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FTX Founder Sam Bankman-Fried leaves the US Federal Court in New York on Feb. 16.TIMOTHY A. CLARY/AFP/Getty Images

Though the mass euphoria surrounding all things crypto has subsided, one facet of the cryptocurrency space is still booming: fraud and unregulated activity.

Canadian authorities are reporting record levels of fraud, while securities regulators are scrambling to crack down on illicit trading related to crypto assets.

The Ombudsman for Banking Services and Investments recently reported that fraud-related cases tripled in the fourth quarter of 2022, largely as a result of complaints involving crypto investments.

The Canadian Anti-Fraud Centre, meanwhile, reported a “staggering” $530-million in losses from fraud last year, a year-over-year increase of almost 40 per cent, with crypto scams as the top culprit.

And every few weeks, the Ontario Securities Commission puts out a new list of companies that may pose a risk to investors – mostly crypto firms that are not registered to operate in the province.

“The regulator constantly has to play whack-a-mole,” said Ryan Clements, a fintech expert at the University of Calgary.

Even within the more legitimate side of the industry, compliance with Canadian securities regulations is an issue.

Last month, the Canadian Securities Administrators announced it was tightening rules for crypto exchanges operating in Canada.

The CSA cited the recent collapse of a number of trading platforms, including FTX, then one of the world’s largest. Those incidents “highlight the significant investor protection risks to Canadian investors of trading crypto assets,” the CSA said.

It gave non-compliant firms until March 24 to sign an undertaking indicating they plan to follow the rules while in the process of registering. Those rules include new prohibitions designed to protect investors from the lapses that led to the FTX failure.

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Crypto assets cannot be used to determine a platform’s working capital requirements, for example. In the case of FTX, a cryptocurrency created by the firm was allegedly used as collateral to borrow billions of dollars, ultimately bringing about a solvency crisis.

The CSA is also introducing restrictions on how retail clients trade with credit or leverage. And there are new limitations on the use of stablecoins, which are typically pegged to a currency like the U.S. dollar. While they’re meant to be a relatively safe haven within the crypto space, stablecoins have recently attracted the scrutiny of U.S. regulators worried that they pose a liquidity risk.

So far, the measures taken by Canadian regulators strike a pretty good balance between encouraging innovation and protecting investors, said James Kosa, a partner with a focus on information technology at law firm WeirFoulds.

“They’ve been shockingly nimble, given the challenges of regulating securities in a country with 13 regulators,” Mr. Kosa said.

“They’re trying very hard to treat the good guys like good guys and the bad guys like bad guys.”

After all, Canadian regulators had a bit of a head start. The 2019 bankruptcy of cryptocurrency exchange QuadrigaCX proved to be an early catalyst for regulatory change. Roughly $170-million of client money effectively vanished when Quadriga’s founder died, in what would prove to be something of a preview of the FTX debacle. In both cases, the misuse of client money and lax accounting were among the critical misdeeds.

Canadian regulators responded with a set of controls on the types of coins that can be traded, restrictions on margin and derivatives and the use of qualified custodians to hold client assets.

So far, 11 crypto asset trading platforms have registered to operate in Canada. But that doesn’t stop Canadian investors from accessing those that haven’t. There is evidence, for example, that some Canadian investors were accessing the unregulated FTX platform, which was domiciled in the Bahamas.

And even though the cryptocurrency bubble has effectively popped, many regular investors are still drawn to the space, Prof. Clements said. “The crypto story is something bigger than just chasing returns. There’s an ethos associated with the crypto ecosystem, like decentralization and peer-to-peer systems, and those are still compelling narratives.”

The strength of that narrative, combined with crypto’s complexity, also seems to make it a haven for fraudsters. Despite the best efforts of regulators, it’s normal for the law to lag an emerging technology by at least a few years, Mr. Kosa said.

“The legitimate side will eventually mature into something that investors can rely on and invest in.”

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