Cayman Islands

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.

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 retail crowdfunded models towards security tokens and stablecoins, which provided greater value stability and more predictable investment returns. This same flexibility means that Cayman remains 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 in 2020 (see 2.2 Categorisation) and has attracted a number of new entrants to the Cayman market. A technology-neutral regulatory sandbox is still awaited but when introduced 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 for their decentralised autonomous organisation (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.

Increased pressure from proposed EU tax and regulatory reforms are likely to 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. However, Cayman is already benefiting from the regulatory uncertainty in the virtual assets sector in the USA which has seen a number of US projects relocate offshore. Cayman is geographically advantaged being in the same time zone as the USA.

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.

DIGITAL ASSETS

2.1 OWNERSHIP

2.2 CATEGORISATION

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. A public consultation on the introduction of phase two of the VASP Act concluded in April 2024. When phase two comes into effect (date still awaited), as well as registering with CIMA, virtual asset custodians and exchange or trading platforms will also need to apply to CIMA for a separate VASP licence.

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 (selling) 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.

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. A date for the introduction of the sandbox is still awaited.

2.3 TOKENISED SECURITIES

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". SIBA has been 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.

2.4 STABLECOINS

Please refer to 2.2 Categorisation and 2.3 Tokenised Securities

2.5 OTHER DIGITAL ASSETS

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.

2.6 USE OF DIGITAL ASSETS IN PAYMENT

The VASP Act does not restrict the use of use of virtual assets for payment for services in the Cayman Islands. Many corporate and financial services providers now accept payments in a range of virtual assets. There is a growing trend in the Cayman Islands for real estate to be purchased using BTC and other virtual assets.

2.7 USE OF DIGITAL ASSETS IN COLLATERAL ARRANGEMENTS

The use of digital assets as collateral in financial transactions is a developing area of law in the Cayman Islands. The practical implementation of such arrangements requires clear legal agreements that address issues such as the custody, control, and valuation of digital assets, as well as the rights of parties in the event of default.

There are also regulatory considerations concerning the custody and control of digital assets, particularly under securities and investment laws, which may impact their use as collateral. Parties utilising digital assets in collateral arrangements must ensure that these arrangements are structured to comply with existing laws and regulations concerning securities and other financial instruments.

SMART CONTRACTS

3.1 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 – the authors' view is that smart contracts are capable of satisfying the requirements for a binding contract and are enforceable by the Cayman 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.

BLOCKCHAIN REGULATION

4.1 REGULATORY REGIME

4.1.1 REGULATORY OVERVIEW

Please refer to 2.2 Categorisation, which explains the VASP Act.

4.1.2 LICENSING

Please refer to 2.2 Categorisation and 2.3 Tokenised Securities.

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. Cayman does however remain an attractive jurisdiction for mining groups to base their headquarters, with their substantive mining operations based overseas.

There are currently no restrictions on the staking of tokens.

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 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 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.

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.

4.1.3 MARKETING

Please refer to 2.2 Categorisation.

4.1.4 ANTI-MONEY LAUNDERING AND COUNTER-TERRORISM FINANCING (AML/CTF) REQUIREMENTS

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.

4.1.5 CHANGE IN CONTROL

Virtual asset providers are regulated within the Cayman Islands under the VASP Act as virtual asset service providers (see 2.2 Categorisation). As part of the registration process, registrants must submit details of their business.

A VASP registrant must notify CIMA within fifteen days of any changes to the information provided as part of their registration, including all changes of control and ownership of that entity.

In addition to the above, no shares totalling ten per cent or more of the total shares in the VASP registrant shall be issued, and no issued shares or interests shall be voluntarily transferred or disposed of, without the prior approval of CIMA.

4.1.6 RESOLUTION OR INSOLVENCY REGIMES

Specific resolution or insolvency regimes for digital asset firms do not exist separately in the Cayman Islands. Firms dealing with digital assets are subject to the same resolution and insolvency frameworks that apply to other commercial entities under the Companies Act and the Companies Winding Up Rules.

However, the nature of digital assets poses challenges in insolvency scenarios, particularly concerning the identification, valuation, and distribution of digital assets. This is, of course, not unique to the Cayman Islands, and the benefit of its common law system is that it can draw on jurisprudence from a range of other jurisdictions as required.

4.1.7 OTHER REGULATORY REQUIREMENTS

Virtual Assets Service Providers are subject to a number of rules and regulatory requirements including enforceable Rules and other Statements of Guidance in respect of: (i) Consolidated supervision; (ii) outsourcing; (iii) business conduct; (iv) corporate governance (including the fitness and propriety of the controllers and owners); (v) record retention; (vi) cybersecurity; (vii) reporting to CIMA.

4.2 REGULATED FIRMS/FUNDS WITH EXPOSURE TO DIGITAL ASSETS

There are no restrictions on the types of assets in which a Cayman Islands fund may invest, including digital assets. However, the VASP Act would need to be considered when structuring a Cayman Islands fund to ensure compliance in all respects.

A fund could potentially trigger the VASP Act requiring registration or licensing under such Act if it provides virtual asset services which fall outside traditional fund activities. "Virtual asset services" include the issuance of virtual assets, custody of virtual assets or the transfer/exchange of virtual assets for or on behalf of others. The VASP Act defines virtual assets as "a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes but does not include a digital representation of fiat currencies". This wide definition captures all cryptocurrencies, security tokens, utility tokens or other digital assets that are tradeable or transferable, with the exception of digital fiat currencies.

4.3 REGULATORY SANDBOX

A technology neutral regulatory sandbox forms part of the VASP Act but its introduction is still awaited. 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 for further discussion.

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 setting 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.

4.4 INTERNATIONAL STANDARDS

Please refer to 2.2 Categorisation and 4.1.4 Anti-money Laundering and Counter-Terrorism Financing (AML/CTF) Requirements.

4.5 REGULATORY BODIES

The Cayman Islands Monetary Authority (CIMA) is the primary regulator of the Cayman Island's financial services industry responsible for the supervision of regulated entities operating in and from the jurisdiction. As part of this role CIMA provides oversight for investment funds and entities caught by SIBA as well as overseeing the VASP Act.

4.6 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.

4.7 OTHER GOVERNMENT INITIATIVES

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.

DISPUTES

5.1 JUDICIAL DECISIONS AND LITIGATION

To date, there have been no significant judicial decisions in the Cayman Islands that directly define the legal regime applicable to the use of blockchain technology. As the blockchain sector continues to evolve, this therefore remains an untested area within the jurisdiction's courts. However, it is anticipated that future cases will provide further clarification and possibly align with principles established in similar common law jurisdictions, such as England and Wales.

Regarding the treatment of blockchain developers and the imposition of fiduciary duties, it is the authors' opinion that developers, typically, are not fiduciaries. This view is based on the understanding that the role of developers in the governance of public blockchain networks generally does not involve the management of third-party assets or rights traditionally associated with fiduciary responsibilities. Instead, their role is more technical, and does not inherently carry the risks of abuse characteristic of traditional fiduciaries.

On the question of whether digital assets are considered "property," the Cayman Islands have yet to produce case law directly addressing this issue. Nevertheless, it is reasonable to expect that the courts might look favourably upon precedents set in the UK, particularly considering the findings of the UK Jurisdiction Taskforce (a government-backed group tasked with promoting the use of English law and the UK jurisdiction for technology and digital innovation), which affirm the property status of digital assets. This alignment would imply that digital assets can be subject to security interests such as fixed or floating charges, and appropriate measures, such as taking custody of digital keys, would be advisable to secure these charges effectively.

As for security over tokens representing equity interests (such as shares) in Cayman entities, it is the author's view that security should additionally be taken over the underlying equity interests according to local practices, such as by way of equitable share mortgages or charges.

Currently, there is no public central registry in the Cayman Islands for registering security interests, but internal registries must be maintained by entities at their registered offices.

In conclusion, while specific judicial guidance on blockchain remains forthcoming, the legal principles applied to emerging technologies are likely to be informed by established common law practices and influenced by developments in comparable legal systems such as that of the UK. No ongoing litigation in the Cayman Islands is specifically expected to impact the blockchain sector imminently, but this is an area of potential development as the technology and its applications continue to expand.

5.2 ENFORCEMENT ACTIONS

Presently, specific enforcement actions in the Cayman Islands within the realm of blockchain and digital assets are somewhat limited, reflecting the relatively nascent nature of this regulatory field. However, the Cayman Islands Monetary Authority (CIMA), which plays a pivotal role in the oversight and regulation of financial services, has engaged in certain regulatory activities that help clarify the "regulatory perimeter" for blockchain-related operations. This includes assisting with bringing into force the Virtual Asset (Service Providers) Act and issuing public warnings regarding unregistered or non-compliant platforms possibly operating within the jurisdiction. These actions help market participants understand the boundaries of legal and illegal activities concerning blockchain and digital assets. By clarifying these boundaries, the Cayman Islands supports a transparent and secure environment for technological innovation while ensuring compliance with international financial regulatory standards.

TAX

6.1 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. 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.

SUSTAINABILITY

7.1 ESG/SUSTAINABLE FINANCE REQUIREMENTS

CIMA has not produced any specific guidance in respect of ESG/sustainable finance requirements but has recognised the importance of ESG considerations and as part of its supervisory mandate.

In a statement issued on 13 April 2023, CIMA stated that it will continue to undertake reviews, including assessing available information, such as best practices undertaken in other key financial jurisdictions, with the aim of developing a suitable regulatory and supervisory approach for climate related risks and other ESG-related risks.

DATA PRIVACY AND PROTECTION

8.1 DATA PRIVACY

The Cayman Islands Data Protection Act (DPA) came into full force in 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 not 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.

Previously published by Chambers Blockchain 2024 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.

2024 Blockchain Guide – Cayman Islands

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