#167 - Is Canada Ready to Regulate Stablecoins?

(upbeat music) Canada has a draft stablecoin bill that has drawn some questions from those in the industry. And a submission was sent to the House of Commons that shared disappointment with Canada's first iteration of a stablecoin act. And those concerns were shared by a lawyer who I work with and deeply respect. Basically, a lot of people see that this doesn't increase regulatory certainty if anything, it does the opposite. And it's also insufficient to protect users in support financial stability. And it also might risk over extending the bank of Canada or the mandate, at least, of the bank of Canada. And joining me to discuss why is the author of that submission, Odin Olucuore of York University, who co-wrote the submission with Darrell Duffy of Stanford and Andres Veneres of the University of Toronto. Now, this conversation really dives in deep to the details of the Canadian stablecoin act. So if you're interested in becoming, I wouldn't say an expert, but really going a long way in your understanding of the rules in Canada and why there are some major, major concerns with this draft stablecoin bill, you'll enjoy this episode. We'll begin after a quick word from our sponsor. This episode of the Law of Code podcast is brought to you by the Decentralization Research Center. The DRC is a nonprofit think tank that advocates for decentralization in emerging technologies. With the mission of ensuring the future of innovation is an equitable one. You can learn more about the DRC by visiting their website at drcenter.org. Welcome to the Law of Code podcast, man. It's great to have you. - It's great to be here, Jacob. Extremely honored to be here. - Now, before we begin, just to set the table on some key existing laws in Canada, there is the Retail Payment Activities Act or ARPA, which governs non-bank payment service providers. There's the proceeds of prime money laundering and terrorist financing act, which is our main AML KYC law, and then the Consumer Driven Banking Act, the CDBA, which establishes a framework that allows consumers to control and securely share their financial data with trusted entities of their choosing. At a high level, what's the goal of a Canadian stablecoin act? - At a very, very high level. I believe the problem that this act tries to solve is monetary sovereignty. It attempts to protect Canada's monetary sovereignty from the effects of stablecoin polarization as a result of US payment, stablecoin. And the strategy that it does adopted is to first ensure that no foreign stablecoins that are backed by some form of foreign deposit insurance, it prohibits that. Absolutely, it prohibits stablecoins that are already being issued prior to this new regime. So this proposed act tells us more about what it does not do as opposed to what it does do. So it does not tell us what the act is opposed to the government. It does not tell us what exactly it's opposed to regulate. So the first thing I noticed after reading the actors that it does not say what these stablecoins are supposed to be for. There is no functional definition. There's no functional description of what these stablecoins are supposed to be used for. And that was the first thing I noticed. - The definition of stablecoin in the act is a digital asset that is intended or designed to maintain a stable value relative to the value of one fiat currency and that has the characteristics if any provided for in the regulations. And like the idea that stablecoins are used in payments might be omitted intentionally. - Yes, that's correct. I believe it's deliberate because constitutionally, it becomes very tricky to cover payment is a payment field because the combined provision of 91 and 92 of the position acts does not allow for either the federal or the provincial authorities to cover that area absolutely regulators. It would have been a big account of warms if they tried to describe this as a payment instrument because at a provincial level, for example, Quebec has money service businesses regulation. And if this act were to cover that field, there would be a lot of constitutional issues under it's tears like the actors walking on eggshells here because it allows for stablecoins that are contained within the provinces. So for example, if the stablecoin is issued within the province and that stablecoin does not have an extra provincial effect, there is not covered by this act. What is the likelihood of that happening? I mean, how many provinces are that contained financially that you wouldn't have the situation where one provinces stablecoin is entering the financial or monetary system of another province. So it's a very strange situation right now. In all honesty, I feel the act was an attempt to signal but I'm not sure what signal exactly the act is passing besides attempting to cover the field that is constitutionally not allowed and also attempting to work things out as they go on because it allows for regulations. But it seems that at this point, the regulation is going to be more detailed than the act itself. I think a lot of the American audience might not understand the difference between the Canadian constitutional rules and those in the US. Yes, so the US has a sectoral securities regulator. We have regulators but for provinces. So Ontario has its own Ontario Security Commission and Quebec and other provinces have this. So securities is an authority or regulations for securities that are assigned to the provinces to govern. So because of how destructive stablecoins are and how destructive the crypto industry has been so far, it's it has affected legal classifications. It has affected federalism, federal division of power. It has affected institutional authority to a large extent. That's why you find a situation where, for example, in the proposed Canadian stablecoin act, you find a minister of finance, which is supposed to be the fiscal governing body, and then you find a backup kind of, which is supposed to be the monetary governing body. So these instruments have kind of caused so much disruption that agencies or organizations or institutions that are already supposed to be separate are beginning to converge. And legal classifications are beginning to blur. So we have a situation that I mentioned before where fiscal and monetary policy are beginning to intersect. And now we have a situation where securities, payment instruments, commodities are beginning to intersect. For us to understand or regulate these things well, we need to understand the jurisdiction or on the pinings of this instrument. So what's the rationale behind government securities bonds coexisting with cash? The legal restrictions theory comes into place because it says that it's the law that actually preventives the similar instruments when you look at them. Just that one is reminerated, one is not. Remineration is actually a question that we're facing right now. You didn't interest the remineration with stable coins. But we have legal restrictions theory that attempts to separate these instruments. But how well do these theories work in the current dispensation particularly with stable coins? When we have arguments, valid arguments in my opinion for stable coins attracting yield and interest. But then again, you have a legal restrictions theory that says that no, you shouldn't have payment instruments. You'd interest why? Because you have questions lost situation where people poured interest bearing instruments and spent the payment instruments. So that's a conflation of a payment instrument and a security and a commodity. I don't know if a lot of work is being done or that because it's a surreal not to issue to solve right now. So yeah, I don't know if I diverged from your initial question but I think we could talk about the prohibition on interest too, because we saw in genius how there was a prohibition on interest but solely in connection with certain activities. And so in the law of code episode I did with Austin Campbell, he talked about how there could be ways around that. And we're seeing a big battle now in the US when it comes to whether or not interest should be paid whether in the form of rewards or otherwise for people to users who do more than just use these tokens for payment purposes. And in Canada, it seems like we just have this blanket prohibition on interest, which when you think about just the way most traditional, I use traditional in the sense that like they've been around for more than two years, but most traditional stablecoin issues. I mean, they're making money off the interests that the underlying assets bear, but they aren't passing that on to consumers. So these consumers, these users are taking the risk by holding the token but getting none of the benefits besides the payment instrument features. It seems like Canada wasn't even willing to entertain that idea in terms of interest payments to users. In total, some genius act allows for existing financial institutions back to indirectly issue stablecoins through subsidiaries. No similar provision exists in the proposed stablecoin act. It's absolutely prohibits financial institutions from issuing stablecoins. I guess maybe there's going to be a separate regime for financial institutions that want to issue stablecoins. I don't know why that is the case. The most appropriate regulated for the prudential regime would have been the office of the superintendent to financial institutions. However, the act does not apply to financial institutions thereby those five would not regulate it. So I don't know what the intention behind this bill is, but I believe it's a signal, some signal that something is being done here. I think one of the most important parts of this that might have been overlooked by a lot of the industry who were applauding this bill and your reaction was different. And so was some other people's, is that they've expanded the definition of payment function in the Retail Payment Activities Act, which governs non-bank payment service providers in Canada. And that, to me, was a huge red flag because what they've done is they've expanded this definition to do something that you right could sweep in while it's validators and even non-financial actors. Well, even potentially excluding stablecoin issuers, can you talk a little bit about that language and how that happens? There's a lot to discuss about the language used and the consequential amendments to the Retail Payment Activities Act. Maybe they're going to be regulations as well for the Retail Payment Activities Act to tell them certain terms need to be defined. Payment instrument needs to be defined because the Retail Payment Activities Act does not find a payment instrument by itself. This consequential amendment includes tokenized and encrypted payment instruments. Those words are not defined, right? And they just introduce that into a new subsection, transmission, and maintenance of an end users and crypto to tokenized payment instruments on end users' private keys. Whether or not the private keys, private key is encrypted or tokenized. So it introduces new words that are not defined at all. The act, payment instrument is not defined in the act, tokenized is not defined in the act. And a broad definition of this word or this terminology is would include people, agencies, or intermediaries that are not paid, play any role in the payment chain at all. And it's why would the Bank of Canada, for example, want to regulate someone that performs no payment function? The stablecoin issue itself, according to the stablecoin act, performs no payment function. However, the proceeds of money laundering acts, which also has consequential amendments, says that the act applies to stablecoin issues. On what basis exactly is it applied to stablecoin issues when they perform no payment function? So it's a bit all over the place. And I see the same problems with genius act, right? Relying heavy beyond the Bank's secrecy act, to a large extent. - Well, look, what this does, I mean, the definition of a payment service provider, so an entity or individual that is subject to the retail payment activities act in Canada, is defined as an individual entity that performs payment service functions as a service or business activity that is not incidental to another service or business activity. So by bringing that definition under a payment function by saying, essentially, you, it doesn't even say if you're doing it, it just says the transmission or maintenance of an end users encrypted or tokenized payment instrument or an end users private key, whether or not the private key is encrypted or tokenized, that in itself is enough for all these payment activity rules to apply to you. That would have pretty, I'm not sure about that. - It's good, it could apply to a user, it could apply to a user, for example, a user could be one way or another, be interpreted as a payment service provider. - That's a great point. - But there's a qualifier here, because it says that definition of the payment function says you should be doing as a consequence of another. You're not doing it as a consequence of another service. So if there's some form of benefit you derive from it that could make it fall under some sort of business service. But then again, how do you define that, right? So these are the things that I think a new digital asset regime is required for, because I don't think conventional legal regulation captures a lot of things. It's too dynamic, a field to regulate in the east. You need to actually let innovation occur to the point where maybe things apply to you to an extent. - There is that qualifier right that it would have to be a service or business activity. But I mean, how do we draw the line there when it comes to stablecoins or when it even comes to just sending tokens online, right? If someone's a trader that could be considered a business activity, so I think it's dangerous. And I wanna just read one quote that was in your paper, 'cause I thought this was excellent. And it's quote, the Axe language is broad and risks sweeping in entities and activities that go beyond stablecoin payments, including wallet providers, whether hot or cold, digital asset custodians and even non-financial service providers that merely store authentication information. However, while the expanded ARPA definition of payment function appears to bring stablecoin transfers within federal payments oversight, it does so in a way that captures validators and other back end actors, such as PSPs, but does not actually covers stablecoin issuers, because issuers do not perform a payment function under the expanded definition. - That's interesting, right? The issuers, the proposed act tells us more about what the issuers should not do, as opposed to what they should, to people what they are supposed to be doing. So it's a very interesting approach to regulate in these instruments. It's a tough job, one must say. It's a very, very difficult job trying to regulate these instruments. But at the end of the day, it's, I don't know, it seems like it's too early right now to attempt to codify these things. I'll rather the courts have their way. I'd rather have these things tested more in the courts and then maybe the legislatures can learn from that, because that's the only way I seem to actually regulate these instruments, clearly and coherently. Now, one more thing on the stablecoin issuer. So it's a new regulatory category. So the act was engineered, was designed in such a way that non-financial institutions perform in different sorts of businesses, the core businesses would be diverse. So you could have maybe, let's not even limit it to people in the crypto industry. Let's say a merchant, for example, namers or Shopify or some other entity wants to issue still coins, it allows that. But how does the back of Canada regulate the issue? What standards are you going to apply broadly to regulate the operations of the issuers, such that you have a coherent risk management structure, potential regime, please? So it's another issue that I do not know yet how it's going to work. One other section that introduces some ambiguity is section 42, which introduces this data security policy. Could you talk about what the stablecoin act does in that regard? I guess it's supposed to be a way to hold the stablecoin issue as accountable to the data security of their platform. So you find that in an earlier provision of the act, the stablecoin issue is supposed to disclose the technologies, the underlying technologies to the back of Canada. Whether the back of Canada has the ability to understand or to determine whether this technology is good or not appropriate or not for the use case. I do not know. But then again, you find that Andreas Daenerys, my co-author, he's of the opinion that we do not know if the back of Canada can actually regulate or determine the technology. And that's why it's appropriating and repropriating at the same time. So it takes the responsibility for compliance, some form of technological compliance or standardization. And then it's also throwing that responsibility back to the stablecoin issue as to have some form of data security points. So the skill gap is very, very clear. The competence gap is very much clear there. I do not know if it's deliberately done so, so as to throw that responsibility on the issue themselves. But yeah, it shows that that's competence of the skill, the ability to determine data security isn't there. Perhaps it's going to be some cross-agency, some alignment or they're going to have to work with some other agency to determine how to work through this or not. Yes, I do not know if the back of Canada can. Yeah, and that seemed to be a theme among your submission that there was this concern about the Bank of Canada's role. And for those Americans, the Bank of Canada's Canada Central Bank responsible for inflation similar to the Fed in some ways with in keeping inflation low and stable, maintaining the stable financial system, issuing currency, acting as the government's banker and managing the money supply through policy tools, such as interest rates. What new responsibilities does the Act assign to the Bank of Canada that troubles you most? It's the prudential regime. That's the issue here. It's necessary to have a difference or maybe a better tailored prudential regime for stablecoin insurance. Because tradition and the prudential regime we have in place are meant for financial institutions, banks, insurance companies. But when you have a situation where multiple issues perform multiple businesses, diverse range of businesses, it becomes very, very difficult to regulate in a uniform manner. So now we have the Bank of Canada probably having to determine the prudential regime for multiple issues that perform multiple businesses. I do not know how the Bank of Canada is going to do that. That was why we recommended that they have a minimum requirement and they also define the high-political liquid assets that forms a majority of the reserves for the stablecoin issuer. Would they need to have some form of control over the operations of the stablecoin issuer? Maybe, maybe the regulations will need to specify that for my biggest concern is that you are regulating institutions or entities that are performing a financial service where they themselves might not be financial service providers. So financial institutions. And I do not know if the current regime would suit that. Yes. If you look into the act itself, I believe financial institutions themselves are exempt from the stablecoin act. And so, yeah, you have this financial body and the Ministry of Finance, which is obviously in the Bank of Canada, which are also finance focused with these entities that aren't really financial entities themselves. I mean, they do have a component that is, but I think we can all agree that stablecoins look very different. I mean, the base, the most important aspect of the stablecoins is very different than the most important aspect of banks today. And so, there's so many new questions that come up here. Just to step back for a second to something you mentioned, which is the definition of high-quality liquid assets. That's something that isn't defined in the stablecoin act itself. And in the submission you wrote, you noted how that's pretty unique because genius act rules, I believe it's Korea, and many other places have defined what high-quality liquid reserves actually are, what at least reserves are needed. - Even if they're exactly, you already don't, they are more specific or they are more detailed in their provisions. But I mean, I guess, yes, maybe we would have the regulations addressed based on during the consultancy because this is, we were told that we were quite early in our reaction to the bill, but still at the first reading. So maybe during the consultation stages, we would have more comprehensive regulations. But yes, that's true. The reserve high-quality liquid assets not defined. And then also, or you need to have the reserves calibrated to the exposure that issues have in the Canadian economy issue, trying to regulate this thing well. So that's the major issue here. You need to ensure, and how that's going to be done, whatever portfolio management is for me, that it's going to be employed here. That's left for the finance and risk management for people to resolve. But yes, the wording needs to be tighter. A few people who I've spoken to have suggested this could be Canada putting the car before the horse, where we don't have a flourishing stablecoin system of at least Canadian dollar-backed stablecoins yet. Is this, in your opinion, putting the car before the horse is it too early to create stablecoin regulation? I think it's too early, I agree with you. I think it's too early. I think if this was supposed to be a response or some way to actually protect monetary sovereignty or avoid the effect of stablecoin dollarization, it's far too early. So if we go back to the remuneration and the interest rates conversation we had previously, there is no way we are not going to, we are going to experience some formal pressures now, because multiple currencies are existing. We have cash, we have stablecoins, we have cash, we have US dollar, we don't need stablecoins. So there's going to be competition and people are going to gravitate to whatever currency serves their needs and people have different needs, right? My need could be some form of security protection 'cause I don't want anyone snooping to my financial activity. And then I gravitate towards the jurisdiction that has better data protection and security that is stablecoin. If my intention is to, okay, I'm on back in a remote area, I don't have access to financial services. I'll gravitate to the closest one that has more accessibility. So people definitely gravitate towards a stable coin that favors their needs. So I feel that maybe we are to earn, to react because if we had a situation where there's access, people have access to, we draw their funds, you have some form of remuneration that is competitive and attractive. That's bank accounts without the existence of, prior to the existence of some form of Canadian stablecoin. You have people remuneration or attractive interests to the bank account, deposit account. If you have something that attracts people to the Canadian dollar by itself, then maybe you'd have something to rely on if you had a Canadian stablecoin. Well, for now, without that, I think, yes, kind of that's too early to respond to. The dollarization effect from the US stablecoin. It's a good example of how stablecoins in particular really have changed the competition that currencies have, whereas now I can opt into a US dollar denominated stablecoin that was never before quite as easily exchangeable and I'd have to pay fees. If I wanted to hold it in the bank account here and so it's really changed the game in that respect. And I think it's a wake up call. And it seems like Canada's got that wake up call just by the fact that there is some rule around stablecoins, which we didn't have before. It was just the CSA, which is the Canadian securities administrator saying, you know, we think these are securities or derivatives. - Perhaps that's the signal, right? That's the signal. Something. - Right, and it's certainly a step. I mean, whether it's a step in the right direction or wrong direction, I think remains to be seen. But it's certainly a step and it's a recognition that we saw across the globe. But every other country was really quick to get some sort of stablecoin rules at least proposed or discussed after genius got passed because they've realized that well, now the US dollar is going to continue to gain strength. And that's not always good for other countries long-term prospects. So I think it's a really important time to have conversations like these and submissions like yours are so important. So thank you for that. - Thank you very much. - Thank you. - Thank you. - Thanks for joining me, men. It was a pleasure, Odin. That's another law of code podcast in the bank. Thank you to our sponsor, the Decentralization Research Center for supporting this podcast. You can learn more about the DRC by visiting their website at thedrcenter.org. We'll see you next time.