An extract from The Virtual Currency Regulation Review - 2nd edition

Introduction to the legal and regulatory framework

Owing to its neutral tax treatment, political stability and respected legal regime, the Cayman Islands is the global jurisdiction of choice for the formation of investment funds, which are increasingly investing in cryptocurrencies and taking advantage of the investment opportunities in this space.

The Cayman Islands securities regime is more favourable to initial coin offerings (ICOs) and security token offerings (STOs) than those of many other jurisdictions, and Cayman Islands entities have gained popularity as the token generation vehicles for ICOs, STOs and platform development companies. There have also been a number of cryptocurrency exchanges launched by Cayman Islands entities. The Cayman Islands Special Economic Zone provides a simplified route to establishing a physical presence and employing staff in the Cayman Islands.

The Cayman Islands has no specific existing or proposed legislation or regulation regarding ICOs, STOs, cryptocurrency exchanges or investment vehicles investing in cryptocurrency; nor has any case law considered issues arising in the cryptocurrency space. The application of existing laws needs to be considered in relation to this developing space.

i Structuring of virtual currency businesses

There is no direct taxation imposed on Cayman Islands entities, and structuring will largely be driven by onshore tax considerations and business needs.

Exempted companies

The most common type of entity used to form investment funds investing in digital assets, issuers of ICOs and STOs and cryptocurrency exchanges in the Cayman Islands is the exempted company. Exempted companies conduct business on the basis of a declaration by the incorporating subscriber that the operations of the company are to be carried on mainly outside the Cayman Islands.

An exempted company must have a minimum of one shareholder and one director. The appointment of officers is optional. There is no requirement for Cayman-resident directors or officers.

Exempted limited partnerships

Exempted limited partnerships are more commonly used to form closed-ended funds investing in cryptocurrencies, which may be investing in illiquid ICOs and STOs rather than more commonly traded cryptocurrencies. The Exempted Limited Partnership Law (the ELP Law) governs the formation of exempted limited partnerships.

The ELP Law also contains provisions relevant to the affairs of an exempted limited partnership, being the primary legislation governing partnerships generally. An exempted limited partnership is a partnership consisting of at least one general partner (who has responsibility for the business affairs of the partnership) and any number of limited partners that is registered as such under the ELP Law.

An exempted limited partnership is not a separate legal entity. It is instead a set of contractual obligations affecting the partners, between themselves, where a general partner is vested with certain powers and obligations in relation to a business and the assets of the business.

Exempted limited partnerships are often treated differently to companies for onshore tax purposes, typically being treated as fiscally transparent. The general partner holds the partnership's assets in statutory trust for the partners, and is tasked with managing the business and affairs of the exempted limited partnership. In the event that the assets of the partnership are inadequate to satisfy the claims of creditors, the general partner is liable for the debts and obligations left unpaid.

Foundation companies

A foundation company shares many of the features of an exempted company. A foundation company is a body corporate with limited liability and separate legal personality from its members and directors and other officers. It can sue and be sued and hold property in its own name. The key feature of a foundation company that often makes it an attractive vehicle for ICOs and STOs is that it is not required to have members following incorporation. This is a particularly useful structure for those projects that will ultimately be decentralised and governed by the community.

A foundation company must, however, unlike an exempted company, appoint a qualified person as a secretary, being a person who is licensed or permitted by the Companies Management Law (revised) to provide company management services in the Cayman Islands, and that secretary must maintain a full and proper record of its activities and enquiries made for giving notice.

Trusts

If ownership and autonomy are concerns, which may be relevant particularly for an ICO or STO, they can be addressed to a certain degree by having a Cayman Islands charitable trust or STAR trust (introduced by the Special Trusts (Alternative Regime) Law) hold all the shares in issue of the exempted company. A Cayman Islands STAR trust is a non-charitable purpose trust that can hold assets for a specific purpose. The trustee must be a licensed trustee in the Cayman Islands.

ii Summary of Cayman laws to be considered in the virtual currency space

The following Cayman Islands statutory and regulatory regimes must be considered when structuring a virtual currency business through the Cayman Islands:

  1. the Securities Investment Business Law (SIBL);
  2. the Mutual Funds Law (MFL);
  3. the Money Services Law (MSL);
  4. the Bank and Trust Companies Law;
  5. the Proceeds of Crime Law (PCL), the Anti-Money Laundering Regulations (the AML Regulations) and existing guidance notes, and the Terrorism Law;
  6. the Stock Exchange Companies Law;
  7. the US Foreign Account Tax Compliance Act (FATCA) and the OECD Common Reporting Standard (CRS);
  8. the beneficial ownership regime; and
  9. the International Tax Co-operation (Economic Substance) Law (the Economic Substance Law).

Looking ahead

The Cayman Islands has not yet implemented specific laws relating to virtual currency. However, it is possible that specific legislation regulating issuers, cryptocurrency exchanges and other entities involved in the cryptocurrency space may be introduced in the future.