Table of contents:
1.1 Purpose of the handbook
1.2 Canadian Market Context and Opportunities
2. Understanding Cryptocurrencies
2.1 What is a cryptocurrency?
2.2 Major cryptocurrencies
2.3 Blockchain technology
3. Canadian Regulatory Framework
3.1 Cryptocurrency laws and regulations
3.2 Regulatory bodies
3.3 Taxation of Cryptocurrencies in Canada
4. Evaluation and Selection of Cryptocurrencies
4.1 Valuation criteria
4.2 Fundamental Analysis
4.3 Technical Analysis
5. Investment Strategies
5.1 Buy cryptocurrencies directly
5.2 Exchange Traded Funds (ETFs)
5.3 Mutual funds
5.4 Hedge funds
5.5 Crypto mining
5.6 Cryptocurrency betting and lending
6. Risk Management
6.1 Volatility risks
6.2 Technology and security risks
6.3 Regulatory risks
6.4 Diversification and portfolio management
7. Trading and custody platforms
7.1 Comparison of major Canadian trading platforms
7.2 Digital portfolios and custody
9.1 Glossary of terms
9.2 Further resources
1.1 Purpose of the Manual
The primary objective of this manual is to provide a detailed and in-depth understanding of the technical, economic, and regulatory aspects of investing in cryptocurrencies for institutional investors in Canada. It aims to equip investors with the necessary knowledge to make informed investment decisions in this rapidly evolving field.
This manual covers the main cryptocurrencies available on the market, the underlying blockchain technology, the relevant Canadian regulatory framework, and the various investment strategies and risk management techniques that can be employed.
It’s important to note that while this manual aims to be as comprehensive and accurate as possible, it cannot cover all aspects of investing in cryptocurrencies. Moreover, the field of cryptocurrencies evolves rapidly, and the information contained in this manual may become outdated or inaccurate over time.
Disclaimer: This manual is intended for informational purposes only and does not constitute investment advice. Investors should always conduct their own due diligence and consult a professional financial advisor before making investment decisions. Investments in cryptocurrencies carry high risk, including the risk of losing the entire investment. Past performance does not guarantee future results.
1.2 Canadian Market Background and Opportunities
Canada is a significant player in the global cryptocurrency landscape. The country boasts robust technological infrastructure, a technologically savvy population, and progressive financial regulation, all of which have fostered the adoption and development of cryptocurrencies.
The Canadian government has adopted a balanced regulatory approach towards cryptocurrencies, seeking to protect investors and prevent illegal activities while fostering technological innovation. This has allowed a number of cryptocurrency businesses to thrive in Canada, including exchanges, wallet services, and Bitcoin mining companies.
Canada has also been a leader in creating cryptocurrency-based investment products, such as cryptocurrency exchange-traded funds (ETFs). In 2021, the world’s first Bitcoin ETF was launched in Canada, paving the way for a new class of investable assets for institutional investors.
However, as with any investment, it’s important to understand that investing in cryptocurrencies carries risks. Price volatility, evolving technology, and the changing regulatory landscape are all factors that must be taken into account.
Despite these risks, the opportunities for institutional investors in the Canadian cryptocurrency market are substantial. Cryptocurrencies offer high return potential and can serve as uncorrelated assets, thus improving portfolio diversification. Additionally, the growing adoption of cryptocurrencies by consumers and businesses suggests that they will play an increasingly important role in the digital economy of tomorrow.
It’s worth noting that each institution will have different objectives and risk tolerances, and it is therefore important to develop a cryptocurrency investment strategy that aligns with these considerations.
2. Understanding Cryptocurrencies
2.1 What is a Cryptocurrency?
A cryptocurrency is a form of digital currency that uses cryptography to secure transactions and control the creation of new units. Unlike traditional currencies, cryptocurrencies are decentralized and operate on a technology called blockchain.
2.2 Main Cryptocurrencies
Bitcoin (BTC): Created in 2009 by an individual (or group of individuals) using the pseudonym Satoshi Nakamoto, Bitcoin is the first cryptocurrency and remains the most widely recognized and used. Bitcoin was designed as a decentralized digital currency without the need for a central authority. In January 2009, Bitcoin’s market capitalization was zero because there was no defined market value for Bitcoin at the time. As of May 2023, Bitcoin’s market capitalization is approximately 1 trillion US dollars.
Ethereum (ETH): Launched in 2015 by Vitalik Buterin, Ethereum is a smart contract platform that allows developers to build and deploy decentralized applications (dApps). Its native cryptocurrency, Ether, is the second-largest in terms of market capitalization. In August 2015, Ethereum’s market capitalization was about 16 million US dollars. As of May 2023, it is approximately 300 billion US dollars.
Binance Coin (BNB): Binance Coin is the cryptocurrency of the Binance cryptocurrency exchange platform, launched in 2017. BNB can be used to pay for transaction fees on the Binance platform, participate in ICOs on the Binance platform, and much more. In July 2017, the market capitalization of BNB was about 10 million US dollars. In May 2023, it is about 80 billion US dollars.
Cardano (ADA): Launched in 2017, Cardano is a smart contract platform that aims to surpass Ethereum in terms of security and scalability. ADA is the native cryptocurrency of the Cardano platform. In October 2017, Cardano’s market capitalization was about 600 million US dollars. In May 2023, it is about 50 billion US dollars.
Polkadot (DOT): Polkadot is a multi-chain platform that allows the transfer of any type of data or assets across different blockchains. DOT, its native cryptocurrency, was launched in 2020. In August 2020, Polkadot’s market capitalization was about 5 billion US dollars. In May 2023, it is about 40 billion US dollars.
These market capitalization figures are subject to strong fluctuations due to the inherent volatility in the cryptocurrency market. In addition, new cryptocurrencies are regularly introduced, which can quickly change the market landscape. It is therefore crucial for investors to stay informed about the latest market developments.
Here is an overview of the evolution of the total market capitalization of cryptocurrencies from 2009 to 2023:
- 2009: Launch of Bitcoin, the first cryptocurrency. The total market capitalization is essentially zero as Bitcoin has no market value yet.
- 2010: Bitcoin’s market capitalization starts to be tracked. In May 2010, Bitcoin’s market capitalization is about 170,000 US dollars.
- 2013: Bitcoin reaches a market capitalization of 1 billion US dollars in March. In December, the total market capitalization of cryptocurrencies reaches 15 billion US dollars.
- 2017: A landmark year for cryptocurrencies with a spectacular rise in prices. The total market capitalization reaches 600 billion US dollars in December.
- 2018: The cryptocurrency market undergoes a significant correction. The total market capitalization falls to about 120 billion US dollars in December.
- 2019: The total market capitalization remains relatively stable around 200 billion US dollars.
- 2020: The total market capitalization climbs to 750 billion US dollars in December.
- 2021: The year 2021 sees explosive growth in the cryptocurrency market. The total market capitalization reaches 2.8 trillion US dollars in April.
- 2022: Despite market fluctuations, the total market capitalization remains around 2 trillion US dollars.
- 2023: In May, the total market capitalization is about 1.2 trillion US dollars.
Please note that these figures are estimates based on historical data and may vary depending on data sources. Cryptocurrencies are highly volatile, and their value can change quickly.
2.3 Blockchain Technology
Blockchain technology, also known as distributed ledger technology, is the foundation on which all cryptocurrencies are built. It is a revolutionary technology that allows the secure transfer of digital ownership without the need for a central authority or intermediary.
A blockchain is essentially a distributed database that records transactions in ‘blocks’ of data. Each block contains a list of transactions, and each new transaction is verified and added to a new block. Once a block is filled with transactions, it is ‘sealed’ and added to the existing blockchain in a process called ‘mining’.
Each block also contains a reference to the previous block in the form of a cryptographic hash, thereby creating a chain of blocks. This makes the blockchain intrinsically resistant to tampering: if someone tries to alter a transaction in a previous block, it would change that block’s hash, which would trigger changes in all subsequent blocks. This would make tampering immediately apparent.
One of the main characteristics of blockchain is its decentralized nature. Instead of being stored on a central server, a copy of the blockchain is stored on every node of the network. This means that even if one node is compromised, the other nodes on the network continue to operate, making the network highly resilient.
Transparency and Security
Blockchain is also transparent: each transaction is visible to all members of the network. This creates a level of accountability that is not possible with traditional systems. At the same time, blockchain ensures security and privacy by using advanced cryptographic techniques to secure transactions and user addresses.
Beyond cryptocurrencies, blockchain has many other potential applications. It can be used to create smart contracts, which are computer programs that automatically execute contracts when certain conditions are met. It can also be used to create secure voting systems, land registries, digital identity systems, and much more.
In conclusion, blockchain technology is a major innovation that has made cryptocurrencies possible and has the potential to transform many other sectors of the economy. However, it also presents challenges, including in terms of scalability, energy efficiency, and regulation. Institutional investors interested in cryptocurrencies therefore need to have a basic understanding of blockchain technology.
3. Canadian Regulatory Framework
3.1 Laws and Regulations Regarding Cryptocurrencies
In Canada, cryptocurrencies are legal and regulated, although the specific regulation can vary depending on the province. Here’s an overview of the main laws and regulations applicable to cryptocurrencies in Canada:
Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA): Since June 2020, virtual currency service businesses (VCSBs) have been considered as reporting entities under the PCMLTFA. This means they are required to register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), implement a compliance program, maintain records, verify clients, and report certain transactions to FINTRAC.
Securities Laws: Cryptocurrencies may be considered securities if they are used in the context of an Initial Coin Offering (ICO) or if they are associated with Contracts for Difference (CFDs). In this case, they would be subject to securities regulation, which implies the obligation to file a prospectus or benefit from a prospectus exemption, as well as continuous disclosure obligations.
Bank Act: Cryptocurrencies are not considered legal tender in Canada. However, Canadian banks may provide services to cryptocurrency businesses, provided they comply with the PCMLTFA and other relevant regulations.
Income Tax Act: The Canada Revenue Agency (CRA) considers cryptocurrency transactions to be barter transactions, which means that individuals and businesses must report their capital gains or losses when they use cryptocurrencies to purchase goods or services or when they dispose of their cryptocurrencies.
Provincial Regulation: In addition to federal regulation, cryptocurrencies may also be regulated at the provincial level. For example, the Autorité des marchés financiers (AMF) in Quebec has issued specific guidelines for businesses wishing to raise funds through ICOs.
These regulations are constantly evolving as Canadian authorities seek to balance the need to protect consumers and prevent illegal activities with the desire to foster technological innovation. Therefore, it is crucial for institutional investors to regularly consult with legal advisors specialized in the field of cryptocurrencies and blockchain to ensure they remain compliant with all relevant laws and regulations.
3.2 Regulatory Bodies
The key regulatory bodies in the field of cryptocurrencies in Canada include the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), which is responsible for overseeing and enforcing the PCMLTFA, and the Canadian Securities Administrators (CSA), which regulate cryptocurrency-based investment products, like ETFs.
3.3 Taxation of cryptocurrencies in Canada
For institutional investors, the taxation of cryptocurrencies in Canada is mainly guided by the Canada Revenue Agency (CRA). The fundamental principles of taxation apply in the same way to institutional investors as to individuals, but there are specific considerations for institutions.
Capital gains and losses
Cryptocurrencies are considered property for income tax purposes. Therefore, the purchase and sale of cryptocurrencies by an institutional investor are treated as the realization of capital gains or losses. When a cryptocurrency is sold for an amount higher than its acquisition cost, a capital gain is realized, which is generally taxable at 50%. If the sale results in a loss, it can be used to offset other capital gains.
If the institutional investor uses cryptocurrencies in the course of its business activities (e.g., accepting cryptocurrencies as a means of payment for goods or services), the fair market value of those goods or services at the time of the transaction must be included in the income of the business.
Institutional investors, like individuals, are required to keep detailed records of all their cryptocurrency transactions. This includes the date and Canadian dollar value of each transaction, as well as information on the acquisition and disposition of cryptocurrencies.
Retirement plans and foundations
For institutions that manage retirement plans or foundations, it should be noted that investments in cryptocurrencies may not be allowed under the investment policies of the plan or foundation. In addition, capital gains realized by a retirement plan or foundation may be subject to different tax rules.
Finally, it is important to note that the tax regulation of cryptocurrencies in Canada is a constantly evolving area, as the CRA and other regulatory bodies adapt to this new form of asset. It is therefore essential that institutional investors regularly consult tax advisors specialized in the field of cryptocurrencies to ensure that they are meeting all their tax obligations.
4. Evaluation and selection of cryptocurrencies
4.1 Evaluation criteria
The evaluation of cryptocurrencies for an institutional investor requires a multidimensional approach that takes into account various factors. Here are some essential evaluation criteria:
- Market capitalization: This is the total value of all units of a cryptocurrency in circulation. Cryptocurrencies with higher market capitalization are generally considered less risky as they are more established and more liquid.
- Liquidity: Liquidity refers to the ease with which a cryptocurrency can be bought or sold without affecting its price. High liquidity is generally preferable for institutional investors as it allows for quick entry and exit from positions.
- Usage and adoption: Cryptocurrencies that have broad adoption and real-world use, whether for transactions, smart contracts, or otherwise, tend to be more stable and less likely to disappear.
- Blockchain security: Cryptocurrencies that use robust security protocols are less likely to be compromised, reducing risk for investors.
- Development team and governance: A strong development team and good governance are positive indicators for a cryptocurrency. It is important to consider transparency, regularity of updates, long-term vision, and responsiveness to security or technical issues.
- Regulation: Some cryptocurrencies may be subject to stricter regulations based on their usage and structure. It is important to understand these regulations and ensure compliance.
- Volatility: Volatility is an intrinsic characteristic of cryptocurrencies. However, some cryptocurrencies may be more volatile than others. It is crucial to understand and accept the level of volatility before investing.
- Growth potential: It is important to evaluate the long-term growth potential of a cryptocurrency. This may include examining its future projects, partnerships, development roadmap, and the industry or sector in which it operates.
- Diversification: As with any investment portfolio, diversification is crucial for risk management. It is important to evaluate how the addition of a specific cryptocurrency would affect the diversification of the overall portfolio.
It is essential to note that all of these criteria must be balanced within the context of an overall investment strategy that takes into account the objectives, risk tolerance, and investment horizon of the institutional investor.
4.2 Fundamental Analysis
Fundamental analysis is a method of evaluating an asset by examining external and internal factors related to its underlying business and market environment. For an institutional investor interested in cryptocurrencies, fundamental analysis may include several aspects:
Underlying technology: Understanding the technology underlying a cryptocurrency is essential. This includes knowledge of the blockchain, network consensus (proof of work, proof of stake, etc.), block size, transaction speed, network security, and scalability.
Usage and demand: Assessing current and future demand for the cryptocurrency. This may include its use in retail transactions, as a means of cross-border value transfer, in smart contracts, DApps, DeFi, etc.
Development team and community: Analyzing the skill and reputation of the development team behind the cryptocurrency. An active and engaged community can also be a sign of health and longevity.
Partnerships and integrations: Examining existing partnerships with companies, governments, or other entities that may promote adoption of the cryptocurrency.
Competitive analysis: Understanding the cryptocurrency’s positioning relative to its competitors. This may include comparisons of market size, technology, use cases, etc.
Regulation and legal risks: Evaluating potential regulatory risks in key jurisdictions. This could include analysis of current and expected regulatory trends.
Transparency and governance: Analyzing the transparency of operations, quality of governance, fairness of token distribution, etc.
Financial analysis: Evaluating financial metrics such as market capitalization, transaction volume, circulating and total supply, inflation rate, etc.
Thorough fundamental analysis will help institutional investors understand the intrinsic value of a cryptocurrency and make informed investment decisions. As with all investments, it is important to note that fundamental analysis does not guarantee success and investors should always be prepared to accept the risk of loss.
4.3 Technical Analysis
Technical analysis is an investment approach that seeks to predict future price movements based on the study of historical market data. For institutional investors in the field of cryptocurrencies, technical analysis can be a useful tool to help determine optimal entry and exit points for their trades. Here are some of the key concepts and techniques used in technical analysis of cryptocurrencies:
Market trends: One of the fundamental principles of technical analysis is that prices move in trends. An uptrend is characterized by a series of higher highs and lows, while a downtrend is characterized by a series of lower highs and lows. Identifying trends can help investors determine the general direction of the market and make investment decisions accordingly.
Technical indicators: Technical indicators are mathematical tools used to analyze price trends and patterns. There are many types, some of which are specifically designed to analyze cryptocurrencies. Among the most commonly used are moving averages, the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD), and Bollinger Bands.
Trading volumes: Trading volume is a measure of the number of coins that have been exchanged during a given period. It can provide information about the strength of a price trend and help identify potential market reversals.
Chart patterns and candlestick patterns: Chart patterns (such as triangles, head and shoulders, etc.) and candlestick patterns (such as doji, hammer, etc.) can provide indications of future price movements.
Support and resistance levels analysis: Support and resistance levels are prices at which a cryptocurrency struggles to go down or up. They can provide buy or sell signals.
It is important to note that while technical analysis can be a valuable tool, it has its limitations and does not guarantee accurate results. Additionally, the effectiveness of technical analysis can be influenced by factors such as market manipulation and significant news. Therefore, it is recommended to use technical analysis in combination with other approaches, such as fundamental analysis, to get a more complete view of the market.
5. Investment Strategies
5.1 Direct Purchase of Cryptocurrencies
Direct purchase of cryptocurrencies is one of the most common investment strategies for institutional investors interested in exposure to digital assets. This method involves buying cryptocurrencies on an open market, usually through a cryptocurrency exchange platform, and holding them in a digital wallet.
To illustrate how this can work for an institutional investor, let’s consider a scenario involving several key players: an institutional investment fund, a cryptocurrency broker (an exchange), a fund services company like SGGG Fund Services, a cryptocurrency trust company like Tetra Trust, and a digital asset storage and transfer solution like Fireblocks.
Institutional Investment Fund: The fund decides on the amount of cryptocurrencies to purchase based on its investment strategy and diversification goals. It then places the buy order with a cryptocurrency broker.
Exchange (Cryptocurrency Broker): The exchange executes the buy order on the open market. It purchases the cryptocurrencies at the market price and debits the fund’s account for the purchase amount.
It is important to note that the exact structure of this transaction may vary depending on the specific needs of the institutional investment fund and the services offered by the various actors involved. Additionally, direct purchase of cryptocurrencies carries a number of risks, including price volatility, the risk of hacking, and the risk of loss of private keys. Institutional investors must therefore take these risks into account when making their investment decisions.
5.2 Exchange-Traded Funds (ETFs)
Exchange-traded funds (ETFs) are investment funds that are traded on an exchange, just like a stock. An ETF holds assets such as stocks, bonds, commodities, or, in this context, cryptocurrencies, and aims to track the performance of a specific index. ETFs offer investors exposure to a basket of assets and are popular due to their liquidity, flexibility, and low costs.
Cryptocurrency ETFs are a type of ETF that invests directly in cryptocurrencies or cryptocurrency futures contracts. These ETFs track the performance of one or more cryptocurrencies, providing investors with exposure to cryptocurrency performance without having to buy, store, or manage cryptocurrencies themselves.
Advantages for Institutional Investors
Exposure to Cryptocurrencies: Cryptocurrency ETFs offer institutional investors exposure to cryptocurrencies, which are a rapidly growing asset class with high return potential.
Security and Compliance: ETFs are regulated by securities regulatory bodies, which can provide greater assurance in terms of security and compliance than direct cryptocurrency holdings.
Liquidity: Since ETFs are traded on an exchange, they offer high liquidity, allowing investors to buy and sell ETF shares quickly and easily.
Diversification: ETFs allow investors to diversify their portfolio by investing in a range of cryptocurrencies, rather than focusing on a single cryptocurrency.
5.3 Mutual Funds
Mutual funds are investment structures that allow multiple investors to pool their money, which is then managed by a professional portfolio manager. Mutual funds can invest in a variety of assets, including stocks, bonds, commodities, and increasingly, cryptocurrencies.
For institutional investors, investing in mutual funds focused on cryptocurrencies has several advantages:
Diversification: Mutual funds allow institutional investors to diversify their investments across multiple cryptocurrencies without having to buy and manage each cryptocurrency individually. This can help reduce the risk associated with investing in a single cryptocurrency.
Professional Management: Mutual funds are managed by professional portfolio managers who have the expertise and resources to analyze the cryptocurrency market and make informed investment decisions.
Liquidity: Mutual fund shares can generally be bought or sold at the net asset value (NAV) of the fund at the end of each trading day. This offers higher liquidity than direct cryptocurrency purchases, which may require time to find an appropriate buyer or seller.
Regulatory Compliance: Mutual funds are regulated by securities regulatory authorities, which can offer greater peace of mind to institutional investors.
However, it is also worth noting that investing in mutual funds focused on cryptocurrencies carries risks. For example, the value of the fund’s shares will fluctuate based on the value of the cryptocurrencies held by the fund, which can be volatile. Additionally, mutual funds typically have management fees that can reduce the net return on investment.
It is important for institutional investors to fully understand the investment strategies, management fees, and risks associated with any mutual fund before investing.
5.4 Hedge funds
Hedge funds are actively managed investment vehicles that aim to generate high returns using various investment strategies. Hedge funds often have greater flexibility in their investments compared to traditional funds and may employ techniques such as leverage, short selling, and derivatives to capitalize on market opportunities. They typically seek to achieve absolute returns rather than simply outperforming a benchmark index. Hedge funds can be managed discretionarily by experienced fund managers and are generally accessible to accredited investors due to their complex nature and potentially higher level of risk.
Crypto-mining is a process that involves using computer hardware to solve complex mathematical problems and add new transactions to the blockchain.
5.6 Staking and cryptocurrency loans
Staking is a process by which a cryptocurrency holder participates in transaction validation on a Proof-of-Stake (PoS) blockchain network by “staking” or “locking up” a certain amount of their cryptocurrency on the network. In return, the investor receives rewards in the form of new units of the cryptocurrency.
For an institutional investor, staking can offer an attractive way to generate passive income from their cryptocurrency holdings. The rate of return varies depending on the cryptocurrency, but can often exceed the interest rates offered by traditional savings accounts or bonds.
However, it should be noted that staking carries risks. The main risk is volatility: if the value of the cryptocurrency decreases, capital losses may exceed the gains realized through staking. Additionally, some cryptocurrencies require staked tokens to be “locked up” for a certain period, which can limit the liquidity of the investment.
In terms of regulation, staking is generally legal in Canada, but income generated from staking is considered taxable by the Canada Revenue Agency (CRA).
Cryptocurrency loans involve lending cryptocurrency to another user or institution, usually through a cryptocurrency lending platform, in exchange for interest. Interest rates can vary widely, but are often higher than those of traditional loans due to the increased risk associated with cryptocurrencies.
Cryptocurrency loans can offer institutional investors another way to generate income from their cryptocurrency holdings. However, they also carry significant risks, including the risk of borrower default and the risk that the lending platform is hacked.
In terms of regulation, cryptocurrency loans are currently in a gray area in Canada. While loans themselves are not illegal, lending platforms that offer guaranteed returns may be considered to be offering unregistered securities, which is illegal. Institutional investors considering lending cryptocurrency should therefore consult with a legal advisor specializing in this area.
In conclusion, staking and cryptocurrency loans can offer interesting opportunities for institutional investors, but they also carry significant risks. It is essential to conduct thorough analysis before engaging in these activities, and to consult with tax and legal advisors to fully understand the tax and regulatory implications.
6. Risk Management
6.1 Risks Related to Volatility
Cryptocurrencies are known for their exceptional volatility, which means that their value can fluctuate significantly in a very short amount of time. This volatility can create opportunities for high returns, but it also presents significant risks for institutional investors.
Impact on Portfolio Value
The volatility of cryptocurrencies can have a significant impact on the value of an investment portfolio. For example, a sudden drop in the value of a cryptocurrency can lead to a substantial loss of portfolio value, especially if a significant portion of the portfolio is invested in that cryptocurrency.
Difficulty of Forecasting
The volatility of cryptocurrencies also makes it more difficult to forecast their future performance. Unlike stocks and bonds, for which there are many predictive models based on years of historical data, cryptocurrencies are relatively new and their prices are influenced by a variety of factors that can be difficult to quantify or predict.
Volatility can also affect the liquidity of a cryptocurrency. In periods of extreme volatility, transaction volume can drop, making it more difficult to sell large amounts of the cryptocurrency without affecting its price. This can be particularly problematic for institutional investors, who typically require more liquidity than individual investors.
Managing volatility risk requires careful planning and monitoring. Institutional investors can use various tools to mitigate this risk, such as portfolio diversification, the use of derivative products to hedge positions, the setting of stop-loss limits, and constant monitoring of market conditions.
It is essential for institutional investors to understand and quantify the volatility risk associated with their cryptocurrency investments. This may require the expertise of finance and information technology professionals who understand the complexities of cryptocurrencies and the markets on which they are traded.
6.2 Technological and Security Risks
Technological and security risks include the risks of hacking, loss of private keys, and malfunction of blockchain software. To mitigate these risks, it is essential to implement robust security measures, including cold storage of cryptocurrencies, the use of hardware wallets, and regular software updates.
6.3 Regulatory Risks
Institutional investors must be aware of the regulatory risks associated with investing in cryptocurrencies. These risks can have a significant impact on investment performance and compliance with regulatory requirements. Here are some of the main regulatory risks that institutional investors may face:
Regulatory Changes: Cryptocurrencies are a relatively new and constantly evolving field. Governments and regulatory bodies worldwide are seeking to balance the benefits of technological innovation with concerns around security, consumer protection, and prevention of illegal activities. Institutional investors must be prepared to adapt quickly to regulatory changes, which could affect the value of their investments or restrict their ability to trade cryptocurrencies.
Compliance with Regulatory Requirements: Institutional investors must ensure they comply with all applicable regulatory requirements when investing in cryptocurrencies. This may include registering with competent authorities, implementing anti-money laundering (AML) programs, and complying with securities laws. Institutional investors who fail to meet these requirements may be exposed to sanctions, fines, or restrictions on their activities.
Risks Related to Initial Coin Offerings (ICOs) and Security Token Offerings (STOs): Institutional investors who participate in ICOs or STOs may face additional regulatory risks. Regulatory bodies worldwide, including in Canada, have adopted varied approaches to regulating these offerings. Institutional investors must ensure they understand the specific regulatory requirements for the ICO or STO in which they are participating, and comply with these requirements to avoid sanctions or investment losses.
Risks Related to Exchange Platforms: Institutional investors who use exchange platforms to buy, sell, or hold cryptocurrencies must ensure that these platforms comply with local regulations. Unregulated or poorly regulated exchange platforms may be vulnerable to cyberattacks, fraud, or insolvency, which could lead to losses for institutional investors.
Tax Risks: Institutional investors must be aware of the tax implications of investing in cryptocurrencies and ensure they comply with all applicable tax obligations. Tax rules for cryptocurrencies may vary by jurisdiction and are likely to evolve as tax authorities adapt to this new asset class. Institutional investors should consult specialized tax advisors to ensure they comply with all tax requirements.
International Sanctions and Controls Risks: Cryptocurrencies may be used to circumvent international sanctions or capital controls, which could lead to regulatory risks for institutional investors. Institutions must establish appropriate controls to ensure they do not inadvertently facilitate these activities and comply with all applicable laws and regulations related to sanctions and capital controls.
Data Privacy and Security Risks: Data protection and privacy regulations may also impact institutional investors in cryptocurrencies. Institutions must ensure they comply with these regulations when handling sensitive data related to cryptocurrency transactions.
ESG Risks: With the increasing importance of environmental, social, and governance (ESG) factors in investment, institutional investors must be aware of the ESG risks associated with cryptocurrencies. For example, Bitcoin mining has been criticized for its high energy consumption, which may be at odds with an institution’s ESG objectives.
Managing these regulatory risks requires active regulatory monitoring, a good understanding of the implications of cryptocurrency regulation, and a rigorous risk assessment before any investment. Consulting experts in cryptocurrency law and regulatory compliance is also essential to navigate effectively in this complex and constantly evolving regulatory landscape.
6.4 Diversification and Portfolio Management
Diversification and portfolio management are key concepts for all investors, including institutional investors. This is especially true in the realm of cryptocurrencies, which can be particularly volatile and risky. Here is a breakdown of these concepts and their importance for institutional investors:
Diversification is the investment strategy of spreading investments across a wide range of assets in order to reduce risk. In the realm of cryptocurrencies, this could mean investing in a variety of different cryptocurrencies rather than focusing on just one.
Diversification can help to mitigate risk because different cryptocurrencies can react differently to various market factors. For example, while Bitcoin and Ethereum are often correlated, other cryptocurrencies may have price movements that are less tied to these flagship assets. Additionally, investing in cryptocurrencies that use different technologies or have different use cases can also help to reduce risk.
Portfolio management involves the ongoing selection, management, and monitoring of investments within a portfolio to ensure that it remains aligned with the investor’s objectives. In the context of cryptocurrencies, this can involve decisions about when to buy or sell cryptocurrencies, how to react to market news, and how to balance cryptocurrencies with other types of investments.
For institutional investors, portfolio management can be particularly complex. These investors typically have fiduciary obligations to their clients or beneficiaries, which means they must exercise due diligence in managing investments. They must also comply with various regulations, which may limit the types of cryptocurrencies they can invest in or the amount of risk they can take.
Importance for Institutional Investors
For institutional investors, diversification and portfolio management are essential for managing risk and achieving investment objectives. Cryptocurrencies can offer significant benefits in terms of potential returns and diversification, but they also present significant risks. By diversifying their investments in cryptocurrencies and actively managing their portfolio, institutional investors can take advantage of the opportunities offered by cryptocurrencies while mitigating risks.
7. Cryptocurrency Exchange and Custody Platforms
7.1 Comparison of Major Canadian Exchange Platforms
For an institutional investor, the choice of cryptocurrency exchange platform is crucial. Here is a comparison of three of the major Canadian exchange platforms:
- Wealthsimple Crypto: Wealthsimple is a popular robo-advisor that recently introduced a cryptocurrency trading option. It offers a user-friendly interface and the ability to trade Bitcoin and Ethereum. However, the platform does not allow for transfers of cryptocurrencies to or from external wallets, which may be a disadvantage for some institutional investors.
- Coinsquare: Coinsquare is one of the largest cryptocurrency exchange platforms in Canada. It offers a wide range of cryptocurrencies, advanced trading and security options, and the ability to transfer cryptocurrencies to and from external wallets. It also offers OTC (over-the-counter) trading services for institutional investors.
- Kraken: Although based in the United States, Kraken is widely used by Canadian traders. It offers a wide range of cryptocurrencies, advanced trading options, and also offers OTC trading services for institutional investors. Kraken is known for its security and is one of the few exchange platforms to have proved its Bitcoin reserves.
Aquanow is a provider of trading and risk management solutions for digital assets. It brings liquidity to the cryptocurrency market by acting as a market maker, offering continuous buy and sell prices for a variety of cryptocurrencies.
For an institutional investor, Aquanow has several advantages:
- Access to liquidity: Aquanow connects investors to over 60 exchanges and market makers around the world, providing access to deep and diversified liquidity.
- Fast execution: Thanks to its advanced technological infrastructure, Aquanow can execute transactions quickly, which is crucial in the volatile cryptocurrency market.
- Security: Aquanow emphasizes the security of its clients’ assets. It uses advanced security measures, including multi-signature wallets and cold storage of assets.
- Services for institutional investors: Aquanow offers services specific to institutional investors, including detailed reports, market analyses, and dedicated customer support.
- Compliance: Aquanow is registered with the Canadian Financial Transactions and Reports Analysis Centre (FINTRAC) and complies with relevant regulations.
7.2 Digital wallets and asset custody
For institutional investors, security and asset conservation in cryptocurrencies are major concerns. Digital wallets, also known as cryptocurrency wallets, are tools that allow users to store, send, and receive cryptocurrencies. They can take several forms, including:
- Online wallets: These wallets are accessible via the web and can be used from anywhere. They are generally easier to use, but they are also potentially vulnerable to online attacks.
- Mobile wallets: These wallets are installed on a smartphone or tablet. They are useful for everyday transactions and are typically secured with PIN codes or biometric features.
- Desktop wallets: These wallets are downloaded and installed on a PC or laptop. They are only accessible from the computer on which they were installed.
- Hardware wallets: These wallets store the user’s private keys on a hardware device such as a USB key. They are considered highly secure because they are mostly disconnected from the internet (known as “cold storage”).
- Paper wallets: These wallets are a form of cold storage where private and public keys are printed on a piece of paper.
For institutional investors, the choice of a wallet depends on several factors, including security, ease of use, cost, compatibility with different cryptocurrencies, and regulation.
Custodial service providers play a crucial role in the storage and security of institutional investors’ cryptocurrency assets. Here are some custodial service providers operating in Canada:
- Tetra Trust: Based in Calgary, Tetra Trust is Canada’s first fully regulated cryptocurrency custodian (SOC2 Type 2). Tetra Trust provides custodial services for a variety of cryptocurrencies and uses cold storage techniques to maximize security.
- Knox: Knox is another Canadian company that provides custodial services for cryptocurrencies. It offers comprehensive insurance for assets in custody and also uses cold storage techniques.
- Gemini Trust Company: Although based in the United States, Gemini offers custodial services to Canadian clients. It is regulated by the New York State Department of Financial Services and offers services for a wide range of cryptocurrencies.
- Coinbase Custody: Also based in the United States, Coinbase is one of the world’s largest cryptocurrency exchange platforms and offers specific custodial services for institutional investors.
It is important to note that each custodial service provider has its own characteristics and advantages, and it is crucial for an institutional investor to choose the one that best suits their specific needs. Factors to consider may include the types of cryptocurrencies supported, storage options, security levels, customer support services, fees, and the provider’s reputation.
It is also essential for an institutional investor to have a good understanding of the risks associated with holding cryptocurrencies, including security risks, regulatory risks, and market volatility risks. Rigorous management of these risks, including a strong custody strategy, can help maximize the benefits of investing in cryptocurrencies while minimizing potential risks.
Finally, institutional investors are recommended to consult with cryptocurrency security experts, legal and tax advisors, and other professionals in the field before making cryptocurrency investment and asset custody decisions.
In today’s digital economy, cryptocurrencies represent a unique and innovative asset class that offers significant investment opportunities. The Canadian market, with its clear and progressive regulation, provides a favorable environment for institutional investments in cryptocurrencies.
However, it is essential to note that investments in cryptocurrencies carry significant risks. The inherent volatility in the value of cryptocurrencies, concerns regarding security and technology, as well as the still-evolving nature of regulation, are all factors that must be carefully considered.
As an institutional investor, it is crucial to have a deep understanding of blockchain technology and the underlying mechanisms of cryptocurrencies. This includes knowledge of the different types of cryptocurrencies available, applicable investment strategies, and how cryptocurrencies are evaluated and traded.
Risk management is also a fundamental aspect of investing in cryptocurrencies. This includes not only portfolio diversification but also the implementation of robust cybersecurity and regulatory compliance measures.
Finally, having a network of professional advisors, including lawyers specialized in blockchain technology, accountants familiar with cryptocurrency taxation, and cybersecurity experts, is crucial.
In summary, while cryptocurrencies offer significant potential, their adoption as an integral part of an institutional portfolio must be approached with thorough due diligence and careful risk management.
Blockchain: Decentralized ledger technology that allows for secure and transparent storage and verification of transactions.
Crypto-currency: Digital currency that uses cryptography to secure transactions and control the creation of new units.
Exchange-traded funds (ETFs): Investment products that allow investors to buy and sell shares representing a basket of underlying assets, including cryptocurrencies.
Digital wallet: Application or device used to store and manage the private keys of cryptocurrencies.
Staking: Process by which cryptocurrency holders put up their digital assets to support the operation of a blockchain network, participating in transaction validation and earning rewards in return.
Mining: Process of validating transactions and creating new units of cryptocurrency by solving complex mathematical problems using specialized computer hardware.
9.2 Additional Resources
Website of the Canada Revenue Agency (CRA): www.canada.ca/en/revenue-agency.html
Website of the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC): www.canada.ca/en/financial-transactions-reports-analysis.html
Website of the Canadian Securities Administrators (CSA): www.securities-administrators.ca
CoinMarketCap: www.coinmarketcap.com – Platform providing information on market capitalizations, trading volumes, and prices of cryptocurrencies.
CoinGecko: www.coingecko.com – Platform offering detailed information on cryptocurrencies, including historical data, charts, market indicators, and news.
By using this guide, institutional investors can develop a deep understanding of the Canadian cryptocurrency market and make informed decisions to optimize their investments. It is important to stay informed about the latest trends, technological developments, and regulatory changes to succeed in this constantly evolving market.
This cryptocurrency investment guide mentions various companies, services, and websites, including but not limited to, Bitcoin, Ethereum, Ripple, Binance, Kraken, Coinbase, Gemini, Canada Revenue Agency, and other entities related to the cryptocurrency industry. Please note that all trademarks, service marks, trade names, logos, and products are the property of their respective owners.
No statement contained in this document should be construed as a claim of ownership or control over the mentioned trademarks, service marks, trade names, or logos. These elements are used solely for identification and informational purposes.
All information contained in this guide is provided “as is,” without warranty of accuracy, reliability, or fitness for any particular purpose. Users are encouraged to conduct their own research and consult competent professionals before making any investment decisions.
All references to specific services, exchange platforms, or products do not constitute an endorsement or recommendation of those services, platforms, or products. Investors are strongly encouraged to exercise due diligence and consult competent professionals before making investment decisions.