Appleby Contributes To Inaugural Blockchain 2020 Guide For Chambers Global – Technology

Fibo Quantum


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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

 3.1
Ownership

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.

 3.2
Categorisation

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.

 3.3
Stablecoins

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.

 4.3
KYC/AML

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

 6.1
Enforceability

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.

 7.2
Security

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.

 7.3
Custody

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

 9.1
Mining

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.

 9.2
Staking

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.