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Sam Bankman-Fried, founder of FTX, speaks via a video feed from the Bahamas to The New York Times DealBook conference in New York on Nov. 30.HIROKO MASUIKE/The New York Times News Service

Canadian watchdogs responsible for investor protection are banding together to enhance their regulation of the crypto sector, using unusually sharp language to threaten legal action against companies that remain resistant to outside oversight and warning trading platforms to stay away from one of the sector’s most nebulous assets.

Canadian Securities Administrators (CSA), a collection of provincial and territorial securities regulators, has pursued oversight of the crypto sector for close to two years, but the process of registering crypto trading companies is a complex task. It is also time consuming, considering that hundreds of trading platforms were already up and running by the time the watchdogs released formal regulations in March, 2021.

Since the rules came out, many crypto firms have either registered with the regulators, or have started the process of getting registered. But some companies still shun the idea, and until now Canada’s regulators have handled them with kid gloves.

In a Monday announcement, the CSA addressed these companies using much more forceful language. It said it will now consider enforcement action against them.

Former FTX CEO Bankman-Fried arrested in Bahamas, official says

Some unregistered companies have held conversations with regulators, but they continue to drag their feet. In the wake of the collapse of FTX, which until last month was one of the world’s largest cryptocurrency exchanges, the CSA is done with being lenient.

“We reserve the right to bring enforcement action if the process is too slow,” Grant Vingoe, chief executive of the Ontario Securities Commission, said in an interview.

Canada’s securities regulators are also warning crypto trading companies to steer clear of stablecoins. These digital assets permit clients to trade in and out of cryptocurrencies without having to convert each trade back to dollars, or their local currencies. But stablecoins have attracted scrutiny from financial watchdogs, including the U.S. Treasury. Some investors think of them as being like bank deposits, yet they remain very loosely regulated around the world.

As it stands, registered crypto companies are prohibited from allowing their Canadian clients to trade any asset that is a security. In its public statement, the CSA said it views stablecoins as securities or derivatives. (Popular cryptocurrencies, such as bitcoin, are considered to be commodities, not securities.)

The third leg of the new approach to crypto regulation announced on Monday will require registered crypto companies to ensure client assets are segregated from the companies’ proprietary businesses, such as trading. Until now, registered companies had to keep client money separate, but the new language around “segregation” adds tougher legal requirements.

In the interview, Mr. Vingoe acknowledged that the new language is a response to the collapse of FTX, which allegedly lent billions of dollars worth of client funds to its sister trading firm, Alameda Research. “Circumstances like FTX suggest assets were co-mingled,” he said.

Regulating the crypto sector has been tricky for watchdogs around the world because there has never been an agreement on what exactly these assets are: securities, currencies or something else. So even though Gary Gensler, a crypto expert who now runs the U.S. Securities and Exchange Commission, gave media interviews warning investors that the industry is “rife with fraud, scams and abuse,” the SEC has very little means of enforcing anything.

While many regulators dithered, Canadian watchdogs – and particularly the OSC – developed a novel way to govern the industry. Instead of focusing on the underlying assets, the OSC determined that the relationship between a crypto platform and an investor can be considered a “crypto contract,” and therefore regulated as a security.

Because of this workaround, the OSC felt comfortable approving the world’s first bitcoin ETF in early 2021.

Around the same time, in March, 2021, the CSA released its rules, which for the first time outlined how existing securities legislation for dealers and issuers of traditional securities would apply to cryptocurrency trading platforms. Broadly speaking, all platforms that facilitate trades in digital tokens or contracts involving crypto assets were required to register as investment dealers and become members of the Investment Industry Regulatory Organization of Canada (IIROC).

At the time, there were hundreds of crypto trading firms operating in Canada, and only one had voluntarily registered for regulation. To convince more companies to register, the OSC warned that crypto trading platforms that failed to begin registering their businesses by April 19, 2021, could face consequences.

But many didn’t, and hardly faced any repercussions.

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