Nick Wright, BA JD MBA LLM (Tax)

Wright Business Law

Crypto asset funds operate within Canada’s existing securities-law framework, although the unique characteristics of digital assets can create additional regulatory considerations. Depending on the nature of the underlying assets and the way investor exposure is structured, crypto asset funds may raise unique questions regarding asset classification, custody, valuation, disclosure, and regulatory oversight.

The regulatory requirements applicable to a particular crypto asset fund will depend on factors such as its investment strategy, investor base, distribution model, and operational structure. Fund sponsors should assess these considerations early in the planning process to help ensure that the fund’s formation, distribution, and ongoing operations comply with applicable securities law requirements.

Public Crypto Funds vs. Private Crypto Funds

The regulatory framework applicable to a crypto asset fund depends significantly on whether the fund is distributed through the public markets or through prospectus exempt distributions.

Publicly offered crypto asset funds, including exchange-traded funds and alternative mutual funds, are generally subject to National Instrument 81-102 ‘Investment Funds’ and related securities law requirements. Fund sponsors should also consider applicable regulatory guidance, including CSA Staff Notice 81-336 ‘Guidance on Crypto Asset Investment Funds that are Reporting Issuers’, which discusses CSA staff expectations concerning asset suitability, custody arrangements, valuation practices, liquidity management, and risk management.

Private crypto funds commonly rely on prospectus exemptions under National Instrument 45-106 ‘Prospectus Exemptions’. Although private funds generally have greater flexibility in their investment strategies and structures, they remain subject to securities law requirements relating to registration, disclosure, investor qualification, marketing practices, and ongoing compliance.

The choice between a public and private fund structure can significantly affect formation costs, investor eligibility, disclosure obligations, operational requirements, and regulatory oversight.

Investor Eligibility and Distribution Requirements

Private crypto funds frequently rely on the NI 45-106 accredited investor exemption and, in certain jurisdictions and circumstances, the offering memorandum exemption. Fund sponsors should carefully assess investor eligibility requirements and ensure that appropriate subscription documentation, investor representations, and supporting records are obtained and maintained.

Investor onboarding procedures should be designed to support compliance with applicable securities law requirements and internal compliance policies. Depending on the distribution model, fund sponsors may also need to consider know-your-client, suitability, anti-money laundering, and record-keeping requirements applicable to registered market participants involved in the offering process.

Marketing activities raise regulatory considerations. Promotional materials, investor presentations, websites, social-media content, and other communications should be consistent with offering documents and should not contain misleading statements regarding expected returns, risk levels, liquidity, or regulatory status. Care should be taken where marketing materials describe novel digital-asset strategies, staking activities, tokenized assets, or other emerging investment structures.

Failure to properly assess investor eligibility, maintain adequate records, or comply with applicable distribution requirements may create regulatory risk for fund sponsors and distribution participants. Accordingly, investor onboarding and distribution procedures should form an important part of a crypto asset fund’s overall compliance framework.

Fund sponsors should also consider securities law requirements in jurisdictions where investors are located. Cross-border offerings may trigger additional registration, filing, disclosure, or marketing requirements outside Canada.

Asset Classification

Although Canadian securities legislation does not provide a single, comprehensive definition of “crypto asset” or “digital asset,” securities regulators generally focus on the substance of the asset and the rights it confers rather than the terminology used to describe it. As a result, certain digital assets or related arrangements may be characterized as securities or derivatives, depending on their features and the surrounding circumstances.

The classification of a digital asset can have significant regulatory consequences. Depending on the characteristics of the asset and the rights granted to investors, a crypto asset may be characterized as a security, derivative, commodity, or other investment product. These determinations may affect prospectus requirements, registration obligations, custody arrangements, disclosure requirements, trading restrictions, and ongoing compliance obligations.

Canadian securities regulators have frequently emphasized that certain crypto assets, tokenized arrangements, and contractual rights relating to crypto assets may constitute securities or derivatives.

Registration Requirements

Fund sponsors should assess whether registration requirements under National Instrument 31-103 ‘Registration Requirements, Exemptions and Ongoing Registrant Obligations’ apply to the fund, its manager, adviser, promoter, or distribution participants. Depending on the nature of the activities conducted, registration as an investment fund manager, portfolio manager, exempt market dealer, or in another registrable capacity may be required unless an exemption is available. The analysis is highly fact-specific and turns on the substance of the activities undertaken, including how the fund is managed, marketed, distributed, and compensated.

Because registration obligations are determined by the activities performed rather than the labels used to describe a business model, fund sponsors should consider factors such as capital-raising activities, investment discretion, investor communications, compensation structures, and distribution practices when evaluating their regulatory obligations under NI 31-103.

Custody of Crypto Assets

Custody arrangements remain one of the most closely scrutinized aspects of crypto asset fund structures. Digital assets present unique operational, cybersecurity, and investor-protection concerns that differ from traditional securities and financial assets.

Fund sponsors should carefully evaluate custodial arrangements, including asset segregation procedures, private-key management, cold-storage practices, insurance coverage, disaster-recovery controls, access restrictions, and ongoing oversight mechanisms. Attention should be paid to the legal rights of the fund and its investors in relation to custodians, sub-custodians, trading platforms, and other intermediaries that may hold or facilitate access to digital assets.

Inadequate custody arrangements may create significant regulatory, operational, valuation, and investor-protection concerns.

Disclosure and Valuation Considerations

Offering documents for crypto asset funds should clearly describe the material risks associated with digital-asset investments. Depending on the fund’s investment strategy, relevant risks may include price volatility, liquidity constraints, custody risks, cybersecurity incidents, technological failures, regulatory developments, valuation challenges, concentration risks, and counterparty exposure.

Valuation methodologies warrant particular attention where digital assets trade across multiple venues, experience periods of reduced liquidity, or involve assets for which reliable pricing information may be limited. Fund sponsors should ensure that valuation policies are reasonable, consistently applied, and appropriately disclosed to investors.

Common Regulatory Pitfalls

Common issues encountered in crypto asset fund structures include:

• assuming a digital asset cannot be characterized as a security or derivative;
• overlooking registration requirements applicable to fund managers, advisers, or distribution participants;
• implementing custody arrangements that do not adequately address operational and investor-protection risks;
• providing insufficient disclosure regarding digital-asset risks;
• relying on inappropriate valuation methodologies; and
• conducting cross-border distributions without adequately considering foreign securities-law requirements.

Early legal review of a proposed fund structure can help identify and address these issues before launch.

Related Regulatory Considerations

Crypto asset funds operate within a broader legal and regulatory framework that extends beyond investment fund regulation. Depending on the structure of the fund and the nature of its operations, anti-money laundering and anti-terrorist financing obligations under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) may also require consideration, including requirements relating to client identification, record keeping, reporting, and compliance procedures.

Tax considerations are similarly important. The tax treatment of digital assets, the characterization of gains and income, withholding obligations, and cross-border investor issues should be assessed during fund formation and ongoing operations. Where non-Canadian investors participate in a fund, additional tax and regulatory considerations may arise.

Illustrative Scenarios

The following examples illustrate how securities law considerations may arise in different crypto asset fund structures.

Scenario 1: Private Fund Investing in Established Crypto Assets

A private fund that invests directly in established crypto assets such as Bitcoin or Ethereum and distributes its securities exclusively under prospectus exemptions may be subject to a relatively familiar investment-fund regulatory framework. Even in this structure, fund sponsors should carefully consider issues relating to investor eligibility, registration requirements, custody arrangements, valuation policies, disclosure obligations, and ongoing compliance.

Scenario 2: Fund Utilizing Staking or Yield-Generating Strategies

A fund that seeks to generate returns through staking or other yield-generating digital asset strategies may face additional regulatory and operational considerations. Staking generally involves committing or locking digital assets to support the operation, validation, or security of a blockchain network in exchange for rewards paid by the network. Depending on the structure of the strategy, fund sponsors may need to address enhanced disclosure obligations, valuation challenges, liquidity constraints arising from lock-up periods and delays associated with withdrawing staked assets, counterparty and operational risks, and the legal characterization of the rights and arrangements associated with the underlying digital assets and staking activities.

Scenario 3: Publicly Offered Crypto Asset Fund

A publicly offered crypto asset fund distributed to retail investors will generally be subject to a more extensive regulatory framework. In addition to prospectus requirements, such funds typically face heightened expectations relating to custody, liquidity management, valuation, disclosure, investment restrictions, and ongoing regulatory oversight. These requirements can significantly influence both the fund’s structure and its day-to-day operations.

Conclusion

Crypto asset funds present many of the same regulatory considerations as traditional investment funds, together with additional issues relating to asset classification, custody, valuation, cybersecurity, and rapidly evolving regulatory expectations. Careful planning during fund formation and ongoing compliance reviews can help fund sponsors identify and address regulatory risks before they become operational or enforcement concerns.

Book a Consultation

If you are forming, restructuring, marketing, or operating a crypto asset fund, digital asset fund, private investment fund, or other exempt-market investment vehicle in Canada, contact us to schedule an initial consultation with Nick Wright.