As cryptocurrencies go mainstream, financial regulators are feeling pressure to reign in the technology — without crushing the innovation going on in the crypto space.

In the absence of a national regulatory body, the task of bringing crypto platforms to heel with the rest of the financial system is falling to the province, specifically the Ontario Securities Commission (OSC), and there are serious questions about whether the body is capable of doing so, or if it should even try.

While many people see promise in the future of cryptocurrencies and blockchain tokens, the global crypto scene is rife with fraud and theft, including in Canada. This was demonstrated in 2019 by the collapse of Canadian cryptocurrency exchange QuadrigaCX, which filed for creditor protection after its founder died unexpectedly, taking the passwords needed to access the money to the grave.

The OSC later found that the company had effectively run as a Ponzi scheme to cover the shortfall on clients’ deposits, describing it in June 2020 as “old-fashioned fraud wrapped in modern technology.”

In a keynote address to the Canadian Club Toronto last May, OSC chair and CEO Grant Vingoe said no one wants to see a repeat of what happened with QuadrigaCX, noting the crypto space is dangerously under-regulated.

“Most dealers and platforms act as their own custodians, running the risk that client assets will not be legally segregated,” said Vingoe. “Without regulatory oversight, investors need to consider what is preventing the misuse of their assets and what protections they have if the platform becomes insolvent.”

Vingoe described a “crypto revolution” going on in the financial world, with global crypto asset market capitalization reaching $1 trillion USD last April and then doubling 94 days later to $2 trillion USD.

At the same time, the OSC and similar bodies are still trying to figure out how blockchain-based assets fit into current securities regulation.

The OSC has determined that pressuring cryptocurrency companies to register with them is a good first step. When Vingoe made his speech last spring, there was just one company registered, compared to six today that have been given conditional approval to sell crypto assets, four of which have registered since September. The OSC told Queen’s Park Today 20 more companies are in “active discussions” with the regulator about registering.

But this has not stopped cryptocurrency platforms from around the world from selling to Ontarians. The OSC has responded by taking regulatory action against four such firms after they failed to meet last March’s deadline for registration: Poloniex, Mek Global Limited, Bybit Fintech Limited and Aux Cayes Fintech.

As far as the OSC is concerned, the cryptocurrencies these companies are selling are “securities,” like stocks and bonds, and, without registering, crypto trading platforms are “flouting Ontario securities laws.”

Declaring cryptocurrencies and other blockchain-based assets, such as nonfungible tokens or NFTs, to be securities is within OSC’s authority, said Dr. Andreas Park of the University of Toronto’s Rotman School of Management blockchain research lab. But, he says, it may not be a wise decision in the long term.

Park argues that to prevent fraud and theft, the OSC should try to make cryptocurrency exchanges safer to use and pressure companies into having the same level of accountability as other organizations that sell more traditional financial assets.

But simply calling cryptocurrencies and NFTs “securities” does not make existing securities regulations capable of looping in a system that works on fundamentally different rules, he said.

“Some of these items are securities, there’s no question, but there are many that are not,” he told Queen’s Park Today during an interview. “Declaring them to be securities can create new problems without any benefit.”

Park points to NFTs, which have sold for millions of dollars online. Unlike with stocks and bonds, nowhere is it said that the holder of a token is “entitled to any cash flows.”

For example, if someone buys one of the “Bored Ape” images that have become emblematic of the NFT market, they don’t own or even possess the image in any traditional way and don’t get a hold of the original file, or even the copyright.

Instead, the buyer owns one of the votes necessary to change or alter the image’s blockchain code or “contract,” as Park puts it, which is stored on a massive global network and overseen by a somewhat enigmatic organization called Uniswap.

“What would you regulate here? If you say that a token is a security, then who has the reporting obligations? Nobody, because it’s not like it’s linked to a phone and an address,” said Park. “When you say something is a security, you have to report on its annual earnings and other things … there’s nothing there to report.”

Even if the OSC did have a better way to regulate blockchain assets, said Park, it’s far from clear there is any effective role for a regulator from a single province in a market that is still developing and is not contained by national borders.

Even Vingoe appeared to concede this point last spring, saying what is required is a uniform approach across Canadian and international regulators.

“The regulatory community must assert a common, principled, predictable, and responsive approach no matter where a firm is based,” he said. “We must constantly strive to make effective coordination a reality.”

The OSC announced its intention to hold hearings against Bybit Fintech Limited, one of the crypto companies that failed to register, earlier this month. They will take place in late March.