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Blockchain & DeFi Protocols – Cayman Islands Investment Structures



Why the Cayman Islands?

The Cayman Islands has proved a popular choice for issuers of virtual assets during the initial coin offering boom of 2017–18. Cayman’s flexible commercial friendly 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. Cayman is well positioned to take advantage of the latest shift towards securitising common assets (tokenisation)and decentralised finance (DeFi) products, with Cayman already being the offshore centre of choice for other securitisation issuers and investment funds.


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.


Decentralized finance (DeFi) explained

Short for decentralized finance, DeFi is an umbrella term for a variety of applications and projects in the public blockchain space geared toward disrupting the traditional finance world. Inspired by blockchain technology, DeFi is referred to as financial applications built on blockchain technologies, typically using smart contracts. Smart contracts are automated enforceable agreements that do not need intermediaries to execute and can be accessed by anyone with an internet connection.


DeFi consists of applications and peer-to-peer protocols developed on decentralized blockchain networks that require no access rights for easy lending, borrowing, or trading of financial tools. Most DeFi applications today are built using the Ethereum network, but many alternative public networks are emerging that deliver superior speed, scalability, security, and lower costs.



Whilst adoption within the Caribbean is slow, we are seeing a growth in 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 (but by the very nature of decentralisation, regulators would find it difficult to regulate truly decentralised products.


Why smart contracts?

Most smart contracts offer Turing Complete programming languages that allow multiple parties to interact with each other, without needing a centralized intermediary. Blockchain’s ability to capitalize on smart contracts has made them ideal platforms to choose when building out financial applications.


The future of DeFi

We’re observing a quantum leap in the new possibilities of the functionalities of money through the innovation of distributed ledger technologies. For the first time in history, a global financial system for a worldwide population is being shaped by that very population. Everyone can take part in the governance of DeFi protocols and get a seat at the table where the world of decentralized finance is actively created.


The Virtual Asset (Service Providers) Act

The Virtual Asset (Service Providers) Act (VASP Act), came into force in October 2020. The VASP Act is intended to provide a flexible foundation 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 and register with the Cayman Islands Monetary Authority (CIMA). When phase two of the VASP Act comes into effect (expected June 2021) virtual asset custodial services and exchange or trading platforms will need to apply to CIMA for a VASP licence.


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 exemption may still apply.


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. 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.


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.


Taxation

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.


Non Fungible Tokens

In the Cayman Islands, NFTs have found increased popularity through wealthy individuals with a broad risk appetite seeking out new investment opportunities. NFTs are attractive to these investors because they come with the reassurance, via the blockchain, that the NFT is the only authentic one of its kind.


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.


For closed-ended funds, the Private Funds Act, 2020 applies and requires registration.


DeFi Platforms

Decentralised finance (DeFi) products are subject to compliance with the VASP Act and SIBA.


Mining

There are currently no restrictions on the use of mining, however, given the high costs on the Islands, large-scale mining is not viable.


Staking

There are currently no restrictions on the staking of tokens.


Bell Rock

At Bell Rock we have worked on a number of protocols, blockchain and digital asset structures from formation to providing experienced governance professionals to help shepherd developments in the respective community. Our team consists of highly experienced seasoned financial professionals with backgrounds in law, corporate governance, investment banking, hedge funds and financial services.


We have also worked on numerous fund launches form fund registration to provision of experienced directors, foundation and company formation, compliance and regulatory support, economic substance solutions plus other support services.


For further information on our Cayman Islands solutions to support blockchain and fintech companies, please contact us: info@bellrockgroup.com



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