Bitcoin and other cryptocurrencies are gaining strength in Canada and around the world. REUTERS/Dado Ruvic
BITCOIN FUTURES, which began trading on the Chicago Board Options Exchange on Sunday evening, rose to a high of $18,700 on their launch day in what might be seen as a modern-day gold rush. But bitcoin and other cryptocurrencies are not gold. They are not issued or governed by a government or central bank. They may not even be a security, and they are virtual. Yet they have the potential to transform vast swathes of the deal world –– as anyone who works in corporate finance already knows.
“The real disruption we’ve seen in 2016-2017 has been on the capital-raising side of the ledger,” says Geoffrey Cher, a partner in Wildeboer Dellelce LLP in Toronto whose practice includes the digital economy. “And it really is only the first innings. So much of what we’re seeing is so new.”
In the bitcoin era, the way many young tech companies raise money is through an Initial Coin Offering, or ICO, which gets them the financing without giving up any equity or control to venture capitalists. In an ICO, investors pay cash (or even use credit cards) to buy digital tokens that give them the right to use the project’s product or platforms; digital coins can also be spent at any businesses that accepts them. These coins and tokens are also tradable assets in the secondary market.
About $3 billion was raised globally in the ICO market in the past year or so, says Cher, which he says outpaced venture capital raised by six-fold. “That’s money that’s gone into the system outside of conventional corporate finance, which the banks would normally handle.”
The hedge funds are all over it, he says. “There are over 100 hedge funds formed globally that we’re aware of that invest just in this area. I’m personally working on six funds that are in the process of assembling themselves to invest in this space and I’m just one lawyer of many. So it’s really the next wave.”
Cryptocurrency will changes role of the middleman
Digital coins and tokens are underpinned by blockchain technology, which is a peer-to-peer digital ledger for recording and verifying transactions made in bitcoin or other cryptocurrencies, chronologically and publicly, across millions of computers without traditional intermediaries.
In conducting deals, having those records publicly available promises to change the role of traditional middlemen such as banks, investment banks and auditors, says Cher and other lawyers who specialize in the digital economy.
To get a sense of how significant the impact is, Jeff Dennis, counsellor and Entrepreneur in Residence at Fasken Martineau DuMoulin LLP in Toronto, says the firm has created a “blockchain taskforce” of 20 lawyers across Canada: some securities lawyers, some tax, some M&A, and some from financial services.
“Do I think there’s going to be an impact on IPOs and M&A and all that? The answer is yes. ICOs are going on without traditional investment banks. They’ve already missed out on over US$2 billion in [global] transactions. Usually there’s a little money that sticks to their fingers but with all these ICOs, they missed it. So now the banks are all trying to figure out, ‘how do we get in on all this action?’”
He compares the potential to the impact that streaming had on the music industry. “Where there used to be record companies and labels and people used to buy whole albums, now people can buy one song and stream it. People are even pirating music and streaming it for free.
“It put a lot of companies out of business and transformed an industry. Some people say cryptocurrency could do the same to the financial services industry. That’s the big bogeyman.”
Banks get on board with blockchain
It’s not as though the banks are oblivious. Canadian banks have joined blockchain start-up R3, a distributed database technology company leading a consortium of more than 70 of the world's biggest financial institutions in research and development of blockchain database usage in the financial system. National Bank of Canada is one such member, says Jillian Friedman, who joined the bank’s in-house fintech legal team in 2015.
Friedman, based in Montréal, believes it will be another five years or so before cryptocurrency really rocks the M&A world, mainly because it’s expensive for businesses to install blockchain technology. But in the meantime, she sees it affecting transactions in a couple of ways.
“One would be where … you have a company that has some of its assets in bitcoin or another type of cryptocurrency. That changes things on the valuation side. When you have an asset that’s so volatile, it becomes a question of how it’s evaluated.”
Also, the coins are not recognized as money under the Currency Act, and therefore “they don’t benefit from the same legal super powers as money. They would be treated as closer to equipment, so the acquirer wouldn’t automatically assume the cryptocurrency could be taken free and clear of any other encumbrances.”
Is it a bird? Is it a plane?
If it’s not money, what is it? Regulators in Canada and other countries are wrestling with that question, and the Canadian Securities Association has noted that digital currency offerings may in many cases be considered securities or derivatives.
One of the challenges regulators face is that because there are so many different models of coins and tokens (Geoffrey Cher of Wildeboer says there are over 2,000 globally) — which give buyers varying rights — a one-size-fits-all set of rules is difficult.
Canadian regulators have so far approved the public sale of just one digital currency, from Quebec’s Impak Finance, a platform for investing in socially responsible enterprises, says Cher. The Autorité des marchés financiers determined that Impak’s token sale fell under the “sandbox” created by the Canadian Securities administrators to jumpstart fintech projects that don't easily fit within the confines of a legacy framework; but it imposed the condition the company not try to create a secondary market for its coins, he notes.
In August Reuters reported that Impak Coin had raised more than $1.5 million for the new currency before the coins were even put up for sale that month, and the company hoped to raise $10 million in its first phase – all while complying with securities commission regulations. In August and September Impak sold 1.64 million Impak Coins in 89 countries around world.
It’s safe to say the financial world will be watching closely.
Lawyers will benefit from the new crypto-marketplace
Other cryptocurrency companies have tried to go public in Canada, and Cher says “there are a bunch that have filed and are waiting for clearance.” But the with uncertainty around issues such as custody and valuation, “regulators are struggling with how to treat them.”
Once regulators agree, “I think it’s going to change very quickly,” he says. “I think we’ll see a lot of product come out where Canadian investors will be able to attain direct exposure to a company that either creates blockchain technology or has issued a token around the technology, and will allow you to invest directly in them.”
Meanwhile, Cher expects to see several bank-syndicated deals in the first half of 2018, with banks backing blockchain companies that are planning to or already using cryptocurrency and want to go public, “either through an IPO or, more conventionally today, through a reverse takeover.”
Fasken’s Jeff Dennis says all this is good news for law firms “because there’s lots of issues and uncertainty, and lawyers can help people navigate all these complex issues. This is new business for us, so it’s good.
“For investment bankers, it’s not been good because it’s happened without them for the first time. So they’re now waking up and figuring out: ‘How do we get in on this action?’ For now, they’re doing ancillary deals. But the investment banks will be creating funds that deal in coins, we’re seeing that already, so I think there’ll be lots of activity for the investment bankers there.
“It’s a double-edged sword for accountants,” he continues. “Auditing is going to be disrupted by blockchain and there’s no dispute about that. It’s going to affect their audit business for sure. They know that.” On the other hand, he says, “there’s lots of regulatory advice, bookkeeping and accounting, and tax advice around how to do this, so they’ll keep busy in other ways.” And Deloitte, for example, has a consulting business that will build a blockchain solution for a business.
“For every risk there are opportunities,” says Dennis; “but you have to be open-minded. If you’re an old-school investment banker, accountant or lawyer, this world will pass you by.”