Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 24 - Evidence - February 26, 2015

OTTAWA, Thursday, February 26, 2015

The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:30 a.m. to study the use of digital currency.

Senator Irving Gerstein (Chair) in the chair.


The Chair: Good morning and welcome to the Standing Senate Committee on Banking, Trade and Commerce.

Today is the fifteenth meeting in our special study on the uses of digital currency including the potential risks, threats and advantages of these electronic forms of exchange.

To date, the committee has received presentations from a wide range of witnesses, including government agencies, digital finance experts, academics and bitcoin companies.

Today, our meeting will be split into two one-hour panels. In our first hour, we will hear from legal experts and in the second hour we will hear from the digital currency platform Ripple.

Moving to our first panel, we will focus on the legal aspects of digital currencies with two lawyers who have recognized experience in this field. Both of these gentlemen were quoted in an excellent article on crypto-currency this past summer in Canadian Lawyer magazine, which I strongly recommend to members of the committee. Copies are available through the clerk if you have not got one.

It is my pleasure to welcome, from Davies Ward Phillips & Vineberg LLP, Mr. Elliot Greenstone. Mr. Greenstone is a partner in the capital markets, mergers and acquisitions, life sciences and technology practices. He is also a member of the firm's technology committee.

If I may be permitted a personal note for a moment, in mentioning the name Phillips Vineberg, I recall very well Mr. Lazarus Phillips, whose name is in the title of the firm. He was a great friend of my parents and I must say a very distinguished member of the Senate of Canada. I might also add he was the deputy chair of this very committee from 1968 to 1970.

From Norton Rose Fulbright Canada, I am pleased to welcome Mr. John Jason. Mr. Jason has practised law for over 20 years and is widely regarded as a leading lawyer in regulatory law across all sectors of the financial services industry.

We will now hear opening statements from Mr. Greenstone, to be followed by Mr. Jason. Mr. Greenstone, the floor is yours, sir.

Elliot A. Greenstone, Lawyer, Davies Ward Phillips & Vineberg, as an individual: Thank you very much. Honourable chair, members of the committee, I would like to thank you for inviting me to speak with you today on the topic of digital currencies.

By way of background, as mentioned, I am an attorney with Davies Ward Phillips & Vineberg with a practice primarily focused on corporate securities information technology matters. I've spent a considerable amount of time over the past few years developing a better understanding of digital currencies and the technologies behind them.

Although I am most interested in the block chain technology and its potential applications in a broad spectrum of industries and businesses, given the focus of this standing committee and the previous presentations that have been made before you, I will focus my comments on bitcoin, since it serves as the most well-known, non-conventional digital currency using the block chain technology. I say "non-conventional" since it's widely acknowledged that virtually all currency is digital today. Cash transactions have become more rare, while transactions in cyberspace, including bank websites, e-money transfers and others have become the norm.

The volatility and speculative nature of bitcoins, in addition to many other concerns that have been raised, have led to significant debate relating to government's regulatory oversight of crypto-currencies.

From a Canadian securities law perspective, while no specific directives have been proposed to date, the Autorité des marchés financiers of Quebec, Quebec's securities regulator, has issued a warning following the unveiling of the first bitcoin ATM in Montreal in March of 2014. The AMF provided some clarity by affirming that crypto-currencies are not covered by the Fonds d'indemnisation des services financiers of the Fonds d'assurance-dépôts. In addition, the AMF announced that it intends to monitor crypto-currencies with regard to the Securities Act, the Derivatives Act and the Money Services Businesses Act.

The Ontario Securities Commission has been similarly prudent in its initial publication on crypto-currencies, refraining from discussing any of their potential advantages. Instead, the OSC warned that all crypto-currencies should be approached with caution, emphasizing instances of fraud and exchange shutdowns and their potential connection with money laundering and terrorist financing. The OSC stated that it will monitor investment activities related to crypto-currencies closely and will take action where violations of the Ontario Securities Act are concerned.

To date, to my knowledge, no Canadian securities regulator has come forward with a position as to whether or not crypto-currencies should or would be treated as a security or derivative for the purposes of securities law. Although I have not reviewed the question from the perspective of each provincial and territorial securities legislation, I will highlight relevant sections from each of the Quebec and Ontario securities legislation that I believe should frame this discussion.

The Quebec Securities Act does not have a definition of security but it applies to, among others, a security recognized as such in the trade, an instrument or other than a bond evidencing a loan of money. And it includes a definition for an investment contract.

The Ontario securities legislation does have a definition of a security. That definition includes, among others, a definition, instrument or writing commonly known as a security — again, it does not lend to what a bitcoin is — but it also has the definition of an investment contract. There have been some parties that have discussed whether or not the bitcoin falls within that category.

However, in Ontario, the final sentence of the definition of security reads "whether any of the foregoing relates to an issuer or proposed issuer." For bitcoins, there is no issuer or proposed issuer. As such, in my view, crypto-currencies are not and should not be considered to be a security, at least for the purposes of and within the current definitions of applicable securities legislation in the provinces of Quebec and Ontario.

They may be subject to volatility and speculation, but so are many national, government-backed currencies. These characteristics in and of themselves do not cause crypto-currencies to be considered to be securities.

I would like to thank the committee again for inviting me to speak with you. I am honoured to have had the privilege.

The Chair: Thank you very much, Mr. Greenstone. Mr. Jason, now the floor is yours.

John Jason, Of Counsel, Norton Rose Fulbright Canada, as an individual: I'd also like to add my thanks to both the chair and the rest of the committee members for inviting me here to talk about this topic. As you mentioned to me before the hearing began, it's truly a fascinating and very complicated topic.

I'd like to talk for a couple of seconds about my perspective or my view on this. At Norton Rose, we have a variety of clients, ranging from banks to insurance companies to some bitcoin-related companies. I like to think of myself as not having a personal view as to whether it's good or bad, but I've spent a lot of time trying to think about how it fits within our legal framework.

I understand that one of the challenges the committee faces is to decide whether or not to recommend that there be regulation of bitcoins or virtual currencies to protect Canadians. In fact, I have read through some of the testimony and saw that some of the companies and some of the individuals who are trying to develop businesses around bitcoin and virtual currencies are actually recommending regulation as a means of really promoting its use among Canadians and getting Canadians to have access to the benefits. In particular, I think one of the issues that was raised was whether or not companies can get access to banking services in Canada because of a concern about a lack of regulation. So, really, there are sort of two perspectives. One is protecting against potential harm, and the other, of course, is enabling in the sense of allowing the developments to take hold and take root in our country.

I also wanted to mention in my opening remarks that one of the things that I've spent a lot of time with is understanding, if you will, other legal issues that are not necessarily what we might classify as regulatory issues. Let me give you an example of some of those things.

I know one presenter mentioned the Currency Act. One of the important things, obviously, that the Currency Act does in Canada is that it determines that the Canadian dollar is the currency of Canada, but it goes on to do some important things. It starts to create some legal framework around that that we lawyers then find very useful in our day- to-day activities.

For example, the act goes on to say that any contract in Canada, any agreement, any promissory note that references money, references the currency of Canada. So that raises an interesting issue if I want to draft a contract and the vehicle of exchange or the value that's being exchanged under that contract is bitcoins. If I'm drafting that and it's Canadian dollars, I simply say that party A owes party B $1,000 per month. The Currency Act helps me and says that's Canadian dollars and I can settle that contract by tendering or offering up Canadian dollars. If I drafted that same contract with reference to bitcoins, what is it exactly that I referenced? I'll have to go further and somehow create an identifiable definition of what it is that can be tendered up to satisfy that contractual obligation.

So it's an area where the Currency Act helped us in terms of trying to start to build a legal framework that supports our economic activity.

Let me give you another interesting example, which we can all relate to on a personal basis. Say I personally decide to start using bitcoin for some of my day-to-day transactions. I've downloaded bitcoin onto my personal computer and that's where those numbers that represent my private key reside. My house burns down and my computer goes with it so I call up my insurance company and say, "Well, in addition to my computer, which I paid $1,500 for, I also had $5,000 of bitcoin on my computer."

The insurer says, "Well, do I insure that? Is that property of some kind that has been damaged? Is it covered by your policy?" Even if we determine it is covered, how do we determine the value for it? Was it the value you originally paid for the bitcoin when you exchanged out your Canadian dollars for the bitcoins? Is it a current value at the time of the loss? How do we determine that value? Is there some reference rate that we can go to?

We know the Bank of Canada publishes reference exchange rates against other currencies, so if you're trying to deal with this contractually, you can say let's reference the Bank of Canada exchange rates. The Bank of Canada doesn't do that for virtual currencies.

These are a couple of simple examples where over the years, since 1935 when the Canadian government decided it would be the sole issuer of Canadian currencies, a legal framework has built up to support that position and support our economic activity. If you introduce a currency, that framework does or doesn't necessarily apply. It will certainly result in a lot of interesting issues that have to be confronted.

I'll pick up on one that Mr. Greenstone mentioned. Is it a security or isn't it a security? As he mentioned, a security conceptually requires an issuer, and in the case of bitcoin, as the coins come out, there's no identifiable person who has issued those coins, so it challenges the framework that we created in respect of securities.

As I say, the challenge right now is not only deciding whether or not there are evils against which we need to protect Canadians from or whether we need to regulate to allow the technology to take hold. There are also going to be a lot of legal issues that arise over the next number of years as we try to deal with things that we had a legal framework around, which may or may not fit this new technology.

Those are my opening comments.

The Chair: Thank you, Mr. Jason.

Mr. Jason, you indicated that you do work for banks, insurance companies and bitcoin companies.

In the article in Canadian Lawyer, I believe you said, "It's hard to regulate that which you can't identify. The first thing that needs to be done is to figure out what you're trying to regulate." Am I close to what you said?

Mr. Jason: Yes, absolutely.

The Chair: Okay. From your vantage point, if you had the privilege of sitting in our seat, what do you think we would be regulating, if anything? How do we approach it?

Mr. Jason: I had the opportunity to work at the Department of Finance in the early 1990s when the financial services regulation was significantly overhauled, so I consider myself a little bit of a financial services regulatory historian.

When I've gone through the testimony that has been before the committee, I find a lot of the presenters spent a lot of time focusing in on the details. We lawyers have an expression that says we have to look at first principles. I would encourage going back to look at some first principles and say, okay, in 1935, the Government of Canada decided that it would become the sole issuer of currency. Prior to that time, the banks all issued currency and that was the medium of exchange in this country, the paper notes issued by the various banks.

So why was it that we made that decision? Why did we decide that it would be better to have a government-backed currency in this country versus all of the individual banks? There were laws that existed at the time. For example, the value of notes that existed at the bank at the time could not exceed the amount of their capital. There was a law in place that tried to ensure that those notes would always retain their full value and that people could have confidence the notes had value because it reflected the capital of the bank.

Even still, we decided that the country would be better served to have the government backing the notes. You have to go back and determine why that occurred. What was it that we were trying to achieve? Then compare that to the virtual currencies and determine whether it gives rise to the need for regulation.

I might give you an example. At one point, the Government of Canada introduced deposit insurance, where we insure individual depositors. Why do we do that? We do it because we want Canadians to be confident that they can put their money in banks. Why do we want them to put their money in banks? Because then the bank puts the money into productive use.

If I say the first principle is that we want to support or ensure that money doesn't stay under the proverbial mattress but gets redeployed in our economy, one of the vehicles we use for doing that is deposit insurance to encourage Canadians to make deposits in banks.

One of the things we lose sight of is the original principles that we were trying to achieve and how this development fits with those concerns.

Senator Black: Thank you both. They were tremendous presentations and very helpful. We're near the end of our process here so your interventions are very timely.

I want to pick up where our chairman left off if I can, Mr. Jason and Mr. Greenstone. I heard what you said about going to first principles. It's always a good practice to do exactly that. What are those first principles, in your view?

Mr. Jason: For a country like ours, which is based on our economic theory, we want to ensure and support economic activity. I think the first principle originally, having the government become the issuer of the currency, was to ensure people had faith and confidence in using the currency so we didn't have to walk around with our bags of gold as they did in the very old times, and that we can rely on paper dollars as a medium of exchange.

We needed to ensure that value would be upheld so people had confidence that the dollars they exchanged — their labours or their goods — and received back would always be able to be used by them because that's what we need. We need our economy working.

So the first principle we have to be concerned about is whether there is certainty of value in the currency. We've heard a lot of testimony about wide fluctuations and the value of bitcoin. Is that something that is a function of it being in low circulation right now? Mr. Greenstone can probably speak to this better than I can, but what the bitcoin advocates say is that the value is going to ultimately be more certain because it's not dependent on the interventions of governments. It's not dependent on other things that people may or may not do to manage the value of the currency. It's wholly dependent on what the market will pay for it.

As I say, an advocate of the bitcoin would say eventually when enough bitcoins are issued, it's going to be a more certain currency than a currency managed by a government. So I think those are an example of the types of inquiries we need to make and say, if this becomes a significant part of our economy, is it going to give us the protections that we feel we need?

Senator Black: Mr. Greenstone, on this question of regulation, can you offer us your view as to whether or not you believe bitcoin and other crypto-currencies should at this time be regulated in Canada and, if so, how?

Mr. Greenstone: Very difficult question. Certainly timely; that's why we're here.

Bitcoins initially, I think it's very important to discuss this, were a proof of concept. The blockchain technology, which we were speaking about before, is really fascinating, ground-breaking technology. Its use as a currency is new. It's only been around since 2008. The difficulty again comes in how you regulate. You have to go back to what you are trying to regulate. What are the basic principles for regulating it? How do you regulate its use?

As an example, I don't, but an individual walking around could have a bitcoin wallet, going across the border with well in excess of the $10,000 cash limit which is the legal restriction for crossing borders, and you would have no idea when an individual crosses the border that they have that amount of cash, not Canadian cash, not American cash, but cash, currency, bitcoin equivalent as they cross the border. Those kinds of issues concern me. There are reasons why those regulations are in place, to prevent that kind of mobility of funds and untraceability of funds.

Do I think it should be regulated? Again, I'm agnostic, as we were discussing before. I have clients who can advocate, and depending on the discussion we're having and the particular industry we're looking at, I can certainly understand both sides of that coin. I know that the Canadian government at one point was looking into its own equivalent of bitcoin. It was looking at MintChip, which you're familiar with, as smaller denominations, smaller transactions. There was a $2,000 limit. It's a different approach; certainly something worth looking into, but you come to the same question that the people who are interested in transacting with bitcoins are looking for a currency that is not subject to government fluctuations, to individual currency fluctuations.

Right now we are seeing tremendous fluctuations in the value of bitcoin, but again, is that simply a factor that it is not very well adopted and so there are individual concerns? There have been concerns with exchanges. There have been concerns with fraud, which has gone on, but this is a very new technology. People are uncomfortable with it, and it will take time. Whether or not bitcoin itself will be around, whether or not bitcoin should be regulated, it's the first. It's a proof of concept. I do believe that we need to look at it on a go-forward basis.

Senator Black: That's very helpful.


Senator Massicotte: I thank both of you for being here with us; your presence is much appreciated.

I see that your opinion is neutral. The international trend, and especially the American trend, in the State of New York in particular, seems to favour mandatory regulation for the greater good of the population. We have only to think of the Mt. Gox experience, where a lot of money disappeared on the invisible Web, a phenomenon we heard about about three weeks ago, as well as of the fact that certain players in the industry cannot open bank accounts, and certain governments are concerned about protecting consumers.

FINTRAC has already issued a regulatory principle that will apply to the current regulations governing this type of currency. The Quebec Securities Commission also issued a position three weeks ago, and the Canada Revenue Agency has spelled out its position on several occasions.

Is this sufficient, since in some cases they also contradict one another, and we are not always dealing with the same kind of regulation? Should we be doing more, in your opinion? In real life, we have to come to a decision and recommend something. What is the right decision to make and why?


Mr. Greenstone: Again, I'll speak in English. I think it's easier. Correct me if I'm wrong.

Government has an obligation to advise its citizens of risks that are present. Certainly, investing in crypto- currencies, be they bitcoins — your guest later will be talking about Ripple. There are multiple different crypto- currencies that are out there which are circulating, which prevent significant risk to the people who are acquiring them, whether they are buying them from an investment perspective, from a holds perspective, from an interest in transacting with them. There are certainly people who are acquiring them who would not meet the typical accredited investor definitions that you would have in securities legislation, where they don't have the financial knowledge and wherewithal to make the decisions, for lack of a better word, the investment decisions as to whether or not they should be holding bitcoins.

So I do think the government has a role in continuing to advise citizens of the risks inherent in these foreign currencies, these new currencies, these new technologies.

I think we also need to separate the currency itself from some of the recent issues that have happened. There has been fraud; there have been failed exchanges; but the issues that have come up have been issues with individual companies. The exchanges have been individual companies. The frauds have been individual entities that have defrauded the system. We have had securities fraud before. We've had money laundering before. We've had terrorist activities before. This is another venture, and I think it's important that this committee and the government as a whole separate the issues between the currency itself, the technology behind the currency itself, and trying to regulate and protect on other aspects of the crypto-currencies.

Mr. Jason: It's difficult because our financial ecosystem, if you will, has a lot of different aspects to it. When you go through, is there a need to regulate, you almost have to think of, well, because there are so many different aspects of a virtual currency, the role that it plays. For example, the first one is what I would call investment risk. Typically in our country, the provinces have regulated essentially the risk of poor investment choices through our securities laws. So we have that risk that exists today in Canada, that people may invest in things for which they don't have appropriate knowledge or appropriate disclosure. So there's a lot of legal framework that has been built up around investing in what we call securities. So there are disclosure requirements. In terms of brokers, individual brokers have to know their client requirements so that investments are suitable.

There's a whole legal framework built up to try to manage that to protect the individual consumer, who may not have all the knowledge and ability to make those investment choices.

That's one of the issues you have to consider: Is there too much investment risk here that we somehow need to bring it within our framework for protecting consumers?

Another risk that was mentioned is what I would call security risk. A lot of what's happened in bitcoins is where we've seen a loss of the value because the securities were stolen or the bitcoins were stolen or removed fraudulently. To the extent that individual consumers are relying on third parties to maintain those coins, maintain that value on their behalf, then it raises the question about whether we need regulation around those entities that offer that service to the public. Do we need to know that those entities are going to truly achieve that which they are proposing they can do, which is keep your value safe? Things like whether there should be an insurance requirement. Should there be some third-party testing of their safeguards and measures? So you get into whether we should create security around that aspect.

We also heard that a bitcoin is essentially an internal system for effecting payments. Well, we have a lot of regulation in this country to ensure the integrity of our payment systems. Do we need to look at it and say, "Well, there's an aspect of being a payment system"? Do we need to bring over some of the safeguards we have embedded in our existing payment system?

It is almost like you have to deconstruct it into all the parts and say, do those component parts pose too much of a risk that we need to introduce regulation?

Senator Massicotte: The witness has been very good at analyzing the questions. What is the answer?

Mr. Jason: Right now, unfortunately, I boil it down to we have deposit insurance in this country, as I said before, in part to encourage Canadians to feel comfortable putting their money in banks, and also, quite frankly, because we don't want the small individual Canadian who can't make reasoned decisions about where the best place to put their money is to be protected.

That's because almost every Canadian uses a bank. If we didn't have protections, the risk to the country, the risk to Canadians would be incredibly high.

Right now what I would say is the penetration of bitcoin is not so great that so many individuals will be harmed by not having, for example, a deposit insurance type of safety net. At this point, I would say maybe we're not there yet. If we reach the point where it becomes more prevalent in our economy, becomes a bigger portion of our economy, then I think we realistically have to look and see whether or not we can build equivalent safeguards.

Senator Massicotte: Do you agree with that, Mr. Greenstone?

Mr. Greenstone: I do. When we talk about regulating this industry, we talk regularly about the different regulations that apply to securities, banking, finance, to insurance; we talk about those from a national perspective. Our legislation is not that dissimilar from that in the United States and in other European countries.

What is important here is when we start talking about crypto-currencies, currencies that are not government- backed, where they can be transacted between various countries that we don't act alone in creating these regulations. If we are creating a more difficult, stringent series of regulations which are out there that we don't inadvertently hurt consumers, investors, businesses, crypto-currencies, the block chain technology, if you believe the business side of the argument, is a potential way to stimulate and to create more business, more flow of funds and more investment.

We have to be very careful we don't stifle that potential growth with new regulation. To have regulation in Canada, whether I'm for or against it, I have already answered that question. I think we have to be careful that we don't implement legislation which is more stringent than foreign jurisdictions and prevent and stifle the Canadian economy when others may be freer to grow.

Senator Ringuette: Gentlemen, you have increased my dilemma in regard to seeing this bitcoin as a currency or a commodity. Mr. Greenstone, you said that from your perspective this is not a security issue because the current definition of security would not encompass this. However, you also, in your example of contract — or was it Mr. Jason's example of a contract? I can say that for this kind of service, in this contract, I will pay with five cows, which is a commodity. Which is it? From your experience, do you see that any kind of regulation in regard to crypto-currency would be to really legitimatize the product?

Mr. Greenstone: I will answer. There are two questions there. Let me answer your second question first. Do I think that creating regulation will legitimatize the product? The product is here. I don't believe it's going away.

I'm not saying bitcoin will be here in a decade, but crypto-currencies, the block chain technology, is new technology, and by all accounts, by experts who have looked at this for far longer than I have, this technology will be here. It may not be bitcoin, it may be some other evolution of bitcoin, but the idea of a crypto-currency will be around.

The question is not do we legitimatize it. It is here. The question is do we react to it or not.

Your first question related to whether or not it is a commodity or currency. Again, there have been many papers written — I have read several of them — most of them refer to crypto-currencies as a pseudo fiat currency. That's the term. That it is neither a commodity nor a currency. It is somewhere in the middle and has characteristics similar to both. It doesn't really fit into what you typically define as a commodity. It doesn't fit into a currency. There is a limited supply, much like a commodity. There are issues that make it very similar to a currency in terms of its ease of use, in terms of transacting with it once you can actually manage to figure out how to use a bitcoin wallet and get it onto your phone and learn how to do a transaction.

It is not an either/or; it is a "something new." And I think people are referring to it as a pseudo fiat currency. That seems to be the term people have adopted for it.

Mr. Jason: I would agree. The problem is that it is a combination of multiple things. In addition to having attributes of a commodity and attributes of a currency, it is also its own payment system. When you think about regulation, you really are looking at the three areas of regulation combined and trying to see, as I have been arguing, well, why do we regulate in that area? What are the attributes of bitcoin that would lend itself to the same kind of regulation?

Senator Ringuette: This increases the issue that we have to deal with because not only is it part of both, in Canada it is also in two different jurisdictions.

Mr. Jason: Well, it is in any jurisdiction.

Senator Ringuette: Exactly.

Mr. Jason: That was one comment I didn't make when answering the last question, and Mr. Greenstone mentioned it, is the problem we confront here is it is not within national boundaries if you make a law in Canada.

For example, the new anti-money laundering laws that have been enacted and are going to come into force soon with respect to virtual currencies, it is interesting. It is one of the first pieces of legislation I have ever seen that attempts to regulate entities outside of our borders.

The way the law is written, it says that if you are not Canadian, not a resident of Canada, but you deal with Canadians, then you are subject to the regulation. Now, let me just compare that. If I go home this afternoon and I fire up my computer and I want to do some Internet shopping, and I happen upon a company in the United States that I make a purchase from, is that company in the United States subject to Canadian law because I reached out to them in their home jurisdiction and said I wanted to do a deal?

The final example on this is banking law. Banking law has always said that we don't regulate foreign banks; we regulate foreign banks that come to our jurisdiction. So we have always said — again, using my historical analogy — if you want to get on your horse and ride down to Buffalo and deal with a U.S. bank, you are on your own; right? If that U.S. bank crosses our border and begins carrying on business in Canada, then we expect it to comply with Canadian law.

Senator Ringuette: This thing has no borders.

Mr. Jason: Exactly — where is it occurring? The law is unique. Again, referencing my principles of law that have developed over many years, one of the principles of law is that we can't regulate extraterritorially.

Senator Ringuette: The United States.

Mr. Jason: Other than the United States. That is the common observation. My point is it is hard to envision how the regulation is going to work in respect of something that doesn't exist within national boundaries.

Senator Greene: We all realize around the table that the most important aspect of this development is not the bitcoin itself but the architecture around bitcoin. What the architecture represents is a new way to send information. It is a communications tool above all else. In the case of bitcoin, which is information, we have decided to assign that a value.

Given the architecture and the fact that when you use it, you are expressing something — to get back to basics — as we have mentioned before: What's the role of freedom of speech laws and freedom of expression laws in relation to this development?

Mr. Greenstone: I have to be honest with you. I have thought about this from many different aspects but not from a freedom of expression perspective.

Mr. Jason: It does raise an interesting question. As you say, and you know this much better than I do: What is the bitcoin technology? It is a trusted data. It is a system that says "This piece of data, the system assures you that that is accurate. That is the true and precise piece of data."

So that is why it has been able to be used as a currency because it says if you make the transfer, you can have confidence that that transfer has actually occurred. So the question you are posing is: If we regulate it, are we not essentially regulating people's right to communicate with one another?

Senator Greene: You can use the architecture for a lot of other things besides bitcoin.

Mr. Greenstone: You are saying it is a transfer of information, and it is, but it can be used to transfer any asset. In the bitcoin example, it is transferring a financial attribute from one party to another. But it can be used for transfer of any asset including, in theory, property. One of the new companies out there has talked about creating land registries, certainly not from a Canadian perspective, because we have those pretty well established, but you can imagine setting up a land registry in a country that doesn't currently keep track of who current owners are of individual parcels of land for far cheaper than it would be to set up what we consider a traditional system of a land registry. That's an easy example.

There are examples where people will be able to get into a rent-a-car, where the key for the car, since they're all electronic push buttons, will be sent to your cellphone. You will walk into a car with your cellphone and be able to start the car while you have it on rent.

There are multiple different technological applications to this block chain and how the transfer of information will be handled between parties. The currency transfer is just the beginning.

That's why I made my earlier comment that the block chain technology is here. Bitcoin is simply a proof of concept. It is the first most well-known, but it is simply a proof of concept of whether people will trust an anonymous network to transfer. Previously, if I wanted to make a payment to somebody, I either went through a bank and did it that way, or I would have to meet them and transfer to them cash or a commodity if I wanted to.

You can now transact and do business with people you have never met on the other side of the world without using an intermediary.

Senator Greene: It is a very interesting topic for sure, to which freedom of speech is a popular way to manage American affairs. Supreme Court judges especially are always looking to that, I think, and broadened it considerably. We don't as much in this country, but it strikes me that we shouldn't limit the technology because it does have aspects of freedom of speech. Do you have a comment?

Mr. Greenstone: There is other legislation that has recently been enacted in Canada which allegedly has the same restriction on freedoms, including Canada's anti-spam legislation, which has been subject to similar criticism in the past for its apparent or alleged restrictions on freedom of expression for businesses wanting to transfer and contact individuals. There is precedent.

Mr. Jason: The only comment I would make is, once again, it is balancing your competing objectives. As I say, we have a carefully crafted financial structure in this country that supports the economic well-being of the country. When that technology is used in that area, I think it is still legitimate to say are we negatively impacting other important objectives.

The Chair: Mr. Jason, might I go back to your first principle, certainty of value. As members of the committee know, a year ago, when we started this study, I purchased, for $100 Canadian, .18 bitcoin, which is now the equivalent of $53.32. You could buy a stock or many things that dropped in half, so bitcoin is not excluded from what might happen.

If you go back to your concept of certainty of value, in a decentralized system, which I understood until I walked into this meeting this morning, was a system not exchangeable into a fiat currency until I heard you use the term "pseudo fiat." I must say I hadn't heard that term before.

Is it your view that in a peer-to-peer system, which the decentralized system is, in which there is no third party, you can in effect evolve into some type of certainty of value through the block chain?

Mr. Jason: Time will tell. The technology argues you should be confident that the thing you hold is unique and of limited number — rarity and scarcity, like a commodity — and that eventually, if there's a big enough market, the value should start to fluctuate more smoothly.

The Bank of Canada does put in a fair amount of effort into managing the value of our currency. Now, as I say, the proponents of bitcoin would say, "We don't want that management of the currency; we want the market in and of itself to determine the value and not be impacted by other concerns or issues."

The answer is I don't know. Clearly now, where there are not enough people in the marketplace, my observation, which is not scientific at all, is that the value is really impacted by the day-to-day fluctuations of information. Just like with a stock when you get bad news, people tend to bail out of the stock.

Here, unfortunately, we had a lot of recurring bad news, so I think those people who would want to invest get nervous quite easily. It is unfortunately too new.

Mr. Greenstone: The only thing I would add to that is besides those risks that have been identified, the other risk, which we have not identified today, is the theoretical risk that somebody could acquire 50 per cent of the computing power behind the block chain. That is a theoretical risk that needs to be addressed because it goes to the longevity of bitcoin, the potential success of bitcoin on a go-forward basis.

In theory, someone in certain situations, potentially a country, could go and acquire 50 per cent of the computing power behind bitcoin. If you did, you would in theory be able to reverse certain uses of the bitcoin and double-spend it. At least that's the theory. That creates an additional concern to how far this can go and how comfortable people will continue to be with the block chain.

Senator Black: Mr. Greenstone, the recent Quebec approach to digital currencies, ATMs and Quebec's view of potential — an interpretation is regulation of bitcoin. Are you able to comment on that?

Mr. Greenstone: I'm sorry, can you rephrase the question?

Senator Black: Sure. Our understanding is Quebec has recently passed some regulations, policies, law — I'm not sure in which context — addressing digital currency in that province. Are you aware of that at all?

Mr. Greenstone: No.

Mr. Jason: I actually know what they have done. In fact, I wrote a blog on it last week.

Senator Black: Thank you.

Mr. Jason: Just to be clear, they already have a law on the books pre-existing that requires money service businesses to register and subject themselves to a certain amount of regulation.

The two things that that actually does, in order to obtain a licence, the Quebec government or the AMF does a background check and ascertains whether you are an honourable person, if I could say that, such that you don't have a criminal record. What they have essentially done is said, "Okay, if you are going to run an ATM machine that offers bitcoins, you need to register under that law, which means we do a background check."

Senator Black: The money services law.

Mr. Jason: The money services law, the same law. That means they will do a background check and determine that you are a fit and proper person before they allow you to operate the machine. It doesn't in any other way regulate the functioning of the machine or the bitcoin.

I might say it is a toe in the water. It deals with some of this exchange problem where people were setting up exchanges and doing it from the get-go for fraudulent purposes or whatever. It is just trying to keep the bad actors out of owning and operating those machines.

Senator Black: What is your view of that intervention?

Mr. Jason: Well, as I say, it was on my list as one of the things I think we need to think about, what I labelled as "security risk," where because this is innovative and entrepreneurial, it is going to attract all kinds of people, some good and some not so good.

One of the things you are going to have to think about is whether we need some way that we ascertain the fitness — in the banking world we call it "fit and proper." You can't get a bank in Canada unless the Government of Canada determines you are fit and proper. That's what it attempts to do.

Mr. Greenstone: I'm sorry; I wasn't sure which legislation you were referring to.

Senator Black: I wasn't clear.

Mr. Greenstone: I am familiar with the ATM piece of it. I agree wholeheartedly with Mr. Jason. It creates a system where to operate that ATM, you need to be registered.

The reason that is important is historically — and when I say "historically," it's a very short history, since 2008 — in order to obtain bitcoins, before the exchanges existed, if you really wanted to obtain bitcoins on your digital wallet, what was allegedly happening was people would be meeting somewhere and some person would exchange cash for bitcoins. That system has to be removed.

When we go back to some of the earlier questions about regulating bitcoins, we certainly do not want an environment where people feel free to walk around and exchange envelopes for electronic cash. Introducing a system where people can now obtain bitcoins in a system that is at least out in the open, such as an ATM, the person who owns the ATM being registered is a great first step to eliminating some of the bigger public policy concerns that are associated with money laundering and terrorist activities. Certainly this eliminates some of that anonymity.

Senator Black: Very helpful. Thank you both.

Senator Massicotte: About Quebec, I understood the wording that was issued in the press release to not only deal with ATMs but for anybody who does money exchange. If you create a wallet, I thought it also covered those parties; is that not the case?

Mr. Greenstone: That is not my understanding. My understanding is it doesn't restrict the individual. You can have on your cellphone a bitcoin wallet. My understanding is the legislation does not apply to that.

Mr. Jason: So there's the act itself and then they have a policy document that further explains who they expect to register. ATMs already have to register, the ones that deal with conventional cash. They amended the language around who has to register ATMs to include ATMs that issue digital currency. I think that was the only thing they have done so far.

Senator Massicotte: We talked about certainty of value. My impression of the witnesses we've heard from is they never said bitcoin would provide certainty of value. The only thing it does is give certainty of supply and the values that fluctuate with supply and demand. That's where you get a significant variation.

Let me go to Mr. Greenstone. You said earlier we should not deal in isolation, and I agree with what. As you are probably aware, New York, which is probably the world's financial centre, has issued two forms of discussion papers on what regulation they see, and in December they issued another one. They're about to issue what they consider their final piece after consultation with many experts in the field.

Are you aware of the proposed regulation? Do you agree with where they're going?

Mr. Greenstone: I have read the papers. I'm still not sure where they're headed, to be honest. There are multiple different views that are still expressed there, and where they will ultimately end up, I'm just not sure. I'm not certain at this point.

Senator Massicotte: Any comments, Mr. Jason?

Mr. Jason: Sorry, I'm not familiar enough with that.

Senator Massicotte: Talk to me about the banks. It is a big issue for the people involved in this business. The banks basically refuse to deal with them for good or bad reasons, probably competitive reasons. What's the solution? A lot of them say we can't expand and we can't get anywhere unless we resolve this issue, yet banks are independent players in our economy; you can't force them to do business with just anyone. What's the solution? What do you do there?

Mr. Greenstone: I don't have a solution for that.

Mr. Jason: I won't speak to whether they're doing it strictly because they're being anti-competitive, but I will give you background around the money laundering issue.

Banks are subject to money laundering laws, but in addition, the Office of the Superintendent of Financial Institutions has said to banks, "We don't want you to ever be a vehicle for money launderers." Regardless of what the specifics of the law say, OSFI has made it very clear that the overarching requirement should be to not allow yourself to become a vehicle for money laundering.

There has been so much in the press about the possibility of bitcoins being used as a vehicle for money laundering that the banks have reacted and said, "Okay, well, therefore, we can't bank them because there's too high a possibility that they will be money launderers, which will then result in us being —

Senator Massicotte: So what's the solution?

Mr. Jason: I think the solution would have to be, as the Government of Canada is doing, to introduce some level of anti-money laundering regulation that applies. What they have targeted is that point of entry, where the real currency comes in and goes back out, because they've determined that's most likely where the bad actor is going to exchange drug money into virtual currency, which they can then transfer pseudo anonymously. We have attacked that point.

Most of these companies that are having trouble getting banked are companies that want to be in that exchange business. The banks are saying, "Well, until you get regulated, I'm not comfortable with that."

Senator Massicotte: So in conclusion, six months from now when FINTRAC has issued the regulations and everybody adheres to it, do you think bankers will be open to do business with the money exchange?

Mr. Jason: Some will. Some will never get over this. I, at one time, was the chief compliance officer of the Bank of Montreal. The Bank of Montreal was known as a bank friendlier to money services businesses. Other banks were not. We had a bigger market, but at least we got over the threshold of saying the ones that were well regulated and can demonstrate to us that they had good anti-money laundering programs we will bank.

The final thought I'll leave you with is if the next thing that becomes interesting is companies that just decide that they will accept bitcoin and carry on their businesses in bitcoin. That means accept bitcoin as payment, make payment in bitcoin. So not the exchanges, but I'm a car manufacturer, what will the bank's attitude be there?

Then I'm not sure what you do if their attitude is, "Well, we have a similar concern because who knows where your bitcoins came from that you sold that car for."

The Chair: Thank you. Mr. Greenstone, Mr. Jason, we opened the discussion today by saying we are dealing with a very complicated subject. I regret to inform you that at the next meeting I suspect we will also be able to start by saying it continues to be a complicated subject, but I don't want in any way to take away from the tremendous help and information you have given us today in terms of our deliberations. We are very grateful for your appearance today. Thank you on behalf of all members of the committee.

To our viewers, in this second hour of our meeting we will focus on one of the digital currency platforms that were mentioned several times when the committee travelled to New York earlier this month.

Today I am pleased to welcome, via video conference from Ripple Labs, Greg Kidd, Chief Risk Officer. Ripple Labs is the creator of the Ripple protocol, which interconnects the world's financial systems to enable secure and instant payments in any currency. Ripple also has its own native digital currency called XRP. Ripple is often referred to as the second-most popular digital currency platform behind what was referred to in our last meeting as the "Kleenex" of virtual currency, bitcoin.

I would like to bring to your attention an article from written by Anthony Lewis on May 11, 2014. The title of the article reads "Ripple explained: Medieval Banking with a Digital Twist." Not exactly self-explanatory.

So to explain what Ripple is and how it relates to our study, I now turn the floor over to Mr. Kidd to make his opening statement. Thank you for joining us, sir, the floor is yours.

Greg Kidd, Chief Risk Officer, Ripple Labs: Thank you. Chairman Gerstein, deputy chair and members of the committee, my name is Greg Kidd, and I am the Chief Risk Officer of Ripple Labs, a technology company that builds payment tools for financial institutions.

Previously I worked on payment systems at the United States Federal Reserve and advised financial institutions on risk and governance.

I greatly appreciate the opportunity to meet with you today. I commend your leadership in investigating virtual currencies and other emerging technologies. I'm pleased to offer an overview of Ripple and address any questions you may have.

Ripple Labs is based in San Francisco. It employs a team of 95 men and women with experience in government and regulation, finance and technology. Their previous experience includes the Federal Reserve, U.S. Securities and Exchange Commission, the NSA, Goldman Sachs, Deloitte, Apple and Google. Our goal is to create faster, safer and more efficient payment systems domestically and across international borders.

In my view, a large portion of today's inefficiencies in payments stem from antiquated infrastructure. In many countries, the technology underpinning payments was last updated in the 1970s and was not designed with interoperability in mind. Because systems are not compatible, banks have to rely on a patchwork of intermediaries to move funds — a process which introduces risks, delays and costs.

Ripple Labs aims to improve payments by offering modern, interoperable payment infrastructure for registered financial institutions, clearing houses and central banks. As Ripple is a payment technology for financial institutions, consumers may never know their transactions are being sent through Ripple, just as they have little to no knowledge of the ACH and wire rails that facilitate their payments today.

Our technology is designed to minimize payment and counterparty risk, reduce costs and enable connectivity between banks and payment networks.

Before discussing the technology we use, I want to highlight that Ripple's technology fully complements existing regulations. When using Ripple, a financial institution's responsibility for OFAC reporting, anti-money laundering, compliance, "know your customer" requirements and other regulatory reporting stays fully intact, just as with existing payment rails. This reflects Ripple Labs' view that ensuring robust security, consumer protections and safety are crucial as we move toward improving payment systems.

I would like to highlight two aspects of Ripple technology that are most relevant to the committee's work: a shared ledger and a virtual currency.

At the core of a financial institution is its ledger, which is used to keep track of all the customers' balances. As each bank and payment system has its own ledger, they must rely on intermediaries or clearinghouses to make payments across different ledgers. This process adds delays, costs and risks to payments.

Ripple uses a shared ledger that enables transactions to be completed in real time, 24/7, 365 days a year, direct from the sending to the receiving bank. This eliminates intermediaries and minimizes risks and costs.

While today's systems require regulators to piece together several banks' ledgers to track funds, Ripple's shared ledger stores all payment records in one location, giving complete visibility into transactions and vastly improving traceability. Ripple's shared ledger enables greater transparency and more direct, point-to-point payments, improving banks' compliance capabilities and supporting regulators in their anti-money laundering efforts.

In addition to the ledger, Ripple utilizes a virtual currency, referred to as XRP, but in a very different way than most virtual currencies are being used today.

As your previous hearings have noted, a majority of virtual currencies are marketed to consumers to be used as means of exchange and a store of value. This poses serious liquidity, volatility and security risks for consumers.

Within Ripple, XRP is used very differently, as a security mechanism and as an optional bridge between currencies. Each financial institution that uses Ripple is required to hold a small reserve of XRPs to be used as a postage stamp on transactions. With each transaction, a portion of XRP is destroyed, typically equating to a tiny fraction of a cent. This imposes a small cost on transactions, yet makes overwhelming the network with illicit traffic or a denial-of-service attack prohibitively expensive. In this way, XRP helps secure the network from attack and ensures its resiliency and reliability.

The other use case for XRP is as an optional bridge between currencies. If a bank needs to make a payment for a customer to a recipient in another country, the bank may choose to use XRP as a low-cost, efficient bridge between sending and receiving currencies. XRP lowers the reserve requirements for making cross-border payments. However, use of XRP as a bridge currency is entirely optional; a bank can freely choose to transact only in fiat currencies.

In your investigations and ultimate regulations on virtual currencies, I strongly urge the committee to consider these alternative use cases for virtual currencies and related technology. As this sector continues to mature, I trust that there will be additional innovative use cases for these technologies, many of which offer benefits to payment systems. Regulations should account for the varying use cases to ensure Canadian banks and consumers can realize their benefits.

In summary, Ripple's technology allows banks to provide customers faster, cheaper and safer payments to countries it previously could not access. Ripple does so while fully complementing and supporting regulatory compliance.

I hope these comments are helpful in understanding Ripple. Thank you for your time, and I am happy to address any questions.

The Chair: Thank you very much, Mr. Kidd, for your opening statement. Could I start by asking you to describe to the committee a little more about what Ripple is? It's obviously a company. It has been in business for how long? It is now currently handling transactions for banks and other currencies around the world. Could you give us a little more background as to Ripple?

Mr. Kidd: Sure. Ripple is a very traditional, Silicon Valley-backed, venture capital-backed company. It has raised money from the likes of Google and recently Horowitz, IDG, the Chinese. It has raised about $30 million in venture capital so far in announced rounds. As I mentioned, there are 95 folks.

So it is a company that has mostly engineers working on building this protocol. Again, to think about the protocol, if bitcoin is like one big ledger, where everybody's amount of bitcoin is in that ledger, Ripple is the same except the ledger includes every form of currency. Instead of just holding bitcoin balances or XRP balances, think of it as one large spreadsheet that everybody can see and use, but the balances also include fiat currencies. It could also include commodities, such as gold and silver.

The part that is like bitcoin is that there is a distributed ledger. Most of the engineers here are sort of ex-bitcoiners. It's just that they extended the protocol to include all currencies rather than simply the bitcoin. It also allows the use of market makers, people that are willing to trade from one currency to another, to actually operate within the protocol. That's the big innovation here, sort of a 2.0 innovation to allow a distributed-ledger virtual currency, but operating right alongside fiat currency as well.

The Chair: How long has the company been in business? You are operating now. For example, are you handling transactions for Canadian chartered banks at this point?

Mr. Kidd: We're not handling transactions for Canadian chartered banks, so there is no Canadian bank on the protocol. There may be Canadian citizens using the protocol through other intermediaries. Ripple Labs has been in existence for three years. There's a site you can go to, called Ripple Charts, and you can see the volume of transactions going through and all the different currencies, day in and day out. There are millions of dollars of transactions being moved each day already on the protocol.

The Chair: Thank you very much. I will go to my list of questioners, starting with Senator Black.

Senator Black: Thank you very much, sir, for being available. It's fascinating. Congratulations to you and your colleagues for what you're doing.

We have heard very interesting testimony throughout the last number of months that the exciting thing about the block chain and bitcoin is that it's new technology and we will see evolutions beyond that. Is your evidence that Ripple is an evolution of bitcoin?

Mr. Kidd: I would call it an evolution. It draws on the same cryptographic technology of a public-private key. It draws on the concept of a distributed ledger. It works a little bit differently as to how we reach the state of the ledger. In bitcoin, there's what's called a proof of work. In Ripple, it's called consensus. It's based more around voting. But the concept of a distributed ledger is really the same. Again, the innovation here is the ability to hold other stores of value besides bitcoin on the ledger.

Senator Black: Right. So if you're example A of this evolution, we would expect to see further evolutions along this line?

Mr. Kidd: We do. Some of the exciting further evolutions we expect to see are things like using this like a title registry — and this could be for both bitcoin and Ripple — for simply taking things like a title in property, or your car, and having that securely stored in a decentralized ledger that everyone can see. There has also been the discussion of smart contracts — the ability of people to write contracts that have just a set of automatic rules that are entirely readable and operatable by computers without human intervention.

Senator Black: That would not be good for lawyers, Mr. Kidd. At any rate, we digress.

Mr. Kidd: Lawyers would be working with decoders to write those contracts.

Senator Black: Perfect. Is your technology based on the block chain?

Mr. Kidd: It's based on the same type of logic as the block chain, but Ripple is its own form. Again, we call it consensus rather than proof of work. We basically just call it the ledger because there are subtle differences between the way block chain works, but there is a common source of DNA between the two.

Senator Black: Okay. I just want to understand what you have said. Would I understand that to be that you have evolved the block chain to meet the needs of Ripple?

Mr. Kidd: It hasn't been an evolution of the block chain. There is a different system. It's called consensus. When a new transaction happens on Ripple, every three to five seconds, all of the different servers in the network negotiate and figure out whether they can agree whether those transactions are valid. Some of those servers are more trusted than others, so it is actually a voting process to figure out whether the ledger is updated. So that happens in three to five seconds. All of the new transactions that come in are analyzed by the entire network, with some basically carrying a greater weighting than others. That allows very fast confirmation of the transactions. In bitcoin, it can take eight minutes or more to have final confirmation. Ripple has focused on basically achieving a real-time status, and that requires a different algorithm.

Senator Black: I see, okay. If I wanted to do a transaction in bitcoin between here and Somalia, just pretend, could I use the Ripple network to do that?

Mr. Kidd: Yes, Ripple will allow it. It won't know that it's going to Somalia because there's no concept of geography in either of the technologies.

Senator Black: But you could do bitcoin?

Mr. Kidd: You could hold bitcoin on the Ripple ledger, just like you can hold Canadian dollars.

Senator Black: I see. Thank you.

Senator Massicotte: Thank you, Mr. Kidd, for being with us this morning. Very useful. Just to clarify, only banks are allowed to deal with your system?

Mr. Kidd: It's a protocol, so anybody can basically use the protocol, but what we're doing is working with banks on the Internet. The Internet is open to everybody, but people build virtual private networks. So banks can use the technology to build their own private bank-to-bank solutions with the technology.

Senator Massicotte: Given that it's so efficient timing-wise and money-wise, why couldn't this evolve to eventually allow anybody to do a transaction, including a currency transaction?

Mr. Kidd: Anybody can do that. The technology already enables that. Anybody can build on top of the protocol. Think of the technology the way that SMTP allows any two email systems to be connected together. Even though there are many different email systems, some run by big companies and some run by very small, independent operators, they can all speak the same language. But some email systems and networks may decide to be closed. They might have a closed network, but they can all use the same protocol technology to have the technical opportunity to interoperate. If you have rules that say, "We only choose to operate with certain people in a particular club," you can build your own sub-domains within the greater footprint of the overall protocol technology.

Senator Massicotte: That being the case, let's fast forward six months or two years. Given that this is available to anybody, democratize the whole system. Given that it's so inexpensive, won't this change the dynamics of the marketplace, whereby competition will be such that the existing system, which is based upon old infrastructure, as you noted in your presentation, would become quickly obsolete? The banks won't have to spend millions and millions of dollars getting there. They should actually offer your type of system or another competitor, and those conversion costs, those transfer costs, should go down dramatically within the next two or three years; is that accurate?

Mr. Kidd: They don't actually have to ask our permission. We actually just offer a consultancy service if they want to work with us, but they don't need our permission to use the protocol. The protocol is open source. It's free to anyone to use. I'm just back from visits with a number of central banks in Europe, also sitting down with the banks in those countries. This is something that they could simply swap out. Think of this as technology that just allows their settlement systems to operate 24/7, 365 days a year as opposed to, like I said, us being open for bankers' hours. This would be a technology that would allow people to reach settlement all day long, just with a common shared ledger between all of the actors.

It's something that you could just swap out that's very far down the stack, while keeping your existing rules in place. It isn't necessarily a huge disruption to their existing investments in technology. This is just swapping out the very lowest layer to something that is real-time and 24/7.

Senator Massicotte: As opposed to each bank and, more importantly, each country having their own payment systems when they do the transfers. This could replace all of that very quickly; is my understanding correct?

Mr. Kidd: Think about it this way: Back in the days of email, there used to be CompuServe and AOL. They all had their little internal networks. The problem was always what happened when you wanted to send email from AOL to CompuServe. There had to be something in between that would be like a translator. You could build those bridges one at a time. This provides a common bridge that everyone could plug into. So it's not that they're going to give up their existing systems. This is just a way of connecting all of the existing systems together, just more efficiently.

Senator Massicotte: In your presentation, you also talked about your system basically discouraging illicit trade. You made a reference to XRP, which is your former currency. It sounds like an iShare, actually, given the symbol. That being the case, how do you discourage illicit trade? How do you make sure it doesn't happen as we saw with bitcoins?

Mr. Kidd: I've worked in the AML, KYC, BSA arena, and the great frustration of working with existing systems in place today is that each financial institution has its own silo of information on its KYC details and also on the transactions that it sees on its side of its ledger. So when you're really trying to catch actors, it's super helpful to see transactions moving across the ledger. You want to basically be able to follow the money wherever it goes. So the concept of having a common ledger that will have transactions from both the sender and receiver makes, from an investigatory and suspicious-activity reporting and analysis point of view, hugely better and more leveraged because you have that ability to see that total picture of the flow of the transaction. That's really transformation. If you were a bad guy and you knew you were putting your transactions through a system in which an analyst was looking at things end to end, it's not a great place to be a bad actor.

Senator Massicotte: I must admit I'm really impressed with the technology. You're taking the technology and making it much more efficient and safer, but, if, two years from now we find out that the Ripple doesn't exist, what's the threat to the system? What could go wrong where this is not involved as you're projecting it will be?

Mr. Kidd: Let me be very clear: The company Ripple could go away tomorrow, but that will not have any impact on the Ripple protocol. The Ripple protocol is like TCIP for the Internet or SMS for text messaging. There is no SMS company that makes text messaging between telephone companies possible. It really is just a set of technical protocols, just like SMTP is for email. There doesn't need to be a Ripple company for the Ripple protocol to survive and thrive. It's already out there.

Senator Massicotte: On that same note, the technology per se is so convincing, but, as we all know, a lot of things don't happen. What is it that could threaten and be why this does not evolve to be a much more efficient way for the world to transact?

Mr. Kidd: The biggest challenge is regulation. It's companies and governments getting together and finding that they're not comfortable with this. Even though the technology works, they make use of the technology either illegal or so ambiguous and uncertain that it doesn't feel safe to work with anything built on top of it.

Senator Massicotte: Our committee is principally meeting to debate the issue of whether we should recommend regulation affecting crypto-currency. From your stand point, what should we do to make sure that what you just said does not occur? Should we implement new regulation?

Mr. Kidd: It doesn't need to necessarily be new regulation, but the regulation has to cover the fact that there could be a new way of moving money, which is a distributed ledger as opposed to relying on nation-based, centralized ledgers. So it just needs to anticipate that there are new ways technologically to think about moving money both within a country and between countries and that you don't have to rely on centralized ledgers run by a single actor but you could have a decentralized solution for moving money much the way that you have a decentralized solution for moving emails and pictures and music around on the Internet.

We absolutely want regulation. We want strong regulation. The key thing is to have clarity. The biggest stopper right now is people don't know where they stand in terms of what regulation does and does not cover. We need clarity.

Senator Massicotte: What do you think of the regulation being considered in New York relative to crypto-currency?

Mr. Kidd: The great thing about that is there's been a dialogue. The initial path of the regulation was pretty unworkable. However, there has been tremendous movement forward to actually try to understand what is different about virtual currency but also what is the same. In some places they have removed some of the strictures that were basically placed an unmanageable or unachievable burden on virtual currency companies that no other financial institution has. They basically have levelled the playing field.

They have also made a distinction between what it means to be a custodian of virtual currencies versus a wallet which may never actually be a custodian of any of the funds but may basically serve as a browser for your money. There is also a concept of materiality in the New York legislation. There's a grace period for small companies getting started, sort of regulation-light. All that indicates there's sensitivity and there's clarity. I would highly predict that the companies that are funded and are willing to move in this space are going to move to get that bit licence and basically set up shop in New York.


Senator Bellemare: Thank you for your very interesting presentation. I would like to talk a bit about the way in which Ripple Labs makes its money. We know that with bitcoin, miners are remunerated based on the production of this digital currency. You produce XRPs. Is it the same situation, with miners who are dispersed all over geographically, or is it Ripple Labs, the company, that produces the XRPs? That is the first clarification I would like to obtain from you.

I would also like you to tell us more about the use of the XRPs, because you say that you use them in a different way. What I understand is that this is how you are paid; you make XRPs disappear, and so somewhere you charge fees in the context of their use. If you could put that in perspective for me in your decentralized system, this would allow me to understand the difference between the digital money we are now going to describe as "classic", the bitcoin, and what you do at Ripple Labs.


Mr. Kidd: One of the issues with bitcoin mining is it's extremely economically expensive to mine bitcoin. There's a lot of money spent on the hardware and a lot of electricity being wasted mining bitcoins. It created a way of basically equitably allocating bitcoin. It was interesting from an economic point of view; it has, unfortunately, practically become a very expensive mechanism to run a currency and payment system.

Ripple did not go down that path. In Ripple a number of founders created in the protocol 100 billion XRP and essentially gifted that to the company. The company is not able to create more XRP. It simply has what it got from the beginning of time. It started with about 80 billion of those. Some of the other 20 billion have been given to charity, but basically think of Ripple Labs as a combination between a central bank and a sovereign wealth fund. It has a finite number of XRP and it can give those out to help get the network started. If we give them all away then they're no longer there.

If they rise in value then the company has that value on its balance sheet and that has been very helpful for us, basically, because the XRP have gone up in value so we've been able to sponsor a number of R&D efforts with that digital currency.

On the business model about how Ripple actually makes money, if you are familiar with the company Red Hat which takes Linux, which is an open-source protocol, and helps package that up and train and provide support to corporations, that's very much Ripple's model. We would help financial institutions basically adopt, integrate, use and support the Ripple protocol. They don't have to use us. There's no tie-up, just that we have probably more experience with the protocol than anyone else.

We do not get paid for transactions that happen on the Ripple network. As mentioned before, there's a very small fee, but that isn't a fee that's collected by us or anybody else, it's simply a fee to discourage, say, a spammer from going onto the network and making millions and millions of small value or no value transactions.

It does create a slight deflationary impact on the overall XRP balance but it really is negligible. At the rate it's at it wouldn't have an impact for several thousand years. That's really the piece there.

Did I address all your questions? Were there more questions?


Senator Bellemare: It was about the decentralized network; could you expand on that concept a bit?


Mr. Kidd: While there's one ledger, think of that like there's one overall position of where everybody stands. That one ledger doesn't sit on one computer. There are multiple copies of it running all around. Each of those ledgers has to stay synced up so when a new transaction comes they have to compare and see whether they all trust and believe in that transaction and not a bunch of bad transactions are being sent in through just one particular server.

If one particular node on the network seems to be producing a lot of transactions that the other nodes don't trust, they can decide to ignore that node. It is very important there be decentralization so that only transactions trusted by a plurality of servers are then validated.

As you can imagine when financial institutions work with us, certain financial institutions trust other financial institutions and they would basically create a network of trust. The actual users of the protocol themselves have to decide who else they trust. It is basically a plurality of trust that stamps the ledger as true and accepted by the plurality.


Senator Bellemare: So there is no puzzle, in that case. With bitcoin, there is a puzzle to be solved, and the one who comes up with the solution the quickest obtains the reward. This does not exist in your protocol.


Mr. Kidd: With Ripple there's a cycle of activity that happens at least every three to five seconds or more frequently depending if there's a volume of transactions. It's simply like a meeting among all the servers to decide which transactions are going to be promoted and accepted on the ledger. It's not a speed-type exercise as with bitcoin.


Senator Bellemare: Can you give us an idea of the value of the XRP, currently, in American dollars?


Mr. Kidd: Today I think it's worth 1.3 cents, so it's worth a little bit more than a yen. The current value of the Ripple network with 100 billion is roughly like $1.3 billion.

The Chair: To pursue Senator Bellemare's question, as I understand it, sir, in the block chain the reward goes to the miners based on this system they have. Where is the revenue stream for Ripple? Is it the consulting contracts you're talking about and your work with various financial institutions? Is that where your revenue will evolve from? As I understand it, it doesn't happen from the transactions.

Mr. Kidd: That's right. It is just from consulting folks on adapting the protocol. There's a number of other consulting firms, like McKenzie and whatnot, that have also decided they want to become experts. Just like for Stas, the German company, many folks now consult on how to do a Statistical Analysis System, SAS, implementation.

The Chair: Thank you.

Senator Massicotte: On the last question relative to your business plan, you say you make the money for transactions. All you offer is basically consulting expertise. Is that really the game? You have $30 million from venture capitalists who obviously expect to make a good return and you're telling me that they basically invested in a consulting company only?

Mr. Kidd: We also have the XRP on our balance sheet. That's currently worth upwards of $1 billion now. That's like a one-time resource. It is like being Saudi Arabia and having oil in the ground. If you spend it all now, you won't have it in the future. Also, it does not mean that there are no other consultancy or service revenues.

For instance, we have been talking all about the settlement technology. We are starting a spin-off company that focuses completely on identity and basically identity solutions. It would allow for the first time a portability of identity. Someone who is using virtual or even traditional currencies could basically KYC up, be attested to by the folks and the likes of Xperia and instead of having to re-KYC for every institution you go to, you could take that as a portable identity.

Wherever you go, you can show up and be already KYC'd. You would simply log in and be known and trusted. With you would flow your balances. In this world, if there's a single ledger and you are a user with funds on that ledger, you should be able to take those funds with you wherever you go.

It is sort of an open debate. There may be more money in the whole identity layer, which provides assurance that the actors are who they say they are and that they are money-good funds. That may be a business in and of itself.

That, too, is a second possible revenue stream for Ripple Labs or a subsidiary of Ripple Labs.

Senator Massicotte: You referred to the whole protocol of consensus relative to the other service. Is it 51 per cent? What's the minimum approval rate you must get to accept a transaction?

Mr. Kidd: Currently, I believe, and the technologists are better at this than I am, there's an 80 per cent threshold on consensus, but it is not just for approving transactions. If there're changes to the protocol, there's a process by which the different validating nodes have to negotiate to decide that this is the new mainstream reality and any other forks or nodes are left behind.

Senator Massicotte: Nobody can manipulate the system when one player controls 80 per cent.

Mr. Kidd: That's like saying in a democracy nobody can manipulate who gets elected. It is a system that relies on human frailty. For a conspiracy, you would have to get enough folks together. You have to remember that if there were a conspiracy, they would end up probably harming only themselves. They could basically cause the ledger to look a certain way. But if everyone loses faith in that fork of the ledger, then because this is open-source software, they will take a copy of the ledger where it was before this bad behaviour happened and say, "That's the last ledger we trust. We're not going to follow this conspiracy group anymore."

The remediation is the same as it would be in any democratic solution. It is a voting solution, and people will vote with their feet. Conspiracies can happen, but in this case our belief is that it would be self-defeating.

Senator Bellemare: I'm fascinated by this topic and what you presented to us. Usually we create value with raw material, manufacturing or human services. What we are discovering now is that this technology is a way to create value. In my mind it is a hypothesis that I want to verify by asking you a discreet question. You said that you employ 25 men and women. Could you disclose for us an idea of the average earnings of those employees?

Mr. Kidd: The number is 95. But I don't know the average earning. We basically pay the same rates that are pretty much the norm in Silicon Valley. We're not above or below market. I don't know what the average rate is.

Senator Bellemare: Do you have any idea of it per year?

Mr. Kidd: I'm sorry, I don't know because I don't have access to that information. Anything about the protocol or Ripple, I'm happy to answer.

Senator Bellemare: Thank you.

The Chair: Mr. Kidd, thank you on behalf of all members of the Banking Committee. You have been very helpful on shedding a little more light on this subject we are pursuing with great zeal. It's complicated but you have been very helpful. Thank you very much for appearing before us today.

Mr. Kidd: Please come out to visit. We love visitors.

The Chair: This meeting is concluded.

(The committee adjourned.)

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