As Bitcoin and other cryptocurrencies surged in value this fall, the top market regulator in the United States created a new unit to monitor this fast-growing but little understood corner of the financial world.
Earlier this week, the Securities and Exchange Commission's new cyber unit filed charges for the first time. Its target: a Quebec cryptocurrency company that was promising investors returns of 1,354 per cent in 29 days or less.
In court filings, the SEC alleged PlexCorps raised $15 million since August through an initial coin offering (ICO) that potentially fleeced "tens of thousands of investors." It claims PlexCorps's founder, Dominic Lacroix, and his girlfriend, Sabrina Paradis-Royer, used the money to finance "extravagant personal expenditures."
The charges underscore the dangers that exist to efforts in Quebec, and Canada more generally, to establish global leadership in the digital currency market, which is now capitalized at more than $200 billion (up from $40 billion at the beginning of 2017).
Already Montreal and Toronto have carved out a reputation as developing hubs, thanks to their concentrations of high-tech knowledge. Montreal's allure is further helped by cheap electricity and cold winters, two assets for the energy-sucking computers required by coin-mining operations.
But industry insiders worry that the dizzying rise in value of cryptocurrencies and an uncertain regulatory environment are attracting unsavoury elements.
"Cryptocurrency or blockchains are a new phenomena that, with the rise in value, is attracting many fraudsters and scammers," said Jonathan Bertrand, who runs Technologies D-Central, a bitcoin mining operation in Montreal.
"We are witnessing numerous scams and are trying our best to inform the public."
Currency or security?
Cryptocurrency markets are often described as the Wild West of the financial world. Currency values oscillate between extremes, and transactions don't benefit from the same protections as fiat currencies that are backed by a government.
Contributing to the volatility is confusion over whether cryptocurrencies are currencies or securities.
If currency, a virtual money company faces fewer disclosure obligations when conducting an ICO.
But regulators in both Canada and the U.S. indicated recently they are more inclined to consider most cryptocurrencies as securities.
In a staff notice from August, the Canadian Securities Administrators suggested that ICOs should be following similar disclosure rules as initial public offerings of stock. These force companies to release financial details about their business operations to allow investors to make more informed decisions.
"The coins/tokens can be similar to traditional shares of a company because their value may increase or decrease depending on how successfully the business executes its business plan using the capital raised," the CSA said.
Among the allegations directed at PlexCorps, the SEC said the company sought to describe its PlexCoin Tokens as a currency similar to bitcoin in order to skirt federal securities laws.
In the materials PlexCorps circulated to investors, there was no mention that Lacroix had been found guilty several times in Quebec of securities law violations.
"A reasonable investor would want to know that a repeated securities law violator such as Lacroix was behind the PlexCoin ICO," the SEC said in its filings in a New York court.
Regulators take first step, but more needed
The move taken by the CSA to clarify the regulatory context for cryptocurrency will go some way towards boosting investor confidence in this emerging asset class, said Manoj Pundit, a Toronto-based securities and capital markets lawyer with Borden Ladner Gervais.
But he also stressed it amounted only to a first step. Despite the guidelines issued in August, companies still have to consult with authorities to determine whether they classify as a currency or a security.
That lingering confusion should be high in the minds of investors looking to enter the cryptocurrency market, said Hugo Levasseur, a cryptocurrency expert with SAP Labs Montreal.
This is a very new technology," said Levasseur (who added his comments don't necessarily reflect those of his employer).
"So as a consumer you need to be aware that it is a space that is not as well defined as the traditional investment space. You need to be very smart about how you're investing."
Both Levasseur and Pundit said Canadian regulators need to be prepared to keep pace with the fast-moving technology in order to allow cryptocurrencies to reach their potential.
"To foster growth in that space, we need to ensure that businesses can raise money through token offerings. They can do so with clarity about what the game rules are," Pundit said.
"There should not be substantial confusion about what they can or cannot do."