What are Crypto Assets?
Crypto assets are purely digital assets that use public ledgers over the internet to prove ownership. They use cryptography, peer-to-peer networks and a distributed ledger technology (DLT) – such as blockchain – to create, verify and secure transactions. They can have different functions and characteristics: they may be used as a medium of exchange; a way to store value; or for other business purposes. Crypto assets generally operate independently of a central bank, central authority or government.
A distributed ledger is a type of database that stores electronic records shared and replicated across many locations and maintained by members of this decentralized network. Each new transaction must be agreed upon by all members of the network before it is added to the ledger. Blockchain is one type of distributed ledger that arranges the data in chunks and chains them together. This unique way of structuring data gives blockchain transactions additional security as they are irreversible. Blockchains can be used to store many types of data but have recently become popular for their use of storing cryptocurrency transaction history.
Some of the more common types of crypto assets you may encounter are:
Cryptocurrency
Cryptocurrency (or virtual currency) is likely the most well-known type of crypto asset. Cryptocurrency is a digital currency or medium of exchange. It can be used:
- To exchange for products or services, like fiat currency (such as Canadian dollars or US dollars)
- For speculative purposes, such as trading on a crypto asset trading platform (CTP)
- As a store of value
It was created as an alternative to fiat money, but cryptocurrency is not considered legal tender in Canada. Cryptocurrencies have no inherent value; their perceived value is based largely on supply and demand in the market. Examples include Bitcoin, Ether, Ripple and Litecoin.
Cryptocurrencies are generally not considered to be securities and, therefore, are generally not subject to securities laws. For example, when you buy a cryptocurrency and take immediate delivery of the crypto asset into your digital wallet, this transaction is generally not subject to securities laws. However, if you trade cryptocurrency on a CTP and the CTP holds your cryptocurrency in a digital wallet for you on their platform, this creates an ongoing contract based on the value of the underlying crypto asset, and this contract is subject to securities regulation. CTPs that provide this service for users must be registered with the appropriate securities regulator(s). You can check that a CTP is registered by using the free National Registration Search tool from the Canadian Securities Administrators.
There may be some circumstances where a cryptocurrency would be considered a security. This may need to be determined on a case-by-case basis by examining the specific situation, scenario or characteristics of the cryptocurrency. Because technology and regulation in this area is evolving, if you are uncertain if securities laws apply to a cryptocurrency you are considering, contact FCNB.
There are income tax implications in using cryptocurrency to generate income, capital gains or to pay for goods or services. You should consult the CRA’s Guide for Cryptocurrency Users and Tax Professionals to ensure you understand how to comply with your taxes.
Utility Tokens
A utility token uses a distributed ledger or blockchain platform to provide access rights to a specific product or service (potentially one that is still in development), or to be used to purchase specific products or services. The provider of the products or services typically issues the tokens, which can only be used within the issuer’s network.
Security Tokens
Security tokens are often sold or auctioned in an Initial Coin Offering (ICO) or an Initial Token Offering (ITO) that allows businesses to raise money to fund an idea or business model. The business offers security tokens in exchange for fiat money or other crypto assets. The security token often comes with a stake in the project and additional benefits, such as voting rights, profit sharing or dividends. However, a project may not succeed, and investors should remember they are putting their funds toward supporting an idea of a business model – not a fully realized product or service.
Non-Fungible Tokens
Non-fungible tokens (NFTs) are tokens that exist on a distributed ledger or blockchain, which record ownership of a unique tangible or intangible object – such as a song, a digital image, a video, designer clothing, etc. Non-fungible means these tokens cannot be exchanged for one another; each one is unique. NFTs are relatively new, even for crypto assets, and the regulatory scheme and marketplace for NFTs are rapidly evolving.
Buying, Selling and Holding Crypto Assets
Initial Coin Offerings
Security tokens may be sold or auctioned in an Initial Coin Offering (ICO) or an Initial Token Offering (ITO). These “Token Generating Events” are used to raise funds for an idea or a business model. Interested supporters can buy tokens with regular currency or another cryptocurrency. The token likely has no value at the time you buy it but may be exchangeable in the future for a new cryptocurrency to be launched by the project, or a discount or early rights to a product or service proposed to be offered by the project. Because there are no guarantees or certainty that the token will have any future value or that the project will succeed, investors should be very cautious when buying into an ICO. The level of disclosure and information available is typically far less than would be available for a typical investment opportunity. Investors should be prepared to lose some, or all, of their original investment.
Depending on the circumstances of the ICO, the tokens may be securities. If they are, then they may be subject to securities law. If you are uncertain, if securities laws apply to the ICO or the tokens you are considering, contact FCNB.
ICOs are high risk, and their structure makes them fertile ground for fraud and abuse. Anyone considering participating in an ICO or other token generating event should be wary of promises of guaranteed returns, plagiarized or otherwise fake investment documents, contracts or website content, and fake or lack of information about the business and company leadership. If you are considering participating in an ICO or are uncertain about the validity of an ICO you are considering, we encourage you to seek professional advice or a second opinion.
Digital and Physical Wallets
You can purchase cryptocurrency directly, receive immediate delivery of the assets and deposit them into your digital wallet or physical data storage device. A digital wallet is an online service that stores your cryptocurrency and allows you to conduct transactions, such as buying goods or services, or trading or transferring your virtual currency. You have sole control over your digital wallet, but risk losing access to your crypto assets if you forget your password, accidentally delete your wallet or are the victim of hacking.
Physical hardware devices designed for storing crypto assets, often referred to as “cold wallets,” are often a secure way to store crypto assets because they are not connected to the internet. Anyone planning to hold large quantities or values of cryptocurrency or other crypto assets may want to consider cold wallet storage. These devices also require you to remember and closely guard your password.
Crypto Asset Trading Platforms
Crypto asset trading platforms (CTPs) are online applications or systems that bring together buyers and sellers of crypto assets to facilitate transactions or trades.
Some CTPs provide a platform for users to buy and sell crypto assets and receive immediate delivery of these assets into their own wallets. This means that the user makes the purchase and the platform has the obligation to deliver the crypto assets directly to the individual, who stores them in their own wallet, over which they retain full control.
Some CTPs retain custody of the crypto assets in a wallet controlled by the CTP. This creates a dependency or reliance on the platform by the user. The user’s crypto assets are stored on the platform and the platform retains control over the assets until the user transfers them off the platform, either into their own wallet or by receiving an equivalent value in fiat currency.
Depending on the model of the CTP, securities laws may apply, and the CTP may need to be registered or recognized by the appropriate securities regulator(s) as a securities or derivatives marketplace or exchange. It’s important to know what the requirements are so you can do your homework before you sign up to use any trading platform. Review the Regulation of Crypto Assets section to learn more about how regulation protects you. If you are uncertain if a CTP has to be registered, contact FCNB. You can check registration by using the free National Registration Search tool from the Canadian Securities Administrators.