What Canadian advisors need to know about cryptocurrencies

Authorities have begun to react to the risks surrounding cryptocurrencies. (Photo: 123RF)

The interest of customers in cryptocurrencies will not go away anytime soon, and the authorities recognize this and develop regulatory frameworks in this area. In Canada, we have seen the emergence of rules governing trade, and more recently, exemptions for traders.

The next thing we can see are specific rules for Canadian advisors. In the meantime, we can try to see where the wind is blowing and establish some guidelines. In the United States, Jasmin Sethi of Morningstar found recent developments to provide guidance in the absence of official regulations: “They call ‘hook-ups’: instructions and precedents that, even if they have been made into law, can indicate that the advisers will be under the strict supervision of the authorities”.

In Canada, this is how it looks:

– Canadian Securities Administrators (CSA): cryptocurrency risks

– Revenue Canada: Virtual currency guide for cryptocurrency users and tax professionals

– CSA — Guidance on the application of existing securities legislation

– CSA/IIROC – Framework for compliance for trading platforms

– IIROC – Exemptions relating to insurance and custody

– IIROC – Crypto trading platform guide re: advertising

– CSO – Enforcement action against crypto trading platforms

– CSI – Investing in bitcoin: opportunities and risks (mini-course)

Cryptocurrencies for Councils: The Risks

Before calling the attention of the authorities, it is worth considering the risks hidden in the notoriety of cryptocurrency assets.

“Cryptocurrencies are too speculative and subject to extreme volatility,” says Ms. Sethi.

The Canadian Securities Administrators (CSA) identified four main risks:

1. Volatility: Social media hype and marketing campaigns can create large fluctuations in cryptocurrencies, and there are generally few restrictions on transactions.

2. Liquidity: In fact, it is quite possible that cryptocurrency trading platforms do not have enough funds to cover your trade order. “Nor is there any guarantee that demand for any cryptocurrency asset will continue,” the CSA submission says.

3. Online Risk: cryptocurrency can be anywhere and interact with any intermediary. It’s great in terms of innovation, but a headache for custody issues. Take, for example, the lender Celsius, which imposes a “pause” on the withdrawals of investors. Morningstar’s James Gard recently found that the company’s custodial agreements give the same company ownership of the assets, to be used “as it sees fit.”

4. Technical and cyber security risks: we hear about hacking, but cryptocurrencies also provide a breeding ground for programming vulnerabilities. Even currencies designed with stability in mind collapse when there is a general run.

What should advisors know about cryptocurrency taxation?

Authorities have begun to respond to the risks surrounding cryptocurrencies, starting with Revenue Canada whose guidance says that all transactions involving cryptocurrencies are generally treated as business income or capital gains.

For investors, according to the CRA, buying a cryptocurrency with the intention of selling it for a profit can trigger the treatment of business income even if it is an isolated incident, because it could be considered a risky business or commercial nature.

An adviser acting on behalf of a client might argue that it was not “risky business”, but will ensure that it is not an extension of their client’s business. Having a crypto wallet opens the door to deposits for whoever owns that address, and transactions are permanent.

Another thing to be aware of is how Canadian tax law applies to alt-coins. Often, to buy alt-coins, paper money must be converted into common cryptocurrencies such as bitcoin or ethereum. This crypto-to-crypto transaction triggers the rules that transaction reports have additional steps.

In general, when you get rid of one cryptocurrency to acquire another, it is the rules of the barter that apply, indicates the brief of the ARC. You have to convert the value of the cryptocurrency you received into Canadian dollars. This transaction is considered a liquidation, and you must report it on your tax return. The resulting gain or loss is reported either as business income (or loss) or as a capital gain (or loss).

A good alternative to the complexity of “holding” cryptocurrencies is to simply buy a fund, of course. For a fee, acquiring an interest in cryptocurrencies is as easy as buying an ETF. Another advantage is that the tax treatment will be much more familiar.

Help customers understand the rules

When it comes to official regulations on cryptocurrency transactions, start by looking at existing legislation, as the CSA did in 2019: “if crypto assets, securities or derivatives​​​​, are exchanged on a platform, this will be subject to securities legislation”, with in 2020 the following clarification: “in some cases, the crypto asset is clearly a security, for example a tokenized security that comes with the rights traditionally attached to shares ordinary as the right to vote and the right to distribute dividends.In other cases, the crypto asset is a derivative product, for example a token that gives the possibility to acquire an asset in the future.

Cryptocurrency trading platforms seem to be the primary target of regulators so far, and while regulators aren’t specifically dealing with advisors’ activities, it gives us a clear idea of ​​what securities law covers. claim to an underlying crypto asset.”

The CSA and the Investment Industry Regulatory Organization of Canada (IIROC) have since defined a specific regulatory framework for trading platforms for cryptocurrency assets. These platforms are now required to be registered, and for now it appears that provincial regulators are taking this seriously.

Addressing custodian issues specific to cryptocurrencies, IIROC granted exemptions to the rules governing traders, placing Fidelity in the first place to offer crypto custodian transactions and services to institutional clients.

IIROC has also produced guidelines on advertising and social media related to cryptocurrency, pointing out activities that could be subject to review, such as publishing statements that may be considered false or misleading. Other behaviors mentioned that are sure to ring alarms are the use of contests such as bets or promotions that result in a bonus.

These concerns expressed by authorities can help counselors know the environment in which clients find themselves when they ask for instructions.

Remember your advisory role

“Cryptocurrencies are a tempting opportunity for those looking to get rich quickly. They hear stories of people making a lot of money and hoping to replicate that success, without much knowledge of the risks involved, Ms. Sethi says. Apart from the attraction of the cryptocurrencies, clients are also less likely to know enough about these investments than traditional asset classes. Valuing cryptocurrency investments is difficult, even for experienced investors. Advisors need to take the time to ensure that their clients are fully informed about this asset and the risks it involves instead of allowing them to accept it naively.”

Giving advice on cryptocurrencies is not easy. There is a whole world of influences and technical factors to consider, which must be compatible with the client’s objectives.

“It is important for advisers to look at the unique circumstances and risks of each client, as well as their degree of wealth to determine the right allocations and to satisfy them that they have a complete understanding of the risks in that asset class. , said Ms. Sethi. Having said that, cryptocurrencies can be of interest and utility to clients who want to allocate a small part of their portfolio at the appropriate level, “and advisors have a key role to help clients to make the right investment decisions. the best way to invest.

Before attempting to answer a question posed by a client, consider subscribing to Cryptocurrency News and Discussions or improving your understanding of the opportunities and risks surrounding this evolving asset class.

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