The Cayman Islands Virtual Assets Framework

These elements can’t be understated, as the multiplier effect of institutional adoption drives further innovation and growth in the crypto space. As the leading brand in hedge funds, the Cayman Islands has already attained a certain seal of approval from the biggest financial institutions as the domicile of choice. Now it is capitalising as a key centre for virtual assets and blockchain projects, building on its reputation in funds. With a solid infrastructure already in place for technology business and a tax neutral framework, there are significant advantages to hosting virtual currency projects in Cayman, supported by well-established arrangements to manage operations and intellectual property.

A flexible corporate environment, a highly regarded legal system - based on UK common law - and deep industry expertise from local service providers, have made the Cayman Islands a leading financial centre for decades. Always recognised as an innovator in financial services, it is notable that a more thoughtful approach has been taken to building its digital infrastructure. While the Cayman Islands was not among the first to implement specific legislation for initial coin offerings (ICOs) for example, as crypto markets exploded in 2018, the laws established since and a business framework hard-wired for technology show it is moving in the right direction in the digital space and is highly conscious of getting things right.

Virtual Asset Service Providers

In the latter part of 2020, the Cayman Islands enacted the Virtual Asset (Service Providers) Act (VASP), which was introduced in consultation with the Financial Action Task Force (FATF) standards to provide a mechanism for regulation and oversight of VASPs. The VASP Act sets out how VASPs can be established with certainty in a straightforward manner and is a flexible and adaptable tech-friendly framework. Cutting edge and in line with global regulatory standards, the law also provides protection for investors. It requires any Cayman Islands entity that engages in any virtual asset business, including issuing virtual assets to the public, to register with the Cayman Islands Monetary Authority (CIMA) and seek approval for that issuance up to a determined level of fiat currency.

Entities that engage in custody services or operate trading platforms for virtual assets are required to be licensed and are subject to more substantial provisions. For trading platforms, these include disclosures and standards related to onboarding and operational practices as well as supervision of trading and the clearing and settlement functions. Custodians must meet capital adequacy requirements as well as standards on transparent reporting and asset safekeeping. Other areas of oversight include governance, conduct of business, risk management, IT and cybersecurity. In addition to crypto trading platforms and custody services, the VASP Act applies to services related to crypto funds and currency, ICOs, security and utility token issuance and stablecoins. Introduced in two phases, registration under the VASP Act which essentially covers the AML side began in January 2021, with the licence phase beginning some months later.

Virtual assets under the VASP Act cover a wide definition, mirroring the language of the FATF and does not include virtual service tokens, such as those issued for customer loyalty, as they are not transferable or exchangeable with a third party at any time. A virtual asset service is defined as either issuance of a virtual asset or conducting activities related to virtual assets on behalf of another person. These activities include exchanging between fiat currencies and virtual currencies, as well as exchanging between virtual assets. It also includes safekeeping or administering virtual assets or any instruments that control virtual assets and participating or providing services related to an issue or offer for sale. This definition of virtual asset services does not cover investment funds, which may purchase and hold crypto assets, providing investors can subscribe or redeem ‘in kind’ such as through shares, and that exchanges of virtual assets and fiat currency take place though an external trading platform.

Setting A Clear Path

One of the key features of the VASP framework in the Cayman Islands is the way in which it opens an important channel of dialogue between the regulator and the entities it covers. More than just providing a measure of managing AML risk, communication with licence holders helps keep CIMA up to date with emerging technologies and rising risks. Furthermore, CIMA can choose to place particularly innovative crypto projects in a regulatory sandbox if they are not yet ready for registration or licensing and the obligations that follow. This scenario can be highly attractive for developers who get a year to establish their operations while CIMA can assess the scope of regulation for these emerging blockchain applications.

With no real harmonised international standards for crypto regulation, CIMA has highlighted its approach in comparison to other offshore centres as well as places like Gibraltar, Liechtenstein and Malta, where there is significant divergence.

It’s notable that that some locales have opted to apply existing regulation to virtual assets, while others have introduced completely new sets of rules.

It’s also fair to say the regulatory regime in the Cayman Islands is more robust than elsewhere. There are fit and proper requirements embedded, in addition to audit requirements and standards regarding remuneration and conflicts of interest among other things. Recently, CIMA solidified its regulatory stance on virtual assets with the implementation of the FATF’s Travel Rule, which forces VASPs to formalise their identification and record keeping practices, strengthening the regulator’s control from an AML standpoint. It is another example of the application of higher standards in the Cayman Islands because many other nations reporting to the FATF have yet to do the same. Over the near term, the crypto sector will likely see more clarity and certainty with formal guidance from CIMA on the responsibilities of registered and licensed entities under the VASP Act. For investors, institutions and service providers who are careful about the type of crypto related business they do, certainty and clarity are welcomed. It is well understood within these shores that some VASPs will seek lower regulatory standards in other jurisdictions. That’s something the Cayman Islands is fairly comfortable with, and is pretty consistent with its success in financial services by focusing on the highest quality business.

Advantage Cayman

From a wider perspective, the flexible and sophisticated corporate framework in the Cayman Islands can provide a VASP project with an important structural advantage. There are a wide range of entity types or vehicles with different features that are highly suited towards particular blockchain applications.

Many of the most exciting blockchain endeavours are now coming as Decentralised Autonomous Organisations (DAOs). These are democratised, member owned communities, with no centralised leadership that follow pre-determined rules written in computer code.  Controlled by voting tokenholders, DAOs make and receive payments according to these rules through smart contracts. The very ethos of a DAO leans naturally towards the Cayman foundation company, a unique structure in the past known more for its use in private wealth management, philanthropy and other commercial activities.  

Cayman Exempted Companies, on the other hand, which are the most successful format for hedge funds, are well suited to Decentralised Finance (DeFi) projects built on the blockchain. Another trend is the use of two or more corporate entities, each offering specific advantages. Often one entity will issue the tokens and be ring-fenced from the company developing the virtual asset project and holding the intellectual property, which in many cases founders are advised to locate offshore due to an uncertain regulatory environment in their home country.  The Cayman Islands’ framework for virtual assets is a strong proposition with corporate vehicles well suited for these distinct purposes in a framework that meets international standards.

Digital Momentum

With this substantial infrastructure in place, it is no surprise that a vibrant technology scene has developed in the Cayman Islands. Cayman Enterprise City (CEC), a special economic zone, has driven some key initiatives here to go along with incentives for entrepreneurs.  CEC’s Tech City has created a cluster of exciting FinTech and blockchain companies, with the Internet Park initiative hosting software, telecom, hosting and data security companies alongside blockchain developers and a host of other innovative firms.

The truth is that at this point in time, we are still at a very early stage of the crypto revolution but things are moving incredibly fast. IFCs that are able to create the right environment for blockchain business, with support for innovation and a legal framework that can be trusted by regulators and institutions will the ones best placed to succeed.

Paul Byles
Paul Byles is Director of FTS, a Cayman Islands compliance and management consulting firm and founder of the Cayman Islands Financial Services Institute. He also serves as an independent director and consultant to financial services firms. He is an economist and former regulator who has worked in the offshore sector for over 25 years. He is author of the books ‘Inside Offshore’ and 'Introduction to Offshore Financial Services: A BVI text'.