Cayman Islands Crypto Regulations

Cayman Islands Crypto RegulationsThe Cayman Islands, renowned for its economic services sector and business-friendly environment, has become a destination of interest for enterprises operating in the cryptocurrency and blockchain space. For companies providing virtual asset services, obtaining a Virtual Asset Service Provider (VASP) license is a crucial step to ensure regulatory compliance and credibility. This article outlines the key aspects of obtaining a VASP permit in the Cayman Islands.

The global surge in interest surrounding digital currencies has prompted governments and regulatory bodies worldwide to grapple with the challenge of striking a balance between innovation and security. Among the jurisdictions seeking to establish a framework for crypto-related activities, the Cayman Islands stands out as an intriguing case.

Cayman Islands crypto regulations

Government Stance and Definition

The Cayman Islands stands as a prominent global financial center, renowned for its innovation and business-friendly environment. Recognized for stability in society and politics, legal ties to the United Kingdom, tax neutrality, and a well-regulated financial services industry, the jurisdiction appeals particularly to sophisticated and institutional investors worldwide.

These attributes have positioned the Cayman Islands as a preferred destination for establishing fintech-related structures. Whether it involves fund vehicles investing in digital assets, cryptocurrency exchanges, initial coin or token offerings, or the introduction of decentralized finance protocols or networks, the jurisdiction’s reputation remains pivotal.

Cayman Islands

capital

Capital

population

Population

currency

Currency

gdp

GDP

George Town 68,136 The Cayman Islands Dollar 86,568.77 KYD

Acknowledging the importance of fostering fintech and digital assets business, the Cayman Islands Government, the Cayman Islands Monetary Authority (“CIMA”), and industry bodies like Cayman Finance and the Cayman Islands Blockchain Foundation share a common goal. They aim to attract and nurture sector growth while upholding the jurisdiction’s commitment to the highest financial standards and transparency, especially in the context of digital assets.

In May 2020, in line with the Financial Action Task Force’s international standards, the Cayman Islands introduced a new framework for supervising and regulating virtual asset service businesses — the Virtual Asset (Service Providers) Act, 2020 (the “VASP Act”). This legislation is phased in two parts, with the first phase focusing on anti-money laundering regulations and VASP registration, while the second phase, addressing licensing and additional matters, awaits implementation.

Although the second phase’s specific implementation date is pending, the new framework reinforces the Cayman Islands’ appeal for virtual asset services businesses. It offers a flexible regulatory foundation, providing certainty for those operating in this space and aligning with international standards.

According to the VASP Act, a “virtual asset” broadly refers to a digital representation of value traded or transferred digitally for payment or investment purposes. Notably excluded are digital representations of fiat currencies and “virtual service tokens” that lack transferability or exchangeability with third parties, including tokens solely serving access or service provision functions.

To enhance clarity on the VASP Act, the Virtual Assets (Service Providers) Regulations (the “VASP Regulations”) were introduced in October 2020. These regulations outline registration application requirements, fee details, and offer additional guidance on virtual asset issuances, as discussed further below.

Crypto regulations

The VASP Act unequivocally establishes the legitimacy of digital assets and cryptocurrencies within the Cayman Islands while also regulating businesses offering services related to virtual assets. Generally, virtual assets themselves and entities dealing with them for their internal purposes are not subject to specific regulation in the Cayman Islands.

According to the VASP Act, all Virtual Asset Service Providers (VASPs) must either obtain a license or register with CIMA, secure a waiver, or hold a sandbox license. A “VASP” refers to an entity incorporated or registered in the Cayman Islands that provides virtual asset services as part of its business activities.

In the context of the VASP Act, a “virtual asset service” encompasses the issuance of virtual assets or the provision of specific services for or on behalf of another entity, including:

  1. Exchange between virtual assets and fiat currencies.
  2. Exchange between one or more other forms of convertible virtual assets.
  3. Transfer of virtual assets.
  4. Virtual asset custody service, involving the safekeeping or administration of virtual assets or related instruments that enable control over virtual assets.
  5. Participation in, and provision of, financial services related to a virtual asset issuance or the sale of a virtual asset.

It’s important to note that cryptocurrency and other digital asset businesses not falling under the mentioned categories may still be subject to general regulations in the Cayman Islands. These regulations, which do not specifically target digital assets, include the Securities Investment Business Act (“SIBA”), the Money Services Act, and AML regulations, each of which is further described below.

Sales regulations

VASP Act

As previously outlined, activities such as the issuance of virtual assets, provision of financial services linked to virtual asset issuance or sale, and transfer of virtual assets, conducted by a Cayman Islands entity as a business on behalf of another party, are likely to fall under virtual asset services, necessitating a license or registration with CIMA under the VASP Act.

Under the VASP Act, any issuance of virtual assets requires prior approval from CIMA. In this context, issuance refers to the sale of newly created virtual assets to the public in exchange for fiat currency, other virtual assets, or alternative consideration. While the term “public” lacks a specific definition in the VASP Act, it should be broadly interpreted. The VASP Regulations distinguish a “private sale” (not advertised and sold through private agreements to a limited number of persons) from a sale to the public, potentially exempting certain sales from VASP Act registration requirements. The sale of virtual service tokens and any transfer without consideration (e.g., an “airdrop”) is also excluded from this requirement.

Direct issuances are subject to a prescribed maximum threshold, yet to be fixed at the time of writing. The threshold exemption applies if the issuance is facilitated by one or more virtual asset trading platforms or obliged entities, provided these platforms are either licensed under the VASP Act or regulated in another non-high-risk jurisdiction.

Investment Funds

An entity operating as an investment fund in the Cayman Islands, issuing digital assets, may fall under the purview of the Mutual Funds Act (for open-ended funds) or the Private Funds Act (for closed-ended funds). Registration or licensing may be required if these digital assets constitute equity or investment interests. The determination depends on various factors, and specific advice should be sought. For example, the definition of “equity interest” under the Mutual Funds Act now includes “any other representation of an interest,” likely encompassing a variety of digital assets.

Pooling vehicles investing in the digital asset space or accepting digital assets by subscription for investments in traditional asset classes should seek Cayman Islands legal advice.

Securities Investment Business Act (SIBA)

Under SIBA, an entity formed, registered, or operating from the Cayman Islands that engages in dealing, arranging, managing, or advising on the acquisition or disposal of digital assets may come under SIBA’s purview. Registration or licensing from CIMA may be required, in addition to what’s needed under the VASP Act. This applies if the digital assets constitute “securities” as defined by SIBA.

Notably, the definition of “securities” includes virtual assets that can be sold, traded, or exchanged immediately or in the future, representing or convertible into traditional securities or derivatives of traditional securities. A case-by-case analysis is required to determine if a digital asset falls within these categories.

Offerings within the Cayman Islands

Regarding offerings, sales, or issuances within the Cayman Islands, certain regulatory provisions should be considered. The Companies Act prohibits exempted companies not listed on the Cayman Islands Stock Exchange from offering securities to the Cayman Islands public. Similar prohibitions exist in the Limited Liability Companies Act for LLCs. Even entities based outside the Cayman Islands must be cautious not to engage in activities constituting “carrying on a business” in the Cayman Islands, which may trigger registration, licensing requirements, and penalties. While there’s no explicit definition for “carrying on a business,” seeking legal advice is recommended.

In practice, these restrictions typically do not pose significant concerns for issuers, as the definition of “public” excludes certain entities, and issuers often target investors outside the Cayman Islands.

Taxation

The Cayman Islands Government does not impose income, inheritance, gift, capital gains, corporate, withholding, or any similar taxes concerning the issuance, holding, or transfer of digital assets.

Stamp duty may be applicable to original documents executed in the Cayman Islands or brought into the Cayman Islands after execution. However, the amounts imposed are typically nominal.

Entities established or registered in the Cayman Islands can request and, upon payment of a relatively modest fee, obtain a tax exemption certificate. This certificate confirms that no law enacted in the Cayman Islands after the specified date imposes any tax on profits, income, gains, or appreciations applicable to the entity or its operations. These certificates generally remain valid for a period ranging from 20 to 50 years, depending on the entity type.

Money transmission laws and anti-money laundering requirements

Money Transmission Laws

In accordance with the Money Services Act, anyone engaging in a “money services business” within or from the Cayman Islands must obtain a license from CIMA. Failure to comply with this requirement constitutes a criminal offense.

A “money services business” encompasses providing services such as money transmission or currency exchange. Although there is no definitive guidance on whether this includes transactions involving cryptocurrency or digital assets, a careful examination of the statute may, in certain cases, suggest its applicability. Especially when digital assets primarily facilitate fiat currency transfers or conversions between fiat currencies, the legislation may be relevant. Therefore, individuals aiming to establish such businesses are advised to scrutinize the Money Services Act’s application and seek appropriate professional advice.

Anti-Money Laundering Requirements

The unique characteristics and intended features of digital assets can pose increased compliance risks and practical challenges. Factors such as the absence of a trusted central counterparty, heightened anonymity, and ease of cross-border transfer without restrictions require careful consideration.

To address these issues, Cayman Islands authorities have adopted a balanced approach, integrating digital assets within the existing legal framework rather than establishing a separate regime. This approach focuses on the specific activity and nature of the assets to assess the risk of potential use in illegal activities.

Under the Proceeds of Crime Act, the Anti-Money Laundering Regulations, and associated guidance notes (collectively known as the “AML Laws”), entities formed, registered, or based in the Cayman Islands engaged in “relevant financial business” must adhere to various obligations aimed at preventing, identifying, and reporting money laundering and terrorist financing.

The term “relevant financial business” is defined in the Proceeds of Crime Act and includes providing virtual asset services (defined slightly differently compared to the VASP Act).

While an in-depth examination of AML Laws specifics goes beyond this chapter’s scope, entities subject to the regime generally need to:

  1. Appoint a named individual as an AML compliance officer, approved by CIMA for VASPs, overseeing adherence to the AML Laws and liaising with supervisory authorities.
  2. Appoint named individuals as the money laundering reporting officer and a deputy, creating a reporting line within the business.
  3. Implement procedures ensuring proper identification of counterparties, risk-based monitoring, maintenance of records, and comprehensive employee training.

CIMA has provided AML-related guidance for VASPs, and new regulatory requirements have been introduced for intermediaries handling transfers of virtual assets. In practice, consulting specialized third-party providers is recommended for effective compliance.

Promotion and testing

Sandbox Licences

The VASP Act has introduced sandbox licences designed for providers of virtual asset services or other fintech services leveraging innovative technology or delivery methods. These licences offer flexibility, allowing CIMA to impose additional requirements or grant specific exemptions tailored to the relevant business.

Sandbox licences are temporary, valid for up to one year. During this period, CIMA is expected to evaluate the optimal approach for future business regulation. This assessment may include considerations for legislative changes to further encourage and monitor the use of the relevant innovations. Detailed eligibility criteria are currently unavailable.

Special Economic Zone

Furthermore, the Cayman Islands Government actively promotes the Special Economic Zone (SEZ) to those looking to develop fintech-related products from the jurisdiction.

The SEZ presents an expedited process for businesses in the fintech industry to establish physical operations within the Cayman Islands. It offers various advantages, such as a simplified, quicker, and cost-effective work permit process, concessions regarding local trade licences and ownership requirements, the ability to become operational within four to six weeks, and allocated office space.

Combined with the jurisdiction’s other benefits and recently updated intellectual property laws, the SEZ has gained significant popularity in the fintech industry. The number of blockchain-focused companies establishing themselves within the SEZ continues to grow.

Requirements for Ownership and Licensing

The Cayman Islands does not impose any specific restrictions or licensing requirements aimed directly at individuals owning, holding, or trading digital assets for their personal accounts.

As explained earlier, under the VASP Act, all entities meeting the VASP definition must either obtain a license or registration from CIMA, secure a waiver, or hold a sandbox license. It’s also important to consider the applicability of other regulatory frameworks, such as the Mutual Funds Act and SIBA (as elaborated above).

According to the VASP Act, a VASP must ensure that its beneficial owners receive approval from CIMA as fit and proper individuals to exercise control or ownership. Except for publicly traded companies, ownership interests or voting rights constituting 10% or more in a VASP cannot be issued or transferred voluntarily without prior approval from CIMA, barring possible exceptions.

Mining

Currently, the Cayman Islands neither regulates nor prohibits the mining of digital assets, and the VASP Act does not introduce regulations or prohibitions specifically for this activity. It is worth noting, though, that the practical barriers to establishing significant mining operations in the jurisdiction include import duties on computing equipment and the relatively high cost of electricity production. The potential mitigation of these challenges may be influenced by the growing availability of renewable energy options and their decreasing costs in the future.

Reporting requirements

VASPs registered or licensed under the VASP Act will need to:

  1. Prepare audited accounts annually and submit them to CIMA.
  2. Obtain prior approval from CIMA for the appointment of senior officers or AML compliance officers.
  3. Provide specific notices to CIMA confirming compliance with AML Laws and data protection laws, ensuring the accuracy of all communications related to the virtual asset service.
  4. Conduct audits of their AML systems and procedures upon CIMA’s request.
  5. Notify CIMA of any license or registration in another jurisdiction, the opening of an office or establishment of a physical presence in another jurisdiction, or the holding/acquisition of a controlling interest in another entity engaged in virtual asset service.

Additional reporting and other requirements may be applicable, and they may vary depending on the type of virtual asset service being offered. In cases where a payment or transfer is associated with the conduct of a “relevant financial business” under the AML Laws, obligations to file reports or make filings may arise if there is suspicion of money laundering or other criminal activity.

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