The Cayman Islands has emerged as a leader in this digital revolution, witnessing a significant rise in the number of Web3 entities being established in recent years. “If it stays on track, and legislation continues to evolve, there should be no limit to how quickly it can expand", says Managing Director, Chris Humphries. This article takes a look at the key factors driving this growth and sheds light on the jurisdiction's appeal for those venturing into the dynamic realms of Web3 and virtual assets.
The Cayman Islands
The Cayman Islands has been the leading offshore jurisdiction for the establishment of investment funds (mutual funds and private funds) for over 30 years. It’s phenomenal reputation has been due in part to the use of innovative legislation; the absence of taxation and exchange controls; and the long-standing presence of sophisticated and professional service providers, ensuring responsible supervision and regulation, and a safe and trusted environment for investors.
How is legislation empowering the growth of Web3?
In the dynamic landscape of Web3, the Cayman Islands stands out with its progressive legislation, notably the Virtual Asset (Service Providers) Act (“VASPA”). This innovative legislation has played a pivotal role in enabling the growth of Web3, Crypto, and other Digital Asset companies. VASPA sets a robust regulatory framework monitored through the Cayman Islands Monetary Authority (“CIMA”), fostering a secure and transparent environment for these entities to thrive.
The establishment of special economic zones such as Cayman Enterprise City (“CEC") and the introduction of modern legislation such as the Special Economic Zones Act (as Revised) (“SEZ Act”) has also contributed toward the growth and expansion of Web3 in the Cayman Islands.
What is the best structure to use for establishing a Web3 entity?
The choice of structure is crucial when establishing a Web3, DAO, or De-Fi entity, and the Cayman Islands offers a versatile array of options. We have outlined the three (3) most popular structures for Web3 companies in the Cayman Islands below.
1. Foundation Company
Foundation Companies emerge as the preferred choice for DAOs, Web3, and De-Fi entities. This popularity is attributed to several key factors:
- Liability Protection: Foundation Companies provide a robust shield, safeguarding stakeholders from personal liability.
- Flexibility of a Trust: These structures offer the adaptability of a trust, providing a dynamic framework for operations.
- No Shareholders: Unlike traditional companies, Foundation Companies operate without shareholders, fostering a more decentralised model.
- Objects are the Priority: Foundation Companies prioritise their specified objects, aligning them with the unique goals and functions of Web3 entities.
Decentralised Finance (“DeFi”)
Cayman Islands legislation adeptly accommodates various DeFi products through the versatile structure of a Foundation. For DeFi projects the foundation company can provide a legal ‘wrapper’ with corporate personality. In this role the foundation company can undertake many of the real-world activities required by the DeFi project. The foundation company can act as a service provider for DeFi projects by signing documents and engaging developers or consultants on behalf of the project. It can also act as a fundraising vehicle for early stage and VC private funding (something expressly provided for by the VASP Act), hold a DeFi project’s treasury assets to pay for ongoing services, or act as a vehicle for providing marketing services such as airdrops for tokens, NFTs, P2E games and metaverse projects.
Decentralised Autonomous Organisation (“DAO”)
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. Foundation companies, unlike trusts or partnerships, have separate legal personality, can hold assets, assume obligations, and can serve as corporate parents with subsidiaries.
Token Issuers
A token issuer can be set up as a standalone entity to issue tokens or NFT’s (the “Token Issuer”) or more commonly as a subsidiary of a second entity that develops the platform or protocol (the “Developer”). In this way, much of the regulatory liability of the Token Issuer is separated from the value built up in the Developer entity. For the Developer, many options are available including a foundation company. However, for the Token Issuer, most Web3 and blockchain companies choose an Exempted Limited Liability Company.
2. Exempted Limited Liability Company
Many Web3 and virtual assets entities choose an exempted company as the tax neutral vehicle to be the Token Issuer. A Cayman Islands special economic zone company (“SEZC”) can also be used , being a form of exempted limited company established within the SEZ and which enjoys several special benefits due to that status.
Platform Controlling Entities
An entity that controls a platform that only provides a forum where sellers and buyers may post bids and offers or, a forum where the parties trade in a separate platform or in a peer-to-peer manner will be exempted from the requirement to obtain a license from CIMA under the VASP Act. This kind of platform controlling entity could be formed using any one of the other described legal forms contained in this article, but most commonly would use an exempted company.
Intellectual Property Holding Companies
As a complementary entity to a DAO, clients often incorporate a separate entity to separate IP holding companies or separate software operators. This choice is often driven by the preferences of each business, its risk appetite and its tax considerations.
The preferred vehicle for an entity established to hold Web3 intellectual property is an exempted company. Any vehicle established for the sole purpose of holding, exploiting or receiving income from intellectual property assets will not be required to register with CIMA under the VASP Act, but it may be required to satisfy an extended economic substance test under the International Tax Co-operation (Economic Substance) Act.
3. Funds
The Cayman Islands are home to both regulated mutual and private fund structures which may be used for Web3 and blockchain applications.
Mutual Funds
There are many types of mutual funds that are subject to regulation and supervision under the Mutual Funds Act by CIMA but the one most popular for virtual assets funds is the registered mutual fund where:
- the initial minimum equity interest purchasable by an investor is US$100,000; or
- whose equity interests are listed on an approved stock exchange such as the Cayman Stock Exchange.
Private Funds
The Private Funds Act regulates private funds under the supervision of CIMA which operate as closed-ended funds.
Exchange Traded Funds (ETF’s)
Offering exposure to the cryptocurrency market through traditional exchange-traded funds is another popular choice among investors.
Read more on how Bitcoin ETF’s work in the Cayman Islands on our website.
Segregated Portfolio Company (SPC)
SPCs offer a unique advantage by segregating assets and liabilities between different portfolios, reducing risk and enhancing efficiency.
An SPC is one legal entity with different “pools” called “segregated portfolios” whose assets and liabilities are separated and protected (under Cayman Islands status) from the liability of all other segregated portfolios in the same SPC.
A Burgeoning Crypto Community: Cayman Special Economic Zone
The Special Economic Zone (“SEZ”) has further catalysed the growth of Web3 and virtual asset entities. The SEZ provides a conducive environment for innovation, offering tax incentives, streamlined regulatory processes, and a collaborative ecosystem for businesses to thrive.
Conclusion
The Cayman Islands continues to position itself at the forefront of Web3 and virtual assets expansion. The strategic selection of a legal framework, whether through Foundation Companies, diverse fund structures, or the advantages offered by the SEZ, positions the Cayman Islands as one of the best places to establish and nurture Web3, DAOs, and De-Fi entities. For those seeking a dynamic environment and legal infrastructure conducive to digital innovation, the Cayman Islands beckons as a hub for the future of Web3.
About Stuarts Humphries
Stuarts Humphries is a leading offshore Cayman Islands legal practice specialising in investment funds and fintech. Our experienced, award-winning attorneys offer exceptional timely legal advice to clients around the world on their most significant and challenging commercial transactions, structures, liabilities and obligations.
At Stuarts, we build and maintain enduring relationships with clients through the combined legal expertise and business acumen of out practice groups and by providing outstanding service.
For more information on the above topic or to schedule a consultation with one of our Web3 and digital assets lawyers, get in contact with us or reach out to one of the key contacts provided below.