutions.
Finance Canada and the Bank of Canada should collaboratively develop and oversee the regulatory framework for fiat-backed stablecoins to avoid regulatory fragmentation. It should include fit and proper person tests for key personnel, capital adequacy requirements, risk management and governance standards, and cybersecurity and operational resilience measures.
For fiat-backed stablecoin issuers, strict reserve requirements should be mandated, including 1:1 backing with fiat currency denominated reserves, regular independent audits, and public disclosure of holdings and audit results. Robust consumer protection measures must be implemented, encompassing mandatory risk disclosure, clear redemption rights, dispute resolution mechanisms, and safeguards against fraud and market manipulation. To address financial stability concerns, the framework should include stress testing for large issuers, coordination with prudential regulators, and risk-based regulatory thresholds.
Fiat-backed stablecoins should also be regulated under the Retail Payments Activities Act (RPAA) as payment instruments. Additionally, the development of interoperability standards, both domestically and internationally, should be encouraged. This comprehensive approach would enhance consumer protection, ensure financial stability, and promote the utility of fiat-backed stablecoins as a global payment instrument while aligning with existing payment regulations. The framework must also include robust anti-money laundering (AML) and countering the financing of terrorism (CFT) measures, aligned with FATF recommendations for virtual assets.
Case Study: UK and EU Approaches to Stablecoin Regulation
The United Kingdom has taken a proactive approach to regulating stablecoins, recognizing their potential to enhance payment systems. In October 2023, HM Treasury published plans for regulating fiat-backed stablecoins, proposing to bring them within the existing electronic money and payments regulatory framework. This approach provides regulatory clarity while fostering innovation in the payments sector.
Another innovation of note is Project Pyxtrial, a Bank of International Settlements/Bank of England joint initiative that aims to develop a data-analytic pipeline for monitoring asset-backed stablecoin balance sheets. It focuses on creating systems for data collection, storage, and analytics to identify potential asset-liability mismatches in stablecoins. It addresses the vulnerability of asset-backed stablecoins to run risks, which could arise from mismatches between circulating stablecoins and their backing assets. This technology could assist regulators in building policy frameworks and help mitigate financial stability risks associated with stablecoins.
Building on the UK’s approach to stablecoin regulation, it’s also worth examining the European Union’s comprehensive regulatory framework for crypto assets, known as the Markets in Crypto-Assets (MiCA) Regulation. MiCA, which came into effect on June 30, 2024, aims to create a unified regulatory environment for crypto businesses across the EU, providing greater clarity and security in the digital asset space.
A significant development under MiCA is the licensing of stablecoin issuers. In this context, Circle, a global financial technology firm, became the first regulated global stablecoin issuer under MiCA. Circle obtained an Electronic Money Institution license from France’s banking regulatory authority, allowing Circle to issue both its USD Coin (USDC) and Euro Coin (EURC) stablecoins in compliance with MiCA’s regulatory obligations.
By implementing a clear and tailored regulatory framework for fiat-backed stablecoins, Canada can create an environment that encourages innovation in the payments sector while ensuring adequate consumer protection and financial stability.
Recommendation 2: That the government implement a comprehensive strategy to support blockchain and Web3 startups, promote financial innovation, and strengthen Canada’s blockchain ecosystem.
The global crypto-asset market has surpassed USD$2 trillion in value, with increasing institutional participation and growing retail interest. Canada has demonstrated leadership in this space, launching the world’s first Bitcoin ETF and fostering a robust ecosystem of crypto-asset funds. Yet Canada is losing market share to U.S. firms in the spot Bitcoin ETF market, highlighting the need for a comprehensive strategy to enhance Canada’s competitive edge in this rapidly evolving sector.
To do so, Canada must create an environment that nurtures innovation, supports startups, and attracts talent and investment.
Regulatory clarity is paramount in achieving these goals particularly given the division of powers in Canada. The government should work with industry stakeholders to develop clear, principles-based regulations for blockchain and cryptocurrency businesses. This includes providing guidance on token classifications, and clarifying tax treatment of crypto assets. Regulatory clarity will give startups the confidence to innovate and attract investment, while also ensuring appropriate investor protections are in place.
Funding is vital for the growth of the blockchain and Web3 sector. Establishing a dedicated blockchain innovation fund, similar to the Strategic Innovation Fund but tailored to blockchain and Web3 startups, would provide crucial support to early-stage companies. Expanding existing programs like the Industrial Research Assistance Program (IRAP) to include blockchain technology streams would further strengthen the ecosystem.
Addressing the persistent challenge of banking access for crypto businesses is essential. Even established players struggle with basic services like international wire transfers and operating accounts. A multi-faceted approach involving regulatory clarity, enhanced compliance frameworks, and specialized banking services is needed. Increased collaboration between the crypto industry, banks, and regulators can help bridge knowledge gaps and foster understanding.
Tax incentives are crucial for encouraging investment and innovation in the sector. Introducing tax credits for blockchain research and development, similar to the Scientific Research and Experimental Development (SR&ED) program, would stimulate growth. Implementing a “patent box” regime offering reduced tax rates on income from blockchain-related intellectual property developed in Canada would incentivize companies to keep their innovations within the country. These measures would collectively support the development and growth of Canada’s blockchain and crypto sector.
It’s also important to note that the crypto-asset industry has made significant strides in addressing concerns related to risk and market integrity. Regulated Crypto Trading Platforms (CTPs) are subject to stringent measures to safeguard client assets, implement effective anti-money laundering programs, and report suspicious transactions. The industry has also led the development of best practices, such as conducting proof of reserves “audits” and smart contract audits to assess vulnerabilities.
Ultimately, the blockchain and Web3 sector represents a significant opportunity for Canada to lead in a transformative new market segment. Supporting it will not only drive economic growth and job creation but also ensure that Canada remains at the forefront of technological innovation. As the integration of crypto-assets and blockchain technology into the global financial system is accelerating, it is an opportune time for Canada to lead in this transition.
Recommendation 3: That the government begin allowing crypto assets and continue allowing crypto-backed assets to qualify as investments for registered savings plans.
We recommend that crypto-backed assets continue to qualify as investments for registered savings plans in Canada, while also expanding the definition of qualified investments to include crypto-assets, like Bitcoin, traded on regulated Canadian CTPs.
Crypto-backed assets, such as crypto-asset ETFs, currently provide Canadians with regulated, familiar products to gain exposure to this emerging asset class. As of July 2024, there were 32 public crypto-asset funds in Canada with aggregate net assets of approximately CAD$5.0 billion. Disallowing these as qualified investments would trigger unnecessary tax consequences for current holders, reduce investment options for Canadians, and negatively impact Canada’s position as a leader in financial innovation.
Expanding the definition of qualified investments to include certain crypto-assets traded on regulated CTPs would provide more cost-effective options for knowledgeable investors and align with the trend of increasing institutional adoption. Indeed, in 2023, 39% of Canadian institutional investors had crypto exposure, demonstrating a growing and enduring interest in this asset class.
To support the integration of blockchain technology into the financial system, we also recommend clarifying the tax treatment of tokenized traditional assets in registered plans. We suggest that if a traditional asset qualifies as an investment for registered plans, its tokenized version should also qualify. This would provide clarity for investors and financial institutions, support Canada’s participation in the growing tokenized asset market, and ensure that tax policy keeps pace with financial innovation.
To implement these recommendations effectively, we suggest aligning the terminology used in tax policy with that used in securities regulations. This alignment would reduce the regulatory and administrative burdens on market participants, provide clarity for investors and financial institutions, and support responsible innovation in the crypto-asset sector.
Our recommendations aim to preserve Canada’s competitive edge in the crypto-asset market while ensuring investor protection. Despite Canada’s early leadership in crypto product development, recent data shows a loss of market share to U.S. firms. These recommendations would impact millions of Canadians with self-directed retirement plans and TFSAs while boosting innovation and capital formation.
The crypto-asset industry has made significant progress in addressing risk and market integrity concerns. Regulated crypto trading platforms now implement stringent measures for asset protection, anti-money laundering, and transaction monitoring. The industry has also developed best practices such as proof of reserves and smart contract audits.
We believe Canadians, with professional advice when needed, should have the freedom to pursue their financial goals. Tax policy should support innovation and allow exposure to this emerging asset class, which has the potential to modernize the financial ecosystem.
Implementing these recommendations would maintain Canada’s position as a financial innovation leader, provide Canadians with more portfolio diversification options, support the growth of the crypto-asset ecosystem, and contribute to modernizing Canada’s financial infrastructure.
Recommendation 4: That the government prioritizes addressing custody in the development of digital asset policy, and implements a harmonized regulatory framework to develop the domestic custodian ecosystem.
Custody is fundamental to digital asset initiatives, particularly due to the irreversibility of blockchain transactions. It’s crucial for consumer and investor protection, affecting all types of digital assets and their use cases. Canada’s experience with the QuadrigaCX collapse ($150M-$200M lost) and the global FTX incident ($10B lost) underscores the importance of regulated custodians.
Currently, domestic digital asset custodians servicing regulated CTPs must meet Acceptable Securities Location (ASL) requirements, demanding $100 million in capital compared to $10 million for Qualified Custodians (QC). These requirements, focused on financial resilience, don’t adequately address digital asset nuances or operational resilience needs. For instance, digital asset custodians are prohibited from rehypothecating client assets, reducing risks that capital requirements aim to buffer.
Only one U.S.-based ASL currently services regulated crypto entities in Canada. This dependence on international custodians can pose risks to the Canadian ecosystem. The government should prioritize developing a tailored framework for Canadian digital asset custody to protect investors and support the domestic industry.
Implementing a harmonized regulatory framework for the domestic custodian ecosystem would set the foundation for successful policy implementation, industry growth, and protection of Canadians as financial technology evolves.
