Sandbox Fictions

Sometimes, new innovations don’t fit cleanly within existing rules. Designed with incumbent business models and offerings in mind, these rules might inadvertently block firms from offering promising new products and services to consumers.

Regulatory sandboxes are designed to help address this problem. They give firms space to offer novel products and services to consumers on a trial basis, under an interim set of tailor-made rules. Ideally, once the trial period is complete, regulators are better placed to understand how their rules ought to be modified to accommodate these offerings on a more permanent basis.

But little is known about sandboxes’ implications for consumers. Will they reduce barriers to entry for innovative offerings that better serve consumer needs? Or will they lead regulators to compromise on consumer protections, allowing low-quality or fraudulent offerings to flow into their markets?

My forthcoming article sheds light on an area where sandboxes have developed enough of a track record that we can start to explore these questions. Canadian securities regulators relied heavily on sandboxes to develop their approach to regulating the online cryptoasset trading platforms many investors use to trade and hold their cryptoassets.

Canadian regulators’ efforts dampened the most significant consumer protection risk posed by these platforms: that platform managers will steal or fail to adequately safeguard the cash and other assets their clients entrust to them, a problem illustrated by the collapses of FTX in 2022 and Canada-based QuadrigaCX in 2019.

More broadly, though, regulators fell somewhat short of sandboxes’ promise of more proactive, better-informed regulation. Rather than anticipating emerging risks posed by platforms, regulators tended to act on risks only where analogies could be drawn to more familiar risks posed in the traditional securities sector, or after these risks crystallized into consumer harms serious enough to turn a public spotlight on regulators’ apparent inaction.

Canadian regulators’ experience also highlights how, contrary to conventional wisdom, sandboxes and mainstream regulation do not always exist in isolation from one another, with clearly defined boundaries and distinct purposes. Rather, these spheres can be deeply connected and even blend into one another.

For example, trading platforms only had reason to seek entry to the sandbox because mainstream regulation incorporated broad prohibitions extending to their activities. And the legal tools regulators used to oversee platforms within the sandbox were repurposed from existing powers to waive and modify the rules that apply to individual firms. Moreover, they continued using firm-by-firm waivers to oversee trading platforms long after their (nominal) exit from the sandbox.

At time of writing, 19 different platforms were operating in Canada under these individualized waivers. The terms of these waivers sometimes varied from platform to platform without any publicly articulated explanation. These terms may not always even reflect regulators’ practical expectations of platforms, as illustrated by regulators’ tolerance of stablecoin trading on platforms over 2023 and 2024 despite public statements suggesting that such activity was contrary to these terms.

What does this mean for those engaged in designing or evaluating sandboxes in other sectors? Firstly, it means taking a closer look at the legal tools that come into play before firms enter the sandbox and after they exit. Does existing regulation create a reason for firms to use the sandbox in the first place? What procedures are in place to monitor how novel offerings fare after they exit? When should regulators be required to replace firm-by-firm waivers with general rules?

Second, to the extent sandboxes and mainstream regulation blend into one another, it may not make sense to give these spheres of regulation distinct and potentially contradictory objectives (eg, innovation promotion and consumer protection, respectively). Instead, sandboxes’ concern with innovation should be reconciled with broader regulatory goals like consumer protection.

For example, rather than setting out to promote innovation in and of itself, sandboxes could instead be framed as a testing ground for new approaches to achieving the goals of mainstream regulation—approaches that account for the opportunities presented by new innovations as well as their risks.

As sandbox adoption grows, it will become increasingly important to seek out and discuss potential lessons from experience that may prove helpful in designing and evaluating these regulatory tools. Canada’s efforts to regulate cryptoasset trading platforms offer one possible source of these lessons.

The author’s complete article can be found here.

Douglas Sarro is an Assistant Professor at the University of Ottawa Faculty of Law, Common Law Section.