Crypto is flourishing through offshore corporate structures
Marc Piano, Senior Associate at the global offshore law firm Harney’s, is a member of the Investment Funds, Corporate and Banking and Finance teams in the Cayman Islands office. Phil Graham, partner at Harneys, is global head of the investment funds and regulatory groups and head of the British Virgin Islands transaction team.
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The buzz around a virtual asset or web3 project will typically focus on the ‘front-end’ – the product offering, the team, partnerships and performance; how it’s going to change the world. Even if one accepts that the corporate structure behind the front end is far less exciting, it can really make the difference between a project’s success and sustainability or its failure and damaging fallout.
Many web3 projects want decentralization, but basically consist of a small and highly centralized team. Like any early stage startup, a crypto project will usually want to set up a corporate structure to protect the project’s team and its assets, secure funding, and start doing business with real counterparts.
Similar considerations will also apply to principals who want to create a crypto-asset focused fund, who will want to seek and provide attractive returns, have an optimized tax structure and be appealing to an investor base worldwide, while protecting the investment. the management company and the fund’s other service providers by using a flexible and appropriately regulated structure for their launch.
With that in mind, international financial centers (IFCs), such as the British Virgin Islands (BVI) and the Cayman Islands, offer attractive solutions for both crypto projects and crypto funds.
For decades, IFCs have offered tax-neutral and appropriately regulated financial services to their users through sophisticated and experienced financial service providers. For example, many investment funds and other financial services are domiciled in IFCs, including the vast majority of the world’s crypto funds: an estimated 63% of these use Cayman Islands and BVI vehicles.
A shining example of innovation by IFCs to create vehicles for specific uses is the Cayman Islands Foundation Company. Foundation companies are not required to have charitable or non-profit purposes and, unlike most corporate vehicles, they are not required to have members to remain in existence. These two factors make foundation companies attractive to projects aiming at decentralization, as they can act as a memberless vehicle with the sole purpose of supporting the project or its governance protocol. The foundation company may engage with third parties or hold certain assets in support of the project and may be bound by its constitutional documents to act according to the instructions of a governance protocol or its representatives.
In addition, virtual asset regulations in the BVI and Cayman Islands allow BVI or Cayman Islands entities to be used as token issuers, with private sales largely unregulated and public sales of tokens subject to appropriate levels of regulatory oversight.
A commonly used structure involves establishing a Cayman Islands foundation company, which owns a token issuing vehicle, usually formed in the BVI. The director(s) of these companies will often be a professional service provider, who can take guidance from the governance protocol adopted by the Decentralized Autonomous Organization (DAO). This approach appropriately separates each unit’s functions in addition to reducing some risk and simplifying accounting for the project and team. For many projects, this can improve decentralization management and further remove the founders and team from the corporate structure that will perform activities.
All of this said, there is no one-size-fits-all approach to crypto fund or crypto project structuring. Each team must carefully consider its commercial requirements, risk appetite and legal, regulatory and tax position.
Slavishly copying a structure used by other projects is a dangerous game, especially without understanding the project’s objectives, legal and tax advice and risk appetite in a changing regulatory landscape.
Engaging crypto-experienced service providers early in the process means that a fund or project can get the right advice early enough to avoid costly mistakes to fully understand their legal and regulatory position, tax implications of a proposed structure (both for founders, users and the project vehicles themselves ), reduce risk where possible, and avoid consequences that may arise well after a fund or project has been initiated that may be difficult or impossible to remedy.
In addition to choosing the right structure, the global crypto regulatory landscape is changing. The Financial Action Task Force (FATF) – the global anti-money laundering and terrorist financing watchdog – published anti-money laundering standards and recommendations for certain crypto businesses that jurisdictions must implement locally to avoid being subject to sanctions such as blacklisting. Not all crypto businesses will be affected in the same way by new crypto regulations and, of course, other laws and regulations such as securities, investment, banking, substance and data protection laws may apply to a project, so a local legal and regulatory analysis may be necessary for each vehicle in a structure.
In this context, it is extremely important for readers to realize that using a vehicle domiciled in an IFC will not exempt crypto projects from their obligations to comply with relevant laws and regulations in countries where they do business or where their clients or customers are based, especially given the fact that a large number of the digital asset projects often involve a mix of IFC and land-based vehicles.
Crypto continues to grow and thrive regardless of market setbacks and downturns. Many of the world’s largest crypto funds and businesses use IFC vehicles to optimize their corporate structure, and start-ups with the right advice can also benefit from the jurisdictional and structuring advantages offered by IFCs and their corporate vehicles.
IFC jurisdictions recognize the value of crypto to strengthen their global offerings, so local governments and regulators regularly consult with the industry to understand trends and implement frameworks to position themselves to capture crypto market share while complying with international standards around corporate and tax transparency and reporting.
This flexibility is hard to find in land-based jurisdictions and helps IFCs maintain their reputation as jurisdictions of choice for businesses with a global client base, to the point where some projects have chosen to have physical offices and staff on the ground themselves. The physical advantages of living in these jurisdictions are for a whole separate publication, but there is no doubt that there is a perfectly aligned approach on both islands, meaning that both the BVI and the Cayman Islands should always be firmly in the minds of anyone who operating in this room.
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Learn more:
– Fundstrat warns about trading on offshore crypto exchanges
– Why regulation is key to the crypto industry
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– Japanese regulator wants to reform the crypto tax law for companies and investors
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– Data validation and the problem of standards: why it’s hard and how to fix it in a decentralized way
– DeFi is ‘Designed to avoid this nonsense’, says Compound founder about Crypto Bailouts
– DeFi suffers from too much centralization, what can be done?
