Appleby has contributed to the Cayman Islands chapter of Chambers and Partners' inaugural "Blockchain 2020" guide. This first edition features 19 jurisdictions and covers key the topics of cryptocurrencies, stablecoins, initial coin offerings, non-fungible tokens, tax regimes, data privacy and protection, mining and staking, and decentralised financial platforms.
According to Lewis Cohen in an introduction to this first-ever guide, the "review of the Chambers Guide yields numerous valuable insights. In terms of business models across the jurisdictions surveyed, we see a vertiginous diversity. Unsurprisingly, given the Cayman Islands' longstanding leadership in the funds space, tokenised funds harnessing the benefits of blockchain technology have been one of the early successes."
Below is the full Cayman Islands chapter.
1. Blockchain Market and Business Model Overview
1.1 Evolution of the Blockchain Market
As one of the foremost offshore financial centres, home to approximately 70% of the world's offshore investment funds and with an absence of any direct taxation on companies or individuals, the Cayman Islands has become an attractive destination for technology entrepreneurs. While much of Cayman's financial services legislation was written before the recent blockchain revolution began, the last few years have seen the Cayman Islands take a number of legal and regulatory steps to make the Islands a jurisdiction that will allow such innovation to thrive. Cayman's ambition to become a global technology hub is also supported by a sound legal framework, a wealth of experienced professional service providers, a modern infrastructure, state-of-the-art communication systems and a stable political climate.
The Cayman Islands proved a popular choice for issuers of virtual assets during the initial coin offering boom of 2017 to 2018. During the "Crypto Winter" that followed, Cayman's flexible business-orientated legislation, multitude of potential issuer vehicle types, and internationally recognised securities regulatory regime enabled the Islands to pivot away from crowdfunded platforms towards security tokens and stablecoins, which provided greater value stability and more predictable investment returns. This same flexibility means that Cayman is well placed to take advantage of the latest shift towards securitising common assets and decentralised finance (DeFi) products, with Cayman already being the offshore centre of choice for other securitisation issuers.
First amongst the leading offshore jurisdictions, Cayman established a technology park within its existing special economic zone (SEZ) to allow technology companies to benefit from specific advantages, including zero-taxes and fast-tracked work permit applications for relocating employees. A technology-neutral regulatory sandbox is expected in 2020 to further attract companies operating in this fast-moving sector to establish themselves in Cayman.
At the time of writing, the pressure created by the COVID-19 outbreak on global trade systems highlights the urgent need to maintain and strengthen the resilience of international supply chains. This resilience depends on trust, transparency and integrity, which can be improved through the responsible deployment of blockchain technologies. Over the next 12 months and beyond, Cayman may benefit from technology companies looking to respond to this shift and establish themselves in a tax neutral jurisdiction.
US, UK and EU tax and regulatory reforms could impact Cayman's current flexibility in this space going forward. In particular, further changes to the economic substance requirements introduced in 2019 could have an impact. At present, all entities are required to make a substance notification filing. In addition to making the a notification filing, relevant entities carrying on relevant activities must prepare and submit to the Cayman Islands Tax Information Authority (TIA) a report, so that the TIA may determine whether the entity has shown sufficient economic substance in the Cayman Islands in relation to that relevant activity. The report is due within 12 months after the last day of each financial year.
1.2 Business Models
New technologies have not yet displaced traditional financial service providers in Cayman. Cayman Finance, a group that represents Cayman's financial services sector, has established an innovation lab to engage with the financial services industry, regulators, the government and the media to promote the development and use of new technologies in the Islands.
Given Cayman's stringent know your customer (KYC) requirements, a number of service providers have adopted technologies to enable the onboarding of clients and the collection of KYC digitally.
Informal conversations have also started concerning a potential framework of laws, developed under Cayman Finance and the Cayman Islands Monetary Authority (CIMA) that might direct new technologies towards the institutional market.
Tokenised funds have proved increasingly popular in recent years. In a tokenised fund, an investor's interest is represented by a cryptographic token, as opposed to shares or other interests or units offered to investors in a more traditional fund structure.
2. Regulation in General
2.1 Regulatory Overview
There is currently no separate framework for the regulation of virtual assets in the Cayman Islands although legislation is expected to be implemented during the course of 2020.
The draft Virtual Asset Service Providers Law (VASP Law), which was gazetted in April 2020, is expected to provide a flexible foundation which will promote the use of new technology and innovative enterprise in the Cayman Islands while complying with newly adopted international standards set by the Financial Action Task Force (FATF). The new legislation would provide for the supervision of persons and entities facilitating virtual asset activities as a business.
Under the draft VASP Law a "virtual asset" is defined as a digital representation of value that can be digitally traded or transferred and used for payment or investment purposes, but does not include digital representations of fiat currencies.
"Virtual asset services" are businesses providing one or more of the following services or operations:
- exchanges between virtual assets and fiat currencies;
- exchanges between one or more other forms of convertible virtual assets;
- transfers of virtual assets;
- virtual asset custody services; or
- the participation in, and provision of, financial services related to a virtual asset issuance or the sale of a virtual asset.
Under the draft VASP Law, virtual asset service providers (VASPs) would need to register or be licensed. For virtual asset custodial services and exchange or trading platforms, simple registration would not be possible and a virtual asset service licence would be needed.
The draft provides for various exceptions including:
- platforms which are mere meeting places where sellers and buyers may post bids and offers and where the parties trade in a peer-to-peer environment only;
- fintech service providers that use innovative technology to improve, change or enhance financial services but which are not virtual asset services; and
- virtual service tokens which are not transferable or exchangeable and include tokens whose sole function is to provide access to an application or service.
Under the draft VASP Law, VASPs would be subject to a number of general obligations including:
- extensive anti-money laundering (AML) obligations;
- strict data protection and cybersecurity requirements;
- the filing of annual accounts with CIMA as the regulator of VASPs;
- the requirement for senior officers and beneficial owners to be fit and proper persons;
- the prior approval of senior officer appointments by CIMA;
- any issuance of virtual assets requiring the prior approval of CIMA; and
- CIMA approval before the issuance or transfer of any shareholding in a VASP entity above 10%.
The draft VASP Law would also provide a framework for a technology-neutral regulatory sandbox.
The primary piece of legislation regulating securities and investment business in the Cayman Islands is the Securities Investment Business Law (SIBL). SIBL provides for the licensing and control of persons engaged in securities investment business in or from the Cayman Islands. Importantly, SIBL is essentially consumer protection legislation, designed to protect the investing public and to be construed broadly. When determining whether a business activity is caught by SIBL, therefore, the emphasis is on substance rather than form.
SIBL sets out an exhaustive list of financial instruments that constitute "securities". Virtual assets are not expressly included in that list. However, whether a virtual asset could constitute a security under SIBL is a fact-specific enquiry dependent on the unique functionalities exhibited by the asset in question. If the virtual asset qualifies as a security, the issuer will be either dealing in, or arranging deals in, securities, although the issuer's activities may fall within a list of excluded activities under SIBL.
An issuer of a virtual asset in the Cayman Islands will also be subject to the general criminal laws on fraud and laws governing intentional or negligent misrepresentation and the general corporate laws applicable to the issuer entity type.
2.2 International Standards
The Cayman Islands has long been committed to implementing best international practices and is compliant with the anti-money laundering and anti-terrorist financing requirements of the OECD and FATF. As a member of the Caribbean FATF, the Cayman Islands implements recommendations promulgated by the FATF.
All Cayman Islands incorporated entities are subject to the Proceeds of Crime Law which sets out the principal money laundering offences. Importantly, businesses in the Cayman Islands need to adopt a risk-based approach to the collection of KYC. Under the risk-based approach, the latest guidelines from the FATF permit the digital verification of identities and receipt of electronic copies of documents instead of traditional "wet ink" paper-based processes.
Certain "relevant" businesses (which would include, for instance, entities caught within Cayman financial services regulations (including VASPs) and other entities thought to be at a higher risk of money laundering) are further subject to the Anti-Money Laundering Regulations which prescribe certain identification, record keeping and internal control procedures for such businesses.
2.3 Regulatory Bodies
CIMA provides oversight for investment funds, entities caught by SIBL and will also oversee the new VASP Law and participants in the proposed regulatory sandbox.
2.4 Self-Regulatory Organisations
The Blockchain Association of the Cayman Islands was established to promote the use of blockchain-based solutions in the Cayman Islands, to facilitate collaboration in the space and to lobby to the government and regulators.
Cayman Finance, a group that represents Cayman's financial services sector has established an innovation lab to engage with the financial services industry, regulators, the government and the media to promote the development and use of new technologies in the Islands.
2.5 Judicial Decisions and Litigation
There have, to date, been no important judgments in the blockchain area.
2.6 Enforcement Actions
There have, to date, been no important enforcement actions in the blockchain area.
2.7 Regulatory Sandbox
A technology neutral regulatory sandbox has been proposed by the government and is expected to be introduced during 2020 as part of the VASP Law. The aim of the sandbox is to encourage, foster and incubate companies operating in this fast-moving sector. CIMA will have regulatory oversight of sandbox participants. Please see 2.1 Regulatory Overview.
The Cayman Islands Government has already established the SEZ, which enables technology companies from outside Cayman to easily and cost-effectively set up and operate in the Islands with a genuine physical presence.
The benefits of being a resident in the SEZ include:
- no corporate, income, sales or capital gains tax;
- fast-track set up in four to six weeks;
- renewable five-year work/residency visas granted in five days for staff from outside the Cayman Islands;
- no Government reporting or filing requirements; and
- presence in a tech cluster with cross-marketing opportunities.
2.8 Tax Regime
The Cayman Islands is a tax-neutral jurisdiction. There is no income tax, wealth tax, profits tax, capital gains tax, payroll tax, social security contribution (aside from mandatory pension contributions for employers and their employees) or corporate tax in the Cayman Islands. A registered Cayman Islands entity is not subject to any direct taxes. There may be tax implications for beneficial owners in their own jurisdiction, however.
2.9 Other Government Initiatives
Please refer to 2.4 Self-Regulatory Organisations.
3. Cryptocurrencies and Other Digital Assets
While we are not aware of this being tested in the Cayman courts, we would anticipate that ownership of a digital asset will be determined by who holds the private key required to access and transfer that asset. This will be subject to particular circumstances, for example:
- where persons hold keys on behalf of others (whether as an employee, custodian or intermediary) (in which case we would anticipate ownership being determined by contractual, trust and agency principles);
- where keys are obtained unlawfully (which may affect whether the holder is treated as the lawful owner); and
- where there exist multiple keys to a single asset (which may result in ownership being split between key holders).
Subject to contractual terms, we would expect transfers to be considered final once they have reached finality on the blockchain and are credited to the wallet of the recipient to which they hold a key (regardless of whether these can be transferred).
Where digital assets represent shares in a Cayman company, legal title to the underlying shares represented by the token will be determined (in the absence of fraud, manifest error, or other extraordinary circumstances) by reference to the company's register of members. A Cayman company's constitutional documents will usually oblige the company to treat the holder entered on the register of members as the sole person entitled to the shares, including any voting rights and dividend payments in respect thereof. In our experience, issuers of security tokens will implement a system designed so that the company's register of members will be updated, automatically, to record the transfer of each share upon any transfer of the corresponding token such that there should never be a split in ownership of the token and underlying share.
There is currently no distinction between different types of virtual assets, save that virtual assets which represent investments under SIBL (Cayman's existing investment business legislation) may result in issuers, custodians and other service providers being required to be licensed (please see 2.1 Regulatory Overview). Whether an asset could constitute an investment is a fact-specific enquiry dependent on the unique functionalities exhibited by that digital asset.
Please refer to 3.2 Categorisation.
3.4 Use of Digital Assets
There are currently no restrictions, subject to AML compliance.
3.5 Non-fungible Tokens
Please refer to 3.2 Regulatory Overview.
4. Exchanges, Markets and Wallet Providers
4.1 Types of Markets
Currently, the Cayman Islands Stock Exchange is the only exchange permitted to operate in the Cayman Islands.
It is anticipated, as discussed further in 2.1 Regulatory Overview, that the VASP Law expected later in 2020 will provide a licensing regime to enable the establishment of exchanges (both custodial and decentralised) of virtual assets within the Cayman Islands.
4.2 On-Ramps and Off-Ramps
Please see 4.1 Types of Markets.
To the extent that cryptocurrencies can be both purchased with, and redeemed for, fiat currencies via a Cayman entity, such transmission is likely to fall within either the currency exchange or money transmission provisions of the Money Services Law and therefore require a licence.
Please see 2.2 International Standards.
4.4 Regulation of Markets
Please see 2.1 Regulatory Overview.
4.5 Re-hypothecation of Assets
Please see 4.1 Types of Markets.
4.6 Wallet Providers
There are currently no restrictions on businesses providing storage solutions for cryptographic keys, either online or offline. However, please see 2.1 Regulatory Overview. It is anticipated that the VASP Law expected to be in force later in 2020 will provide a licensing regime for virtual asset custodians operating within the Cayman Islands.
5. Capital Markets and Fundraising
5.1 Initial Coin Offerings
Please see 2.1 Regulatory Overview.
5.2 Initial Exchange Offerings
Please see 2.1 Regulatory Overview.
5.3 Investment Funds
There is no separate framework for the regulation of funds that invest in virtual assets in the Cayman Islands.
The primary piece of legislation in the Cayman Islands relating to open-ended investment funds is the Mutual Funds Law. A "mutual fund" is defined as a common investment vehicle which issues equity interests (such as tokens in a tokenised fund structure) that allows participation amongst a pool of investors in the profits or gains of that vehicle's investments and which is redeemable at the option of the investor.
The Private Funds Law, 2020 and the Mutual Funds (Amendment) Law, 2020 came into force in the Cayman Islands on 7 February 2020. These laws expand the regulatory reach of CIMA, bringing closed-ended funds and previously exempted mutual funds (ie. open-ended funds with not more than 15 investors, the majority of whom have the power to appoint and remove the operators) into scope of a regulatory framework. Such funds are now required to register with CIMA, pay an annual fee and file prescribed documentation.
5.4 Broker-Dealers and other Financial Intermediaries
Please see 2.1 Regulatory Overview.
6. Smart Contracts
There are no laws, regulations or Cayman judicial decisions addressing the enforceability of smart contracts.
Provided that the defining features of a contract are present - offer, acceptance, the intention to be legally bound and consideration - our view is that smart contracts are capable of satisfying the requirements for a binding contract and are enforceable by the courts.
Arguably the role of contractual interpretation for smart contracts written wholly in computer code may be limited as the language (in this case code) typically will be clear and unambiguous, although issues may arise where the code is ill-defined.
The Electronic Transactions Law (ETL) puts electronic signatures on an equal footing with "wet ink" signatures in the Cayman Islands.
Technologically neutral, the ETL was established to promote public confidence in the validity, integrity and reliability of conducting transactions electronically and recognises electronic records as records created, stored, generated, received or communicated by electronic means.
The ETL is not prescriptive as to the method of authentication protocol used. An electronic signature will be considered to be reliable where:
- the means of creating the electronic signature is linked to the signatory and to no other person;
- the means of creating the electronic signature was, at the time of signing, under the control of the signatory and of no other person; and
- any alteration to the electronic signature, made after the time of signing, is detectable.
6.2 Developer Liability
Although the point remains untested in Cayman, our view is that developers of blockchain protocols are not fiduciaries. The role played by protocol developers in the governance of public blockchain networks does not pose the risks of abuse that characterise traditional legal fiduciaries and therefore does not require the imposition of fiduciary duties.
We would also add that the risk of developer abuse in a publicly governed blockchain is minimal. By its nature, each update to the open-sourced code is analysed and tested by other network participants who have a significant economic interest and the technical abilities to audit the code before implementing it.
7. Lending, Custody and Secured Transactions
7.1 Decentralised Finance
There is currently no separate framework for the regulation of virtual assets in the Cayman Islands. Decentralised finance (DeFi) products are currently not restricted, subject to compliance with existing laws, and in particular SIBL. Please see 2.1 Regulatory Overview.
We are not aware of any case law in the Cayman Islands regarding whether digital assets will be treated as "property", but we expect the Cayman courts would be persuaded by English court rulings and the recent findings of the UK Jurisdiction Taskforce on the legal status of digital assets. As such, we think it likely that digital assets would be treated as property in Cayman and, consequently, could be the subject of a fixed or floating charge. In order to ensure the effectiveness of any such charges, lenders should consider taking custody of digital keys.
Where tokens are held by obligors through a custodian or other agent, security could be taken over the rights that obligor has against that custodian or agent. We would expect an assignment of rights to be governed by the same governing law as the custody or agency agreement.
Where tokens represent underlying shares of a Cayman company or interests of a limited liability company (LLC), we would expect security to be taken in the Cayman Islands in the usual way that security is taken over the equity interests of such an entity type, which is typically by way of an equitable share mortgage or charge.
There is no general central registry in Cayman for the public registration of charges. However, Cayman companies and LLCs are required to maintain a register of mortgages and charges at their registered office in the Cayman Islands, and an LLC is required to maintain a register of security interests at its registered office in the Cayman Islands in which shall be registered any security interests taken over the interests of such an LLC.
Please see 4.6 Wallet Providers.
8. Data Privacy and Protection
8.1 Data Privacy
Cayman's Data Protection Law (DPL) came into full force on 30 September 2019. Drafted around a set of EU-style data protection principles to which data controllers must adhere, personal data must be collected in a fair and transparent manner and only be used and disclosed for purposes properly understood and agreed to by data subjects. Any personal data collected must be adequate, kept up-to-date and should not be retained for longer than is necessary to fulfil the collection purpose.
The DPL introduces globally recognised principles about the use of personal data to the Cayman Islands. The DPL aligns the Cayman Islands with other major jurisdictions around the world, notably the EU, and thereby facilitates the free flow of data - a pre-requisite for the Cayman Islands being an equal and competitive participant in today's globalised economy.
Importantly, the DPL provides a standard framework for both public and private entities in the management of the personal data they use. Internationally active organisations will find many similarities between the data protection law of the Cayman Islands and those of other jurisdictions where they are active. The DPL aims to reduce the administrative burden of operating internationally and cement the Cayman Islands as an attractive jurisdiction in line with international developments.
The DPL also serves as a guide to provide assurance to individuals whose personal data is being processed. Indeed, where individuals feel that they are empowered to manage and control their personal data, they are more likely to share personal data with an organisation, to the benefit of both parties.
The Office of the Ombudsman is the Cayman Islands' supervisory authority for data protection.
8.2 Data Protection
Please see 8.1 Data Privacy.
9. Mining and Staking
There are currently no restrictions on the use of mining, however, given the high utility costs on the Islands, large scale mining would not be viable.
There are currently no restrictions on the staking of tokens.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.