It’s about keeping jobs in FinTech in Canada
By Christine Duhaime
A few weeks ago, I was having dinner in Toronto with a Bay Street infrastructure financier who is also the chairman of an organization of venture capitalists, who informed me that Bitcoin is an “illegal currency” in Canada. About a month ago, an expert witness testified before the Senate that a Bitcoin ATM takes in cash and spits out a Bitcoin. Last year, the Bank of Canada issued a report on digital currencies in which it described digital currencies like Bitcoin as a private digital currency like Liberty Reserve, which operated the largest money laundering Internet scheme in the world.
All of those statements are incorrect. Bitcoin and Blockchain tech are not illegal in Canada. Nor is it a physical thing like a coin that is spit out of an ATM. And it has never been a privately issued digital currency or in any way similar to the now-defunct Liberty Reserve.
Yet those statements are significant because they typify the unique problem Bitcoin and Blockchain face in this country, which is that what many Canadians, bankers, venture capitalists, regulatory agencies, and legislators know about them seems to be based on fiction and not fact.
Digital currencies like Bitcoin are a global disruptive technology evolving about five times faster than corporate management or government. It is hard to keep up, even for Millennials, but if Canada doesn’t, we risk losing out on the FinTech R&D promises of new technology (and driving away the huge amount of venture funding pouring into companies). We also run the hazard of not sufficiently mitigating against its legal risks.
So what is it exactly?
Bitcoin and the Blockchain underlying it are three separate things – an economy, an open-source computer protocol and a digital currency.
Its economy is larger, in fact, than the economies of some of the world’s smaller nations. Its market capitalization is over US$8 billion.
Bitcoin is the world’s first completely decentralized digital currency. It operates peer-to-peer. Unlike traditional fiat currencies that are issued and controlled by central banks, Bitcoin has no central monetary authority and is not backed by a government. No central authority controls its supply either. Yet Bitcoin has the theoretical potential and capacity to compete with all national fiat currencies.
Users buy Bitcoin with real monetary instruments on Bitcoin exchanges online or at an ATM. The exchange rate is determined by supply and demand within its own unique economy. Users can use Bitcoin to buy goods and services anywhere in the world, or to transfer currency to anyone in the world. Because Bitcoin transactions are P2P, they aren’t processed through a central authority, or clearing house. The purchase and sale of Bitcoin and the purchase and sale of goods and services using Bitcoin is largely unregulated, relatively anonymous and usually fee-free.
Technically, the digital component of such a transaction is a math-based transfer of one item of value to another virtually instantaneously on the protocol—basically machine-to-machine (M2M). Bitcoin transactions rely on cryptographic software to validate each transaction, rather than a central administrator. All transactions are recorded on a public online ledger called a Blockchain. The Blockchain validation process prevents anyone from spending money (or Bitcoin) they own twice, known as the “double spend” problem.
Other online currencies or payments systems, such as bank credit cards or PayPal, involve a central administrator or financial institution middleman. These intermediaries reconcile transactions to avoid the “double spend” issue. In contrast, Bitcoin relies on computer software, cutting out the institutional go-between in all financial transactions.
So for the first time in history, it is now possible to buy currency, shop for goods or services and remit money overseas instantaneously, purely P2P without the need for institutional middlemen for almost no fees. For global consumers, Bitcoin eliminates the need for traditional banking services and eliminates banking fees, credit card fees and currency exchange fees, and because it can be anonymous, consumers can conduct financial transactions with privacy and without the risk of identity theft.
As is abundantly clear, trillions of dollars in financial, institutional, transactional and remittance fees globally are at stake as Bitcoin gains more traction. Just recently, Macquarie Financial released a report estimating that in Australia alone, digital disruptive technologies would cost banks $27 billion in lost revenues annually unless they adapt to the new digital financial technology.
Bitcoin and Blockchain have enormous promise.
It is the world’s first programmable financial instrument and as such, its financial applications are endless. Cisco’s The Internet of Everything, for example, will very likely have to intersect with a digital currency protocol to effect its M2M transactions. The same is true for future collaborative economies and collaborative cities.
The shifting of traditional banking services digitally opens the door to the explosion of new financial technology to bridge digital currency protocols with traditional financial institutions. MasterCard recently filed a patent in the States for precisely this purpose—to leverage Bitcoin technology with its payment systems with a view to bringing Bitcoin onboard as a payment method.
The creation of an inexpensive Bitcoin remittance system means that millions of poor and unbanked populations, mostly in Africa and Asia, can receive value from relatives abroad to keep their families alive, and it allows more fortunate Canadians to send value directly to them.
Charities and NGOs that operate in remote places—for example, at refugee camps—can receive Bitcoin payments more quickly, more reliably, and without coughing up large fees to hawalas in the Middle East and Africa. Charitable donations can go farther for those in need.
In times of national crisis, such as after a terrorist attack, an earthquake or other natural disaster when traditional banking systems are shut down or destroyed, currency can be transferred using Bitcoin to pay for emergency goods and services such as food, water and medical supplies.
The Blockchain can also help reduce financial crime. Because every transaction is recorded on the Blockchain, it provides a permanent and public record of global transactions, in other words a permanent bank of evidence which law enforcement can use for years to come in cases where they may suspect money laundering, tax evasion or other criminal conduct.
The elimination of the double spend problem means the Blockchain also wipes out some forms of fraud. And the Blockchain prevents a person from spending Bitcoin they do not own. These advantages combined mean that securities-related fraud or fraud that occurred in the carbon credit markets in the EU could be eliminated if those transactions were programmed using the Blockchain.
As well, Bitcoin can eliminate systemic corruption by allowing people to opt-out of using corrupt institutions such as in Vietnam, where account holders routinely have to pay bank officials for the privilege of cashing a pay cheque or withdrawing funds from their own bank account.
The legal risks
Although Bitcoin is not illegal in Canada, it does have legal risks, especially when used as a currency for international transfers of value.
The biggest legal risk is consumer protection. Bitcoin accounts are tied to what are called wallets that have public and secret keys that allow users to send and receive Bitcoin and to access their accounts. The secret key is a computer-generated string of letters and numbers that can be easily lost. Lose the secret key, you’ve lost your Bitcoin forever. And some people have. Users all over the world have lost tens of millions of dollars in Bitcoin because they didn’t understand the importance of the secret key when they set up a Bitcoin wallet—they have no way of recovering their money.
There are also significant consumer protection risks with using digital currency exchanges that are unregulated, may not have sufficient liquidity or resources to operate in a technically secure manner to protect consumers, or be qualified to operate and manage consumer funds, or that have no financial crime systems in place. In Canada, digital currency exchanges often do not have bank accounts to operate in their corporate name, posing more risks for customers, and operating without visibility.
Some Bitcoin ATM operators accept purchases with large amounts of cash anonymously and from minors. The anonymity is a natural concern for law enforcement agencies because the transactions can’t be monitored for money laundering or terrorist financing, or tied to a specific person. Purchasing Bitcoin anonymously with cash at an ATM means a person can send funds to anyone anywhere, including a terrorist organization, and they can easily get around economic and trade sanctions.
Bitcoin is better than a Swiss bank account. A wealthy person could anonymously and instantaneously convert unreported income earned anywhere in the world into Bitcoin and redeem it in a tax haven, such as the Cayman Islands without paying taxes. There are anecdotal stories that in cases of adversarial divorce, wealthier spouses have bought huge amounts of Bitcoin using advisors to hide their assets to avoid expensive settlement payments. The more common example of tax evasion risks arises from its use as an investment, or from merchants accepting it as a payment method without reporting to CRA.
If tax evasion is possible, so is bribery. There’s anecdotal evidence that corrupt officials in other countries ask for payments in Bitcoin to avoid being caught in the corruption crackdown. The difficulty here is that the bribes aren’t easily traceable and asset recovery would be exceedingly difficult.
There’s also no dispute resolution mechanism governing Bitcoin transactions and the use of the Blockchain in the event of a dispute associated with its acquisition, disposition or storage. There are no obvious laws that apply to Bitcoin transactions, which makes for enormous legal uncertainty.
Bitcoin is used to circumvent restrictions in countries like Argentina and China that control the exchange and removal of currency. Given its power to transfer funds anywhere in the world, Bitcoin has the potential to undermine the economies of these jurisdictions.
But none of these legal risks are insurmountable. They are simply risks to be mitigated in the same way we mitigate other risks – with appropriate legislation.
Mitigating against the risks
Canada has given Royal Assent to the world’s first Bitcoin law, although it won’t be in force for some time yet. Canada will regulate Bitcoin similar to a money services business, and our legislation is aimed at mitigating the money laundering and terrorist financing risks where they intersect with the financial system.
But it’s unclear how far the legislation will extend. It may be too much or too little in terms of addressing the legal risks. If it’s too much, it will drive venture capital funding for Bitcoin startups to other countries and with it, countless jobs in cutting-edge FinTech out of Canada. If the regulation’s too little, the legal risks aren’t solved and the public isn’t protected, particularly with respect to consumer protection where it is needed most to ensure Canadians don’t lose money spent on digital currencies, or with digital currency exchanges.
The challenge for Canada, as with any government facing emerging financial technology is balancing the risks posed by the tech with regulation. It’s no easy task.
Only time will tell if Canada has achieved the right balance and one hopes that if the law is an over-reach or drives away innovation and technology investment, the government will not be adverse to amendments to achieving a better balance. No one wants the next PayPal to leave Canada.
@2014 – 2019, Christine Duhaime.