Coinsquare Capital Markets Inc. (“Coinsquare”) is offering crypto contracts to purchase and sell Ethereum in reliance on a prospectus exemption granted by the Canadian Securities Administrators (CSA) in the exemptive relief decision dated October 12, 2022. The statutory rights of action for damages and the right of rescission in section 130.1 of the Securities Act (Ontario) and similar legislation in the other CSA jurisdictions do not apply in respect of a misrepresentation in this statement to the extent that a crypto contract is distributed under the above-noted prospectus relief.
No securities regulatory authority in Canada or any other jurisdiction has expressed an opinion about any of the crypto assets (or crypto contracts) that are available through Coinsquare’s platform, including an opinion that the crypto assets are not themselves securities and/or derivatives.
Coinsquare has compiled the information contained in this Crypto Asset Statement to the best of its ability based on publicly available information.
Ethereum is a blockchain platform, which is open-source, that has its own cryptocurrency, called ETH (or Ether). The Ethereum Network is often used for the creation and transaction of ERC20 tokens, controlled by parties outside of the Ethereum development team. ERC20 refers to a scripting standard that dictates a number of rules and actions that an Ethereum token or smart contract must follow and steps to be able to implement it. Additional standards exist for NFTs and other token types on the Ethereum network. Ethereum’s cryptocurrency Ether is currently second in value to Bitcoin.
Vitalik Buterin created Ethereum after developers weakened his beloved World of Warcraft character. “On that day I realized what horrors centralized services can bring,” he wrote on his tell-all blog. He eventually launched ethereum at 21 years old in 2015. The platform was created to allow developers to build and publish smart contracts and decentralized applications, which may be used without the risk of any fraud, downtime, or interference by a third party due to its decentralized nature.
As with all assets, investing in Ethereum is not without some general risks. Many of these risks are identified and explained in our Risk Statement.
The relevant sections in the Risk Statement are as follows:
Platform Risk, Short History Risk, Price Volatility, Potential Decrease in Global Demand for Digital Assets, Potential for Illiquid Markets, Transfers of Digital Assets are Irreversible, Concentration Risks, Uncertainty in Regulation, Financial Institutions May Refuse to Support Transactions Involving Digital Assets, Digital Assets’ Blockchain May Temporarily or Permanently Fork and/or Split, Cyber-Security Risk, Airdrops, Issues with Cryptography Underlying Digital Asset Networks, Internet Risk, Open Loop System, Risk if Entity Gains a 51% Share of Digital Asset Network, Possible Increase in Transaction Fees, Possible Increase in Service Fees, Limited Canadian Investor Protection Fund Account, No Voting Rights, Custody of Digital Assets, Custody Risk Insurance, Threats to Coinsquare’s Physical Assets, Covid-19 Outbreak, Use of Leverage, Halting, Suspending, and Discontinuing Digital Assets.
In addition to the general risks, we outline some risks that are specific to Ethereum below. While we make an effort to identify every source of risk, we encourage you to do your own research and ensure you are comfortable investing in Ethereum.
As the creator of Ethereum, Vitalik Buterin had significant control of Ethereum in its early stages. Even as the network grew and became increasingly decentralized through distributed token ownership, node dispersion, and distributed development, Vitalik’s vision typically remained influential and guided most changes to the network. Recently, Vitalik has claimed that his influence on the network is diminishing, indicating increased decentralization. However, the diminishing influence also means that changes to the Ethereum network are slower and take more persuasion of various parties.1 Slower changes could lead to delays in important developments in the Ethereum network. Conversely, significant influence from a single entity shows signs of centralization and could be harmful to the network if that entity ever acts in a way that is not in the best interests of the network. Both scenarios have impacts for the network and ETH’s token value, and should be considered by investors.
Part of Vitalik Buterin’s vision for Ethereum is a phased upgrade to proof-of-stake consensus, increasing throughput and scalability of the network. This plan was originally named Ethereum 2.0, but has recently been rebranded as Ethereum Upgrades by the Ethereum Foundation.2 These upgrades are very complex and require considerable development from contributors to the Ethereum ecosystem. Additionally, different layer 2 solutions are being developed by organizations like Polygon, Loopring, Arbitrum, Optimism, and others, to provide solutions to increase the throughput of Ethereum and reduced fees through sidechains, zero-knowledge rollups, and optimistic rollups. Eventually, some of these layer 2 solutions will be adopted and integrated into the Ethereum network through sharding, which will break the Ethereum chain into multiple shards. However, the planned upgrades have experienced significant delays. Originally, the upgrades were expected to complete in June 2022, however the network is still in the early stages of upgrading the network and has revised completion to sometime in 2023 or 2024.2, 3 These significant delays may impact market sentiment and ETH token price as other networks with superior throughput and lower fees continue to consume market share from Ethereum. Investors should be mindful of the timeline and roadmap for Ethereum Upgrades when evaluating ETH.
Additionally, as described, the planned upgrades to the Ethereum are significant and extensive. The introduction of proof-of-stake consensus, protocol changes to enhance security, and eventual sharding to integrate scaling solutions introduces multiple sources of complexity to the Ethereum network and its code. To combat this, Ethereum developers have been actively working to de-complexify these concepts and develop solutions that allow upgrades with the least amount of technical complexity possible.4 However, investors should consider that all of the upgrades to Ethereum, and the forks that will be necessary to implement them, will introduce more complexity to the Ethereum network which could have an effect on it’s usability, it’s market sentiment, and ultimately its token price.
As with staking any crypto asset, staking ETH is not without risk. Many of the risks of staking ETH are explained in our Risk Statement https://coinsquare.com/en-ca/ccml-rsa/
in the following sections:
What is Staking, How Does Coinsquare Help You Earn Staking Rewards?, Validators, Custody, Slashing, Unbonding Periods, Rewards, Fees, Risks Related to Staking, Reliance on third party vendors, Slashing and missed rewards, Due diligence on validators may be insufficient, Illiquidity during unbonding periods, Due diligence on Digital Assets may be insufficient, Short History risk.
In addition to these general staking risks, we outline some information and risks that are more specific to ETH below.
Since the Merge, Ethereum now uses a consensus mechanism to achieve distributed consensus in a proof-of-stake (PoS) protocol. The PoS mechanism relies on third-party validator nodes to verify transactions included in each new block. Validators are incentivized with ETH rewards in exchange for verifying transactions. To ensure compliance with the protocol rules, validators must “stake” assets, thus risking loss of the staked asset should the validator fail to comply with the rules of the blockchain (a penalization process called “slashing”).
PoS networks allow for users to participate in staking by operating a validator node. ETH holders may stake their assets with a validator to earn rewards for securing the network. These staked assets are moved from the original location to a smart contract on the Ethereum Beacon Chain, from which they are used to create a new validator. The creation of a new Ethereum validator requires 32 ETH, which means that Coinsquare pools ETH assets from various clients and may contribute some of its own ETH assets to compile the necessary 32 ETH to create a new validator. Once a validator verifies a block of transactions and earns rewards, Coinsquare receives a net reward and splits the ETH reward proportionally to each client that has any assets staked within that validator.
Coinsquare provides staking functionality for users in respect of ETH, allowing users to stake their ETH with validators and earn the apdeplicable staking rewards. However, there are various risks associated with staking and such risks are in addition to the generalized risks pertaining to ETH described below, all of which continue to apply to ETH staked through the Coinsquare platform.
Validators are network node operators that verify the accuracy of data being recorded on the blockchain. Validators are typically rewarded in crypto assets for their transaction confirmation activities and the reward is based on the number of validators operating on the network. The size of rewards is generally inversely proportional to the number of validators on the network. The rewards payable to validators are automatically calculated by the Ethereum Network, and validators are paid when staking rewards are distributed.
Currently, the third-party service provider we use is our custodian, BitGo. BitGo is regulated as a trust company under the Division of Banking in South Dakota. Pursuant to Coinsquare’s relationship with BitGo, BitGo may act as the validator in respect of staked crypto assets or may select a third-party service provider to act as the validator. BitGo currently has a contractual relationship with Figment, whereby Figment acts as validator for the crypto assets stored in Coinsquare’s custodial wallets with BitGo. Headquartered in Toronto, Figment is one of the world’s largest blockchain infrastructure and services providers.
In PoS Ethereum, time is divided into “slots” of 12 seconds. 32 slots equal 1 epoch (approximately 6.4 minutes). Each slot may or may not have a block in it. The total number of validators is split up in committees and one or more individual committees are responsible to attest to each slot. One validator from the committee is randomly chosen to be the aggregator, while the other validators are attesting. The selected validator is responsible for the creation of a new block and distributing it to other nodes on the Ethereum network. After each epoch, the validators are mixed and merged to new committees. There is a minimum of 128 validators per committee.
Once staking is initiated, a validator enters a queue to become “activated”. Once initiated, the network acknowledges the ETH to be deposited to the staking smart contract. Once completed, the ETH deposit is officially accessible to the Beacon Chain and remains in a “pending state” until activated. Since only four validators are activated per epoch, activation may take days or even weeks to complete. Once activated, the validator begins accruing rewards for securing the network.
Withdrawing staked ETH or rewards from a validator is not supported until the completion of the Shanghai upgrade. Once the Shanghai upgrade is completed, it will be possible to withdraw all or some of one’s stake (“unbonding”). Similar to the activation of a validator, a queue will be formed for users attempting to unbond their stake and withdraw their assets. This queue is estimated to consist of 6 validators per epoch.
The Ethereum network issues staking rewards from user fees paid to the network and with the distribution of newly issued ETH. The current post-Merge inflation rate is 0.49%.
Ethereum computes and issues staking rewards once per epoch. Any accrued rewards in a given epoch are issued in the first block of the subsequent epoch. When rewards are received, Coinsquare will provide statements to users indicating the amount of the rewards that the user is entitled to as well as the total rewards that were earned and any fees payable.
Coinsquare’s staking service is designed to automatically stake any rewards (“auto re-staking”) that are earned by clients through the staking service. This means that when rewards are distributed to any client account, those rewards immediately enter that network’s bonding period. Once the bonding period is complete, the rewarded amount joins the pre-existing staked balance to earn rewards through the staking service. Currently, Coinsquare does not offer the ability for clients to opt out of the reward auto re-staking mechanism. However, if a client withdraws enough of their staked balance, causing the total staked amount to fall below the minimum stake amount for that asset, no rewards earned from then onwards will be automatically staked and instead will be credited to the client’s unstated holdings. Any assets that were in the bonding period when the staked amount fell below the minimum amount will enter the unbonding period immediately upon completing the bonding period, after which it will be added to that client’s unstaked holdings.
The estimated rewards percentage that appears throughout the Coinsquare app is a calculated annual percentage yield (APY) rate, which is derived from an APY rate that reported to us from our Staking partner, BitGo. The reported rate is then reduced by Bitgo’s fee and Coinsquare’s fee, leaving the estimated rewards percentage that is displayed to in the app. The displayed rate is approximately what you can expect to earn by staking the asset, but is subject to fluctuations based on various factors for each network. Coinsquare evaluates the net rewards paid to clients against the calculated and displayed estimated rewards percentage on an ongoing basis, at least quarterly.
Each crypto asset for which Coinsquare provides staking services is subject to specific fees because of the unique nature of each blockchain network. These fees are calculated on a percentage basis in relation to the amount of rewards earned (as more fully described in our fee schedule https://coinsquare.com/en-ca/ccml-fs/).
Coinsquare receives gross ETH rewards from its Custodian, BitGo. This means that BitGo’s fees are not removed on-chain from the total amount earned by the validator before the net amount is distributed to CCML, which is unlike most of the other assets offered for staking through the Coinsquare platform. CCML removes the fee as per our agreement with BitGo, then also removes the CCML fee as explained below, and distributes the remaining amount proportionally to each user that had assets staked for the entirety of the period in which the rewards were earned. BitGo’s fees are paid from CCML to BitGo on a monthly basis, equating to 9% of the gross rewards.
With respect to any rewards earned on your staked ETH: (i) Coinsquare’s custodian, BitGo, will be entitled to a fee (as described above) and may pay a portion of that fee to any third-party service provider it selects to act as validator; (ii) any remaining portion of the rewards (the “Net Rewards”) will be delivered to one of Coinsquare’s custodial wallets with BitGo; (iii) Coinsquare will be entitled to a fee of up to 30% in respect of the Net Rewards (the “Coinsquare Service Fee”); and (iv) after the Coinsquare Service Fee has been paid, your account will be credited with any remaining portion of the rewards, and, subject to any unbonding or lock-up period, you will be able to hold, sell or withdraw your rewards.
Validators miss out on ETH rewards if they fail to participate when called upon, and their existing stake can be destroyed if they behave dishonestly. There are two primary behaviours that can be considered dishonest: proposing multiple blocks in a single slot (equivocating) and submitting contradictory attestations. The amount of ETH slashed depends on how many validators are also being slashed around the same time. Slashed validators will be unable to withdraw their ETH or re-stake until after the Shanghai upgrade.
Coinsquare may, at its sole discretion, transfer reimbursements for slashing penalties it receives from BitGo to its users less any administrative costs or expenses Coinsquare incurs in reimbursing users. In the event a supported Ethereum validator is slashed, Coinsquare has no obligation to replace any lost ETH or otherwise provide any compensation for any losses. Negative impacts of slashing will be allocated to all clients using the staking service in proportion to the amount of ETH they had staked.
To be made available for trading on Coinsquare’s platform, a digital asset must pass the following due diligence reviews:
Coinsquare undertakes these three levels of due diligence in order to determine whether the digital asset is compliant with our legal and regulatory obligations, is secure, and has historical data supporting a beneficial business case. Coinsquare’s New Product Committee must provide final approval for a new digital asset to be made available on the platform.
