Sponsored briefing: Utilising offshore structures for digital assets

Conyers’ Barnabas Finnigan and Eric Flaye on how offshore jurisdictions have positioned themselves to take advantage of recent developments

The development of blockchain applications and the rapid growth of cryptocurrencies and other virtual assets have opened up new opportunities in the fintech space in recent years. Increasingly, sophisticated investors are seeking ways to access this niche sector.

We have seen a flurry of investment funds being established to focus on decentralised finance (De-Fi) platforms and cryptocurrencies, while other entrants undertake coin and token offerings and establish virtual asset-trading platforms.

PwC’s 3rd Annual Global Crypto Hedge Fund Report 2021 highlights the sector’s rapid expansion, noting that total assets under management (AUM) of crypto funds almost doubled from 2020 to 2021, rising from US$2bn to US$3.8bn. Traditional hedge funds are actively embracing this trend, with around 20% currently investing in digital assets, and over 25% of fund managers not currently invested in this asset class actively planning to do so. The report also highlights the UK’s importance in this space, being second only to the US as the jurisdiction of choice for managers of crypto-focused funds.

Notwithstanding the UK’s role in originating and managing investments in digital assets, De-Fi structures and crypto-focused funds are still predominantly structured through more traditional fund jurisdictions, including the US, Cayman Islands, British Virgin Islands (BVI) and Bermuda.

Offshore jurisdictions have positioned themselves to take advantage of recent developments and put in place the appropriate regulatory frameworks to support this growing industry.

Cayman Islands

The Cayman Special Economic Zone has a strong focus on supporting fintech-related businesses and facilitates the establishment of a physical presence in Cayman by offering fast-tracked incorporation, five-year work permits and duty waivers.

Cayman introduced the Virtual Asset (Service Providers) Act (VASPA) in 2020 to regulate ‘virtual asset service providers’ (VASPs) that provide “virtual asset services” as a business, or in the course of business, in or from within the Cayman Islands. Examples of these virtual asset services include offering an exchange between virtual assets and fiat currencies, and transfer of virtual assets.

For the purposes of VASPA, ‘virtual assets’ are digital representations of value that can be digitally traded or transferred and can be used for payment or investment purposes. Regulation of VASPs under VASPA is conducted by the Cayman Islands Monetary Authority. VASPA also introduces a regulatory sandbox regime.

Cayman does not have specific legislation relating to initial coin offerings (ICOs) as these are governed by the existing securities and investment business laws.

Bermuda

Bermuda has carved a niche as a premier jurisdiction for digital asset businesses wishing to set up a presence offshore or intending to conduct an ICO. With a very pro-fintech government, Bermuda has recently attracted a number of key industry players, and new initiatives are being developed to support businesses in this area and in the wider fintech space.

Bermuda introduced the Digital Asset Business Act (DABA) in 2018 to regulate entities carrying on digital asset business in or from within Bermuda. Under DABA, a ‘digital asset business’ is one that provides certain services to the general public such as issuing, selling or redeeming virtual coins, tokens or other form of digital asset, or operating as a payment service provider business utilising digital assets. DABA requires any person carrying out digital asset business to be licensed by the Bermuda Monetary Authority (BMA).

Bermuda also has a Digital Asset Issuance Act to regulate ICOs. An offer by a company or LLC to the public to purchase digital assets will, subject to certain exemptions, be a ‘restricted business’ requiring consent from the BMA, together with the publication and filing of an offering document.

British Virgin Islands

BVI has positioned itself as a flexible and attractive jurisdiction for innovative fintech businesses, and has proven very popular for crypto exchanges, ICOs and crypto funds. The BVI Financial Services Commission launched a regulatory sandbox in 2020 targeted at new technologies in the financial services sector.

Unlike the Cayman Islands and Bermuda, there is currently no legislation in force in BVI specifically targeted at cryptocurrencies or digital assets. A BVI entity engaging in business or investment activities involving cryptocurrencies or digital assets would need to assess any potential regulatory implications under the more general securities and investment laws in place in BVI, primarily the Securities and Investment Business Act.

A new regulatory regime is due to be implemented in BVI later this year that will specifically regulate this sector for the first time.

Why Choose Offshore

For investment fund managers looking to enter the De-Fi, cryptocurrency and blockchain space, the offshore jurisdictions of the Cayman Islands, Bermuda and BVI are a natural choice. Not only do they offer tax-neutral platforms and legal systems based on English law, they are also commercially flexible and friendly locations from which to structure and operate a crypto-focused fund or other digital assets business or platform.