Canadian Securities Administrators Staff Notice 81-336: Guidance on Crypto Asset Investment Funds that are Reporting Issuers

Canadian Securities Administrators Staff Notice 81-336 Guidance on Crypto Asset Investment Funds that are Reporting Issuers July 6, 2023

1. Purpose of this Notice
   Staff of the Canadian Securities Administrators (CSA staff or we) are publishing this notice (the Notice) concerning investment funds that seek to invest in crypto assets, either directly or indirectly1 under Regulation 81-102 respecting Investment Funds (Regulation 81-102) (Public Crypto Asset Funds). This Notice is intended to provide guidance to stakeholders and to outline CSA staff’s views and expectations regarding the operations of Public Crypto Asset Funds within the framework of Regulation 81-102. This Notice will

• provide an overview of the Public Crypto Asset Funds market in Canada and clarify the
  current securities regulatory requirements applicable to Public Crypto Asset Funds;
• discuss key findings from reviews of Public Crypto Asset Funds conducted by CSA staff,
  including fund liquidity, exchange-traded mutual fund (ETF) structural matters and custody; and
• outline CSA staff expectations for stakeholders with respect to matters that could impact
  existing and future Public Crypto Asset Funds, specifically concerning o liquidity, valuation and other considerations with respect to potentially investing in crypto assets other than bitcoin and ether, which are currently the only crypto assets accepted as investments for Public Crypto Asset Funds; o expectations for custodians of crypto assets (Crypto Custodian) to meet standard of care obligations under Regulation 81-102; o issues relating to staking of crypto assets or other similar yield-generating activities within Public Crypto Asset Funds; and o know-your-product (KYP), know-your-client (KYC) and suitability obligation issues with respect to Public Crypto Asset Funds. Guidance provided in this Notice is based on existing securities regulatory requirements and does not create any new legal requirements or modify existing ones. 1 For example, through the use of derivatives or fund of fund investing.

2. Background
   The first prospectus receipt for a Canadian Public Crypto Asset Fund was issued on April 1, 2020, following a panel decision of the Ontario Securities Commission (the Bitcoin Decision). 2 The Bitcoin Decision resulted in a prospectus receipt being issued with respect to the Bitcoin Fund, a non-redeemable investment fund that invests substantially all of its assets directly in bitcoin. The Bitcoin Decision also led to the launch of several other Public Crypto Asset Funds, including the first ETFs in the world that invest directly in bitcoin and ether. As of April 30, 2023, there are 22 Public Crypto Asset Funds in Canada that collectively have approximately $2.86 billion in net assets. The Public Crypto Asset Funds currently invest only in bitcoin and/or ether and achieve this primarily through direct holdings of those crypto assets (including through fund of fund structures). More detailed market data concerning Public Crypto Asset Funds is provided in the Appendix to this Notice.

3. Regulatory Framework for Public Crypto Asset Funds
   Public Crypto Asset Funds are subject to the same regulatory framework as other publicly distributed investment funds in Canada. This framework includes having a registered investment fund manager (IFM) and portfolio manager(s) under Regulation 31-103 respecting Registration Requirements, Exemptions and Ongoing Registrant Obligations (Regulation 31-103), distributing securities of the fund by way of a prospectus prepared in accordance with Regulation 41-101 respecting General Prospectus Requirements (Regulation 41-101) or Regulation 81-101 respecting Mutual Fund Prospectus Requirements (Regulation 81-101), as well as being subject to the operational framework of Regulation 81-102, among other rules and instruments. Public Crypto Asset Funds must also compute a net asset value (NAV) on a daily basis that must be calculated in accordance with Regulation 81-106 respecting Investment Fund Continuous Disclosure (Regulation 81-106). The existing Public Crypto Asset Funds that are structured as ETFs or conventional mutual funds are classified as “alternative mutual funds” under Regulation 81-102 and accordingly have a greater ability to borrow cash or provide a security interest over their assets, engage in short selling or use specified derivatives applicable to alternative mutual funds, subject to the limits set out in that rule.3 They are also subject to issuer concentration and control restrictions, restrictions on holding illiquid assets, 4 and other investment restrictions set out in Part 2 of Regulation 81-102. The Public Crypto Asset Funds have appointed custodians and sub-custodians to hold their portfolio assets, each of which is required to meet the applicable qualification criteria set out in
   Part 6 of Regulation 81-102.
   2 3iQ Corp (Re), 2019 ONSEC 37, available at https://www.osc.ca/sites/default/files/pdfs/proceedings/rad_20191029_3iq-2.pdf. 3 See subsection 2.6(2) and sections 2.6.1, 2.6.2 and 2.9.1 of Regulation 81-102. 4 See sections 2.1, 2.2 and 2.4 of Regulation 81-102 respectively. Public Crypto Asset Funds structured as non￾redeemable investment funds are permitted to invest a higher proportion of their portfolio in illiquid assets but are otherwise subject to the same investment restrictions as alternative mutual funds under Regulation 81-102.

4. Oversight by CSA Staff
   As part of the CSA’s general oversight role, and in response to issues that have arisen in crypto asset markets, CSA staff have conducted reviews of Public Crypto Asset Funds that directly hold crypto assets, 5 focused on liquidity, ETF structure, and custody. Our findings are described below. (a) Liquidity Liquidity reviews of the Public Crypto Asset Funds structured as ETFs were initiated in May 2021. CSA staff noted that the Public Crypto Asset Funds had not experienced any material difficulties in meeting redemption requests since their respective inceptions. IFMs reported using various approaches for liquidity risk management of Public Crypto Asset Funds, which included ongoing portfolio management and continuous liquidity assessments of the underlying crypto asset, in addition to ongoing monitoring of relationships with liquidity providers and ensuring that alternative sources of liquidity are available. (b) ETF Structure In May 2021, CSA staff conducted a review of Public Crypto Asset Funds structured as ETFs to better understand how they managed their subscription and redemption activities, where they sourced their crypto assets, and how they continued to accurately calculate their Public Crypto Asset Funds’ NAV. CSA staff found that most of the ETFs traded very closely to their NAV. In June 2022, CSA staff made further inquiries to understand how certain Public Crypto Asset Funds structured as ETFs were able to meet large redemption requests including whether extraordinary measures were needed to meet the redemption requests. We found that in those cases, the ETFs were able to meet the redemption requests as part of their normal operating procedures, with all redeemed securities paid in cash at NAV based on their respective valuation index, with settlement the next business day. We also found that none of the ETFs needed to borrow cash to meet the redemption requests.6 (c) Custody In November 2022, CSA staff conducted a review of the custody arrangements for several Public Crypto Asset Funds that directly held crypto assets. We confirmed, among other things,

• the segregation of the Public Crypto Asset Fund’s crypto assets from those of the Crypto
  Custodian and other clients of the Crypto Custodian;

• the use of offline or “cold wallet” storage of crypto assets held by the Crypto Custodian;

• the listing of Public Crypto Asset Fund as the beneficial owner of its crypto assets in the
  Crypto Custodian’s books and records;
  5 As is noted in the Appendix, the existing Public Crypto Asset Funds that directly hold crypto assets in their portfolios are primarily structured as ETFs. 6 An investment fund can borrow cash as a temporary measure to accommodate redemption requests pursuant to subparagraph 2.6(1)(a)(i) of Regulation 81-102.

• the existence of controls and procedures that validate security, segregation and ownership
  of the crypto assets including verification on the blockchain; and

• the maintenance by the Crypto Custodian of insurance over custodied crypto assets.

5. Stakeholder Considerations Regarding Public Crypto Asset Funds
   The nature of crypto assets can create unique challenges for funds that hold these assets directly, which may require specific regulatory consideration. We have identified a number of areas for which we believe greater guidance regarding CSA staff expectations may be warranted, for both existing and possible future offerings of Public Crypto Asset Funds. One or more of the identified areas may also become the subject of future policy work by the CSA. (a) Crypto Asset and Crypto Asset Market Characteristics The unique features of each crypto asset and its market are key to determining whether the crypto asset is a suitable investment for a publicly distributed investment fund under Regulation 81-102. Among the most important considerations are (i) the ability to determine a fair value of the crypto asset, (ii) liquidity of the crypto asset and (iii) the classification of the crypto asset and the implications arising from its classification, each of which is discussed further below. (i) Valuation Markets for various crypto assets have been evolving rapidly over the course of the last several years and now fall on a wide spectrum in terms of maturity. CSA staff are of the view that the more efficient and transparent the facilities provided by a market, the more such a market can support the operations of Public Crypto Asset Funds. Less mature markets may offer less efficient facilities and institutional support for Public Crypto Asset Funds to operate without compromising investor protection. The market for any crypto asset in which a Public Crypto Asset Fund seeks to invest should support the fund’s ability to calculate its NAV in accordance with Regulation 81-106. CSA staff will take into consideration the particulars of a given crypto asset’s market in their analysis of whether to recommend the issuance of a receipt for the prospectus for an investment fund that seeks to directly invest in the crypto asset. These particulars will include

• sufficient evidence of an active market for the crypto asset comprising actual and regularly
  occurring market transactions on an arm’s length basis;
• the presence of a regulated futures market for that crypto asset; and
• publicly available indices administered by a regulated index provider for the crypto asset.
  Active markets
  Under Regulation 81-106, an investment fund’s NAV must be calculated using the “fair value” of its assets and liabilities. “Fair value” in this context means either the market value based on reported prices and quotations in an active market or, if the market is not an “active market”, a

value that is fair and reasonable in all the relevant circumstances.7 A market is generally considered an active market when the quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency and those prices reflect actual and regularly occurring market transactions on an arm’s length basis.8 There is data that suggests evidence of market manipulation in some unregulated segments of existing crypto asset markets9 such that the markets for certain crypto assets may not be considered “active markets”. CSA staff think that this would impair or limit an IFM’s ability to determine a fair value for the crypto asset in question for the purpose of calculating a NAV. Crypto asset markets that are active markets provide more accurate and legitimate information and, therefore, a fair and reasonable market value. To accurately value a crypto asset, an IFM should consider whether the market for that crypto asset has real and substantial trading volume, in large size, both in absolute terms and when compared to other markets for commodities and equities. 10 These types of markets will generally provide enough liquidity to promote accurate price discovery.11 Additionally, markets that have a significant volume of transactions on regulated exchanges as opposed to unregulated exchanges will promote more reliable price discovery due to the lower risk of market manipulation. Regulated Futures CSA staff are also of the view that the presence of a regulated futures market for a crypto asset provides support for the proper valuation of a Public Crypto Asset Fund that invests in that crypto asset, along with other operational benefits. First CSA staff consider that the presence of a regulated futures market for a particular crypto asset promotes greater price discovery, a view that is supported by recent research. 12 We note that there is some evidence of market manipulation in crypto asset futures markets, which highlights the importance of relying on a regulated futures market rather than an unregulated futures market. 13 Accordingly, in their analysis of whether to recommend the issuance of a receipt for the prospectus of an investment fund that seeks to directly invest in a crypto asset, CSA staff would consider a crypto asset for which there is a regulated futures market where anti-manipulation rules allow for a fair and transparent value of that crypto asset to be more accurately determined, to raise fewer investor protection concerns. 7 See subsection 14.2(1.2) of Regulation 81-106. 8 See subsection 9.4(1) of Policy Statement to Regulation 81-106 respecting Investment Fund Continuous Disclosure. 9 See for example Cong, L. W., Li, X., Tang, K., and Yang, Y. “Crypto Wash Trading” (July 1, 2021), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3530220 and Paz, J., “More Than Half Of All Bitcoin Trades Are Fake” (August 26, 2022), available at
https://www.forbes.com/sites/javierpaz/2022/08/26/more-than-half-of-all￾bitcoin-trades-are-fake/?sh=17f7f7666681. 10 See the Bitcoin Decision, par. 47 and 49 to 51. 11 See the Bitcoin Decision, par. 50. 12 See for example Sharma et al., “Investigating the Efficiency of Bitcoin Futures in Price Discovery” (2022), available at International Journal of Economics and Financial Issues:
https://www.econjournals.com/index.php/ijefi/article/view/12783. 13 Cong, L. W., Li, X., Tang, K., and Yang, Y. “Crypto Wash Trading” (2021), p. 5, available at SSRN:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3530220. 14 CSA staff note that the Australian Securities and Investments Commission has expressed a similar view. See

Additionally, market makers for ETFs use different tools, including derivatives, to hedge against market price fluctuations in the ETFs’ underlying assets. The presence of a regulated futures market can support the ability of authorized dealers and market makers to properly carry out their market making duties with respect to Public Crypto Asset Funds that are ETFs. Regulatory expectations relating to the proper functioning of these ETFs include the ability for market makers of an ETF to be able to carry out their duties under their agreements with the ETF, including being able to make liquid markets for the ETF’s units.15 We further note that the presence of a regulated futures market for a given crypto asset generally correlates with institutional support for that particular crypto asset. Use of Pricing Indices CSA staff note that several existing Public Crypto Asset Funds base their valuations on spot pricing from available crypto asset indices. 16 Selecting publicly available indices that aggregate pricing from a variety of sources to determine a spot price, and that are administered by regulated index providers using transparent, auditable and replicable calculation methodologies that comply with industry best practices as well as International Organization of Securities Commissions standards, will help mitigate the risks of inaccurate pricing of a particular crypto asset. 17 In addition, an IFM may be better able to confirm the ongoing accuracy and reliability of the index by referring to other widely used and reputable pricing sources for the crypto asset.18 Crypto Assets that Best Support Fair Valuation Considering the above criteria, CSA staff are of the view that the markets for bitcoin and ether best support the operations of Public Crypto Asset Funds at this time without compromising investor protection. In the future, greater institutional support and mainstream adoption of other crypto assets may result in those crypto assets becoming suitable investments for publicly distributed investment funds. (ii) Liquidity of Underlying Assets and Factors to Consider in Assessing Liquidity Under Regulation 81-102, investment funds are subject to restrictions on the proportion of “illiquid assets” that can be held in their portfolios.19 When contemplating an investment in a particular crypto asset, a fund must conduct the necessary due diligence to determine if that crypto asset is of sufficient liquidity to comply with the requirements in Regulation 81-102. A crypto asset may Report 705 Response to Submissions on CP 343 Crypto-assets as Underlying Assets for ETPs and Other Investment products, 29 October 2021, p. 8, available at https://download.asic.gov.au/media/p3tnevtt/rep705-published-29- october-2021.pdf. 15 See Exchange Traded Funds – Good Practices for Consideration Consultation Report by the International Organization of Securities Commissions, p. 24, available at https://www.iosco.org/library/pubdocs/pdf/ IOSCOPD701.pdf. 16 This is
the primary approach taken by existing Public Crypto Asset Funds that directly hold bitcoin or ether. 17 See also the Bitcoin Decision, par. 65. 18 See also the Bitcoin Decision, par. 141. 19 See section 2.4 of Regulation 81-102.

be an “illiquid asset” within the meaning of Regulation 81-102 if, among other things, it is a portfolio asset that cannot be readily disposed of through market facilities on which public quotations in common use are widely available at an amount that at least approximates the amount at which the portfolio asset is valued in calculating the NAV of the investment fund.20 The markets for many crypto assets are generally volatile and price movements can be accompanied by significant inflows or outflows of capital due to changes in investor sentiment. Recent events21 have also highlighted that crypto asset businesses may not always have sufficient liquidity to facilitate significant redemption and withdrawal requests, resulting in their collapse and increased market volatility. In some cases, the market for a crypto asset may become significantly one-sided to the point that it is not possible to liquidate existing holdings of that crypto asset in a timely fashion, or at a fair and reasonable price. Public Crypto Asset Funds that hold crypto assets directly often acquire their underlying crypto assets from a variety of liquidity providers, including crypto asset trading platforms (CTP). Previous CSA staff guidance noted concerns may arise where there is a potential mismatch between the liquidity of an investment fund’s underlying portfolio assets and the redemption terms offered to investors, and that IFMs are expected to regularly measure, monitor and manage the liquidity of the investment fund’s underlying portfolio assets, considering the time to liquidate each underlying portfolio asset, the price the asset may be sold at and the pattern of redemption requests. 22 Given the observed volatility in crypto asset markets and the failure of some large firms that engaged in crypto asset trading, CSA staff emphasize the need for Public Crypto Asset Funds to have effective liquidity risk management programs that include the use of stress testing and ongoing monitoring of underlying crypto asset market liquidity and encourage regular review of such programs. (iii) Classification of Crypto Asset The CSA has stated in previous CSA guidance23 and announcements, 24 that certain crypto assets may be considered to be securities or derivatives. CSA staff expect Public Crypto Asset Funds to conduct appropriate due diligence to determine whether or not the crypto assets they propose to invest in are securities or derivatives. Depending on how a given crypto asset is characterized, 20 Under Regulation 81-102, an “illiquid asset” may also be a restricted security held by an investment fund. See the
section of this Notice titled “Classification of Crypto Asset” for further guidance about when a crypto asset may be a
security.
21 See the examples of the bankruptcies of crypto asset exchange platform FTX, the crypto asset lender Genesis and the collapse of the algorithmic value-referenced crypto asset (commonly referred to as a stablecoin) and crypto asset UST/LUNA pair. 22 See CSA Staff Notice 81-333 Guidance on Effective Liquidity Risk Management for Investment Funds. 23 See CSA Staff Notice 46-307 Cryptocurrency Offerings, CSA Staff Notice 46-308 Securities Law Implications for Offerings of Tokens, CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto assets, Joint CSA-IIROC Staff Notice 21-329 Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements and CSA Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings, Changes to Enhance Canadian Investor Protection (CSA Staff Notice 21-332). 24 Per CSA Staff Notice 21-332, CSA staff are of the view that value-referenced crypto assets may constitute securities and/or derivatives.

various provisions of Regulation 81-102, including concentration25 and issuer control restrictions, 26 may limit an investment fund’s ability to buy and hold a single crypto asset, as is currently done by existing Public Crypto Asset Funds holding bitcoin or ether. Public Crypto Asset Funds that invest in crypto assets that are characterized as securities also need to consider the restrictions in Regulation 81-102 related to securities lending.27 CSA staff are aware of various investors engaging in “crypto lending”. Under these arrangements, investors typically deposit crypto assets onto crypto lending platforms. The crypto assets are then lent out to borrowers in return for regular interest payments. We expect that a Public Crypto Asset Fund that proposes to engage in such activity conduct appropriate due diligence to ensure compliance with applicable securities laws. We also note that Public Crypto Asset Funds are generally prohibited from lending portfolio assets that are not securities.28 CSA staff also note that in addition to the requirements applicable to investment funds subject to Regulation 81-102, there are general securities law requirements that would apply to crypto assets that are securities or derivatives. These include the prospectus requirement for securities, as well as restrictions on secondary trades. Recognizing that the properties of a crypto asset may materially change over time, such as through updates to the prevailing network protocols, CSA staff also expect that Public Crypto Asset Funds will regularly update their due diligence on crypto assets they invest in to ensure that their investments remain in compliance with applicable securities laws. (b) Custody Requirements Public Crypto Asset Funds are subject to the custody requirements set out in Part 6 of Regulation 81-102. Their portfolio assets (including crypto assets) must be held by custodians or sub-custodians that qualify under sections 6.2 and 6.3 of Regulation 81-102 as applicable. In addition to the usual consideration of trust law principles that apply to all types of assets held on behalf of clients, crypto assets present unique custodial considerations, including expertise and infrastructure specifically tailored to the safekeeping of this type of asset. This is reflected in the additional practices that have developed concerning the custody of crypto assets held by a Crypto Custodian on behalf of a Public Crypto Asset Fund. These include the following practices, which we would consider to be the minimum expectations for practices pertaining to the custody of crypto assets of a Public Crypto Asset Fund by a Crypto Custodian and consistent with existing legal obligations under Part 6 of Regulation 81-102, including the standard of care for custodians and sub-custodians:

• Crypto Custodian Expertise. The IFM, consistent with its fiduciary obligations to the
  Public Crypto Asset Fund, should satisfy itself that a proposed Crypto Custodian has the 25 See section 2.1 of Regulation 81-102. 26 See section 2.2 of Regulation 81-102 27 Among these restrictions include those in section 2.12 of Regulation 81-102. 28 See paragraph 2.6(1)(f) of Regulation 81-102. 29 In particular, where the crypto asset is a security, the requirement that the issuer is a reporting issuer or that the secondary trade is conducted in accordance with Regulation 45-102 respecting Resale of Securities.

necessary expertise and experience to safely custody the crypto assets to be held on behalf of the Public Crypto Asset Fund;

• Primary storage of crypto assets in “cold wallets”. Crypto assets held on behalf of a Public
  Crypto Asset Fund should be held in online storage or “hot wallets” only as is necessary to facilitate purchases and redemptions by the fund. Otherwise, crypto assets are to be held in offline storage or “cold wallets” in secured facilities maintained by the Crypto Custodian;
• Segregation of assets, visible on the blockchain. Assets of an investment fund held by a
  custodian or sub-custodian are required to be segregated under Part 6 of Regulation 81-102. In the context of a Public Crypto Asset Fund, this will generally include the use of segregated wallets that confirm the fund’s ownership of the applicable crypto assets or in an omnibus wallet visible on the blockchain so long as in each case the Crypto Custodian’s books and records clearly reflect the fund’s ownership of the crypto assets held by it;
• Website security measures. Crypto Custodians should be using website protection
  measures such as two-factor authentication, strong password requirements that are cryptographically hashed, and encryption of user information, among other measures to secure client information and protect the Crypto Custodian’s website from hacking attempts;
• Maintenance of insurance for corporate crime/theft relating to the storage of crypto assets.
  The Crypto Custodians for the existing Public Crypto Asset Funds should each maintain appropriate insurance for the crypto assets in their custody; and
• SOC-2 Type-2 Reports of the crypto custodian provided to the Fund’s auditors. The Crypto
  Custodians will generally provide or make available for review, on an annual basis, by the Public Crypto Asset Fund’s auditor in connection with its audit of the Public Crypto Asset Fund, System and Organization Control (SOC) reports prepared on the Crypto Custodian’s behalf by a public accountant, which assess a service organization’s security, availability, processing integrity, confidentiality and privacy controls. Where a SOC report is not available, we expect the Crypto Custodian to permit the Public Crypto Asset Fund’s auditor to directly examine its controls for similar purposes. -CSA staff note that these practices and expectations are substantially similar to the proposed terms and conditions for entities that seek to act as custodians for CTPs in Canada as is set out in CSA Staff Notice 21-332. . (c) Staking Crypto Assets In this Notice, “staking” refers to the act of committing or locking crypto assets in smart contracts to permit the owner or the owner’s agent to act as a validator for a particular proof-of-stake consensus algorithm blockchain. A validator, in connection with a particular proof-of-stake consensus algorithm blockchain, is an entity that operates one or more nodes that meet protocol requirements for a crypto asset and participates in consensus by broadcasting votes and committing new blocks to the blockchain. Validators are incentivized to add legitimate transactions to a proof-

of-stake blockchain through rewards and can be penalized for breaching protocol requirements, including through having staked crypto assets “slashed” (i.e., removed from the offending validator). CSA staff continue to monitor and assess the presence and role of staking in the crypto asset industry. As a result of this ongoing work, CSA staff are of the view that, depending on how it is conducted, staking may involve the issuance of a security or derivative. CSA staff would therefore expect Public Crypto Asset Funds interested in staking crypto assets held in their portfolios to have established policies and procedures to assess whether any staking or similar activity involves the issuance of a security and/or derivative. Our view is that such policies and procedures should include a process for independent analysis of the staking activities and consideration of statements made by any regulator, except in Québec, or securities regulatory authority about whether staking conducted in the contemplated manner involves the issuance of a security and/or a derivative. We note that there are circumstances in which a Public Crypto Asset Fund’s participation in staking may result in a portfolio crypto asset that may otherwise be liquid, becoming an “illiquid asset” within the meaning of Regulation 81-102. This could occur for example, if a staked crypto asset is subject to any lock-up, unbonding, unstaking, or similar periods imposed by the crypto asset protocol, custodian or validator, where such crypto asset would not be accessible to the Public Crypto Asset Fund or would be accessible only after payment of additional fees, penalties or forfeiture of any rewards. CSA staff expect a Public Crypto Asset Fund to conduct appropriate due diligence with respect to the effect on the crypto asset’s liquidity within the fund’s portfolio as a result of the fund’s participation in staking and in turn how this impacts the Public Crypto Asset Fund’s compliance with the illiquid asset restrictions in section 2.4 of Regulation 81-102. Public Crypto Asset Funds interested in staking should also consider the prohibitions in section 2.6 of Regulation 81-102 related to lending and other investment practices by an investment fund. Specifically, investment funds are prohibited from lending portfolio assets and guaranteeing securities or obligations of a person. Depending on how it is proposed to be conducted, staking could be viewed as akin to lending portfolio assets to or even guaranteeing obligations of a person engaged to act as validator.30 If the underlying staked crypto assets are themselves securities, staking such assets could also be viewed as akin to securities lending. Public Crypto Asset Funds should therefore also be mindful of the restrictions on securities lending transactions detailed in
section 2.12 of Regulation 81-102.
Consistent with the definition of “non-redeemable investment fund” in Regulation 81-102 and the CSA’s discussion in section 1.2 of Policy Statement to Regulation 81-106 respecting Investment Funds Continuous Disclosure, CSA staff regard an investment fund as an issuer that does not seek to exercise control over, or become involved in the management of, investee companies. Since staking requires a validator to actively participate in consensus of a proof of stake network protocol by broadcasting votes and committing new blocks to the blockchain, this could be viewed as exerting control over or being involved in the management of the proof of stake protocol (which can be viewed as being akin to an investee company). To mitigate this concern CSA staff would expect that neither a fund nor its IFM would act as its own validator. Rather, a Public Crypto Asset Fund would be expected to engage a third party to act as validator (i.e., “staking as a service”). 30 See paragraphs 2.6(1)(f) and 2.6(1)(g) of Regulation 81-102.

The expectation that a Public Crypto Asset Fund would not act as its own validator is also consistent with requirements imposed on registered CTPs that engage in certain staking activity.31 CSA staff would expect that any staking activity permitted to be engaged in by a Public Crypto Asset Fund would be done within a framework similar to the terms and conditions imposed on registered CTPs, where applicable. CSA staff would expect that the practices relating to staking by Public Crypto Asset Funds include that

• the fund will engage in staking only for (i) crypto assets of blockchains that use a proof
  of stake consensus mechanism and (ii) the staked crypto assets that are used to guarantee the legitimacy of new transactions the validator adds to the blockchain;
• the IFM must be proficient and knowledgeable about staking crypto assets;
• the IFM must enter into written agreements with one or more third parties to stake the
  fund’s crypto assets and each such third party is proficient and experienced in staking crypto assets. The IFM must also consider the application of securityholder approval requirements under Part 5 of Regulation 81-102 concerning any fees that may be payable by the fund under those agreements;
• the fund’s Crypto Custodian will remain in possession, custody and control of the
  staked crypto assets at all times;
• the fund’s staked crypto assets be held in offline storage or “cold wallets” in secured
  facilities maintained by the Crypto Custodian, where applicable;
• the IFM will monitor validators retained on behalf of the fund, for downtime, jailing
  and slashing events and take any appropriate action to protect crypto assets staked by the fund; and
• the IFM will appropriately manage any liquidity risk and other risks to the fund’s
  financial viability that may arise because of the fund’s staking activities. IFMs of Public Crypto Asset Funds are expected to engage in their own due diligence to determine whether proposed staking activity by a Public Crypto Asset Fund will comply with applicable securities legislation. We also encourage Public Crypto Asset Funds interested in staking portfolio assets to contact their principal regulator to discuss the applicability of securities legislation and possible approaches to compliance. (d) Know-Your-product, Know-Your-Client and Suitability Obligations Registrants have to comply with obligations under securities legislation related to KYC, KYP, and suitability determinations in connection with purchases or sales of securities of Public Crypto Asset Funds for, or recommendations of Public Crypto Asset Funds to, their clients. To comply with their KYC obligations, registrants must collect certain information from clients, take reasonable steps to have clients confirm the accuracy of the information and keep the 31 Consult National Registration Search https://info.securities-administrators.ca/nrsmobile/nrssearch.aspx for terms and conditions imposed on the registrations of CTPs that engage in certain staking activity.

information current.32 For KYP compliance, registered firms are required to take reasonable steps to assess and understand any securities that are made available to clients and in particular, are required to assess and monitor on an ongoing basis all relevant aspects of the securities, including the securities’ structure, features, risks, initial and ongoing costs and the impact of those costs.33 Once a registrant has complied with its KYC and KYP obligations, it is expected to have sufficient information to make a reasonable determination of whether an investment action34 is suitable for a client and registrants must put their clients’ interests first when taking any investment action.35 When conducting KYC, KYP and suitability determinations in connection with recommending Public Crypto Asset Funds to clients, registrants should be cognizant that holding crypto assets, including Public Crypto Asset Fund securities, comes with elevated levels of risk that may not be suitable for many investors.
6. Questions
Please refer your questions to any of the following CSA staff:
Bruno Vilone
Acting Manager, Investment Products
Oversight
Autorité des marchés financiers bruno.vilone@lautorite.qc.ca Philippe Lessard Securities Analyst, Investment Products Oversight Autorité des marchés financiers philippe.lessard@lautorite.qc.ca Michael P. Wong Senior Securities Analyst, Corporate Finance British Columbia Securities Commission mpwong@bcsc.bc.ca James Leong Senior Legal Counsel, Corporate Finance British Columbia Securities Commission jleong@bcsc.bc.ca Chad Conrad Senior Legal Counsel, Investment Funds Alberta Securities Commission chad.conrad@asc.ca Cathy Tearoe Senior Legal Counsel, Market Regulation Alberta Securities Commission cathy.tearoe@asc.ca 32 See section 13.2 of Regulation 31-103. Registrants that are members of the Canadian Investment Regulatory Organization (CIRO) must also comply with all applicable CIRO rules relating to KYC, including Rule 3200 of the Corporation Investment Dealer and Partially Consolidated Rules (the ID Rules) and/or Rule 2.2.1 of the Mutual Fund Dealers Association of Canada Rules (the MFD Rules). 33 See section 13.2.1. of Regulation 31-103. Registrants that are members of the CIRO must also comply with all applicable CIRO rules relating to KYP, including Rule 3300 of the ID Rules and/or Rule 2.2.5 of the MFD Rules. 34 An investment action includes opening an account for a client, purchasing, selling, depositing, exchanging or transferring securities for a client’s account, taking any other investment action for a client, making a recommendation or exercising discretion to take any such action. 35 See sections 13.3 and 13.3.1 of Regulation 31-103.

Ashlyn D’Aoust
Senior Legal Counsel, Market Regulation
Alberta Securities Commission ashlyn.daoust@asc.ca Heather Kuchuran Director, Corporate Finance Financial and Consumer Affairs Authority of Saskatchewan heather.kuchuran@gov.sk.ca Patrick Weeks Deputy Director, Corporate Finance Manitoba Securities Commission Patrick.weeks@gov.mb.ca Christopher Bent Senior Legal Counsel, Investment Funds and Structured Products Ontario Securities Commission cbent@osc.gov.on.ca Frederick Gerra Senior Legal Counsel, Investment Funds and Structured Products Ontario Securities Commission fgerra@osc.gov.on.ca Michael Tang Senior Legal Counsel, Investment Funds and Structured Products Ontario Securities Commission mtang@osc.gov.on.ca Ella-Jane Loomis Senior Legal Counsel, Securities New Brunswick Financial and Consumer Services Commission ella-jane.loomis@fcnb.ca Peter Lamey Legal Analyst Nova Scotia Securities Commission peter.lamey@novascotia.ca

Appendix
Select Public Crypto Asset Fund Market Data
The following charts provide key market data36 about Public Crypto Asset Funds in Canada. The information provided is current to April 30, 2023. By Fund Structure Public Crypto Asset Funds are structured as non-redeemable investment funds, ETFs and open￾ended mutual funds, with the ETF structure being the most common, as is illustrated below:
Fund Structure No. of Funds Net Assets
($millions)
Non-redeemable investment fund 2 $576
ETFs 12
$2,289
Open-ended mutual fund37 8
Total 22 $2,865
By Crypto Asset Type
The existing Public Crypto Asset Funds seek exposure only to bitcoin and/or ether, with funds focused on bitcoin representing the majority of net assets in this space as is illustrated below:
Crypto Asset No of Funds Net Assets
($millions)
Bitcoin 11 $1,860
Ether 8 $1,005
Bitcoin and Ether 3 n/a
Total 22 $2,865
36 The information was collected internally by CSA staff through publicly available sources, including SEDAR, fund company websites and other third-party data providers. 37 The open-ended mutual funds invest their assets in securities of one or more of Public Crypto Asset Investment funds that are ETFs. As such, their net assets are part of the total assets under management for the ETFs listed above.

By Fund Strategy
The existing Public Crypto Asset Funds employ 3 main strategies for achieving the desired exposure to bitcoin or ether, namely:

• directly holding bitcoin or ether in a “buy and hold” strategy;
• indirectly holding bitcoin or ether through a fund of fund structure; or
• indirect exposure through investment in bitcoin or ether futures that trade on regulated
  derivatives exchanges.
  Direct investment remains the most common strategy as is illustrated below:
  Strategy No of Funds Net Assets
  ($millions)
  Direct investment 12
  $2,838
  Fund of fund 838
  Investment in listed futures 2 $27
  Total 22 $2,865
  38 The Public Crypto Asset Funds that employ a fund of fund strategy invest their assets in one or more of the “direct investment” Public Crypto Asset Funds structured as ETFs. The net assets of the “fund of fund” strategies are therefore included as part of the net asset of the “direct investment” funds.