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 2017–18. 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.
Framework legislation regulating virtual asset service providers came into force on 31 October 2020 (see 2.1 Regulatory Overview) and has already attracted a number of new entrants to the Cayman market. A technology-neutral regulatory sandbox is expected later in 2022 and it is hoped this will further attract companies operating in this fast-moving sector to establish themselves in Cayman.
Recent years have also seen Cayman's foundation company becoming a popular choice for projects looking for a flexible governance entity to kick-start their DAO or other community-led projects.
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.
The pressures created by the COVID-19 outbreak on global trade systems highlighted 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. With applications to join the technology park within the SEZ at an all-time high, it is anticipated that Cayman will continue to benefit from technology companies looking to respond to this shift and establish themselves in a tax neutral jurisdiction.
A new administration in place in the USA and increased pressure from proposed 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 Cayman in 2019 could have an impact.
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 information 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.
1.3 Decentralised Finance Environment
Whilst adoption within the Caribbean is slow, there is growing awareness and use of decentralised finance (DeFi) protocols and, in particular, a heightened awareness and understanding among corporate service providers who cater for entities registered in Cayman and who utilise DeFi protocols.
To date, the use of DeFi protocols is not regulated, except where they can be established to fall within existing regulation (see 2.1 Regulatory Overview) but by the very nature of decentralisation, regulators would find it difficult to regulate truly decentralised products.
1.4 Non-fungible Tokens
There has been an explosion of interest around non-fungible tokens (NFTs) in the last 18 months. However, the recent introduction of the Virtual Asset (Service Providers) Act (VASP Act), which is discussed in further detail in 2.1 Regulatory Overview, has not led to a corresponding rise in offerings from the Cayman Islands as market participants and CIMA seek to determine whether NFTs are virtual assets and therefore whether activities related to NFTs require separate registration under the VASP Act.
However, it is clear that NFTs could open new revenue streams and are a source of earning potential for brands and many others in the "creator" economy. We expect interest in using Cayman as a launch pad for such opportunities will continue to grow as the regulatory landscape becomes clearer.
2. Regulation in General
2.1 Regulatory Overview
The VASP Act
The VASP Act came into force in October 2020. The VASP Act is intended to provide a flexible framework to 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 provides for the supervision of persons and entities facilitating virtual asset activities as a business.
Under the VASP Act 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:
- issuing of virtual assets;
- 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 VASP Act, from 31 October 2020, all virtual asset service providers (VASPs) need to apply to register with CIMA. When phase two of the VASP Act comes into effect (expected now later in 2022), as well as registering with CIMA, virtual asset custodial services and exchange or trading platforms will also need to apply to CIMA for a separate VASP licence.
The VASP Act 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 VASP Act, VASPs are 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 VASP Act also provides a framework for a technology-neutral regulatory sandbox. The sandbox is expected to come into effect during 2022 and further details are still awaited.
The Securities Investment Business Act
The primary piece of legislation regulating securities and investment business in the Cayman Islands is the Securities Investment Business Act (SIBA). SIBA provides for the licensing and control of persons engaged in securities investment business in or from the Cayman Islands. Importantly, SIBA 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 SIBA, therefore, the emphasis is on substance rather than form.
SIBA sets out an exhaustive list of financial instruments that constitute "securities". In 2020, SIBA was amended to include virtual assets in that list. A virtual asset that can be sold, traded or exchanged and that represents, can be converted into or is a derivative of any of the existing SIBA listed securities will also qualify as a security although certain exemptions may still apply.
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 Act which sets out the principal money laundering offences.
Certain "relevant" businesses (which would include, for instance, entities caught within Cayman financial services regulations (including VASPs and those registered or licensed under SIBA) 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.
Importantly, businesses in the Cayman Islands need to adopt a risk-based approach to the collection of know-your-client (KYC) information. 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.
2.3 Regulatory Bodies
CIMA provides oversight for investment funds, entities caught by SIBA and also oversees the VASP Act and, when it comes into effect later in 2022, 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 forms part of the VASP Act and is expected to be introduced later in 2022. 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, however, be tax implications for beneficial owners in their own jurisdiction.
2.9 Other Government Initiatives
Please refer to 2.4 Self-regulatory Organisations.
3. Cryptocurrencies and Other Digital Assets
While the authors of this article are not aware of this being tested in the Cayman courts, it is likely 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 ownership is likely to be 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, transfers would probably 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 the authors' 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.
Virtual assets which represent securities under SIBA may result in issuers, custodians and other service providers being required to be licensed (please see 2.1 Regulatory Overview).
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
The FATF in its most recent Guidance made clear that NFTs are generally not considered to be virtual assets under the FATF definition. This is on the basis that NFTs are not used for payment or investment purposes and therefore would not meet the definition of a "virtual asset" under the VASP Act. However, as with all tokens, each project will turn on its own facts and so consideration should be given to the qualities of each NFT before a determination is made.
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 but at the time of writing (May 2022) the authors understand that a range of service providers including trading platforms, token issuers and custodians have applied to be registered under the VASP Act.
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 the VASP Act and potentially also within either the currency exchange or money transmission provisions of the Money Services Act 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
Cayman entities providing storage solutions for cryptographic keys, either online or offline now need to be registered under the VASP Act and, under phase two of that Act, will require a separate licence.
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 Other Token Launch Mechanisms
Please see 2.1 Regulatory Overview.
5.4 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 Act. 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 Act, 2020 and the Mutual Funds (Amendment) Act, 2020 came into force in the Cayman Islands in 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 the scope of a regulatory framework. Such funds are now required to register with CIMA, pay an annual fee and file prescribed documentation.
5.5 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 – the authors' 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) will typically be clear and unambiguous, although issues may arise where the code is ill-defined.
The Electronic Transactions Act (ETA) puts electronic signatures on an equal footing with wet ink signatures in the Cayman Islands.
Technologically neutral, the ETA 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 ETA 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, the authors' 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.
It should also be borne in mind 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 Platforms
Decentralised finance (DeFi) products are subject to compliance with the VASP Act and SIBA. Please see 1.3 Decentralised Finance Environment and 2.1 Regulatory Overview.
The authors are not aware of any case law in the Cayman Islands regarding whether digital assets will be treated as "property", but the Cayman courts would probably be persuaded by English court rulings and the findings of the UK Jurisdiction Taskforce on the legal status of digital assets. As such, it is 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. An assignment of rights would likely 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), security would need 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 Act (DPA) 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 DPA introduces globally recognised principles about the use of personal data to the Cayman Islands. The DPA aligns the Cayman Islands with other major jurisdictions around the world, notably the EU, and thereby facilitates the free flow of data – a prerequisite for the Cayman Islands being an equal and competitive participant in today's globalised economy.
Importantly, the DPA 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 DPA aims to reduce the administrative burden of operating internationally and cement the Cayman Islands as an attractive jurisdiction in line with international developments.
The DPA 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 from within the Cayman Islands would likely not be viable.
There are currently no restrictions on the staking of tokens.
10. Decentralised Autonomous Organisations (DAOs)
Cayman is proving a popular choice for projects wishing to use a legal wrapper for their decentralised and community-driven projects. Combining the limited liability protections of a corporate entity with the flexibility of a trust, the Cayman foundation company provides DAO projects with a very user-friendly option.
For projects looking to issue virtual assets privately, the foundation company is also able to represent the DAO. The VASP Act only regulates the sale of virtual assets to the public. Private sales which are not advertised, and made available to a limited number of persons who are each selected prior to the sale by way of a private agreement, are outside of scope.
Projects that wish to decentralise immediately by carrying out an airdrop of tokens can also utilise a Cayman foundation company. The VASP Act is only concerned with "sales" of virtual assets in return for a cash or other crypto payment.
Where the DAO wishes to carry on VASP activities, one alternative is to create a wholly owned subsidiary of the foundation company in a virtual asset-friendly jurisdiction. The Cayman foundation company will then procure the subsidiary to carry on whichever activities it cannot perform from the Cayman Islands. Whilst this structure is more complex it allows projects to take full advantage of the benefits of the foundation company vehicle in a way that ensures compliance with the VASP Act.
10.2 DAO Governance
DAO projects using Cayman structures have adopted a range of governance models with both "one token, one vote" and weighted vote arrangements proving popular.
Cayman vehicles typically provide a legal wrapper for the community voting arrangements but also act as service providers to carry out the instructions of the token-holders following a vote.
10.3 Legal Entity Options
Please see 10.1 General.
Originally published by Chambers Blockchain 2022 Guide.
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.