Initial Coin Offerings (ICOs) are booming in offshore financial centres. In 2017, only a small minority of cryptocurrency transactions were taking place offshore but just a year later, according to a study by PriceWaterhouseCoopers and CryptoValley, the Cayman Islands, British Virgin Islands (BVI) and Singapore were the top three jurisdictions of choice for ICOs in the world in 2018.
How did these top three jurisdictions raise more than US$7.67 billion through ICOs, 60% more than the rest of the top ten jurisdictions combined? And why are the world’s ICOs all looking to take place offshore?
Playing in the sandbox
In the last year, many international financial centres (IFCs) have enacted what have been seen as excessively stringent ICO-specific regulations that have curtailed activity.
But in BVI for example, it’s adopted a ‘regulatory sandbox approach’. Christopher Simpson, a partner at O’Neal Webster said:
“Right now there are no specific ICO/cryptocurrency rules in the BVI. We’re operating within a regulatory structure that is rigid enough for an issuance to be transacted legally, but the government is collecting data and analysing transactions to determine what would be best for ICO practitioners and investors before putting anything concrete in place.”
Importantly, these issuances are currently recognised as an ICO token, not a security, so they do not fall under fiat regulation.
Jeffrey Kirk, managing partner at Appleby noted that to be able to continue to operate outside of securities regulation is a huge advantage to the tech-led issuers and investors who are currently leading the way in ICOs.
He said:
“These issuers are tech guys, they are not securities experts. They have created amazing algorithms to launch innovative tokenisation projects but they have little experience in the finance world, so they tend to lean towards more flexible jurisdictions as a result.”
Kirk added that it’s not just issuers who are attracted to offshore ICOs:
“The regulation of securities is a heavy burden. To take part in a securities transaction, you need to be an accredited investor or at least a highly sophisticated investor. But just as the issuers of the ICOs aren’t finance guys, neither are many of the investors. They are investing in the technology, and are unlikely to be interested in gaining the sufficient accreditation to take part in complex securities investment and trading. For them, the lure is the tech, not the money.”
Kirk stressed that managing an ICO offshore is not an exercise in trying to avoid authorities, rather the emerging regulation around ICOs is onerous and as a security, an ICO would bring with it significant obligations that are perhaps too much for crypto entrepreneurs.
Flexible company structures
Aside from being able to grow within a regulatory sandbox, issuers are looking offshore because of the flexibility of the company structures available to them in these jurisdictions.
Simpson said that right now, many offshore ICOs are opting for the ‘IPO model’ where the issuers use a ‘BVI business company structure’ in conjunction with their white paper to distribute the tokens and manage the process.
“Importantly, this model and structure for raising capital is globally recognised and trusted by the wider investment community,” he said.
But Kirk noted that some issuers are opting for the ‘hedge fund’ model:
“An established structure for the issuing company is to distribute tokens via an orphan entity which holds the intellectual property, and then for a separate management company to consult and guide on the issuing. This offshore structure has been used for many years by hedge funds that issue shares from one entity, and then another manages the fund. It’s not necessary, but in this field the legal set-up can be useful.”
The need for a mature rule of law
The traditional route to creating an ICO offshore is to do so via a corporation or a Limited Partnership agreement. This is important, as via these two structures issuers have the power of English Common Law behind them, which is crucial if things go wrong.
As Christopher Farmer, an insolvency practitioner and advisory director at KPMG noted, investors are, by their very nature optimistic, and although enforcement of their rights may not be the primary driver for investing within a particular jurisdiction, it is certainly one that should be considered.
He said:
“The simple fact is that there is no consensus position as to the legal characterisation of digital tokens across those jurisdictions issuing ICOs. Are they akin to currency or commodities? Can they be made the subject of a security interest? Although there are some useful case studies in respect of digital currency based insolvencies, most notably the Mt Gox bankruptcy and its ongoing civil rehabilitation, there is still much uncertainty.”
He added:
“There has to be legislation in place that allows for insolvency practitioners to do their job and enforce the rights of the creditor. This is a strength of the BVI as there are legal frameworks that already exist which can provide safeguards in crypto-insolvencies and, if you are aware of them, related precedents. Although asset recovery in the digital currency space is complicated and the means to make such recoveries relatively untested, a mature legislative system like the BVI’s will make that job significantly easier.”
The future of offshore ICOs
While offshore issuances continue apace, IFC regulators are listening to the ICO community to determine what the future looks like. Simpson noted that this is reflective of how the BVI has enacted much of its regulation:
“I think some jurisdictions may have jumped into ICO regulation and acted somewhat hastily, but historically that hasn’t been the approach of the BVI. Given the nature of this evolving technology, well-thought-out regulation will eventually be necessary, since, notwithstanding the inherent benefits of using BVI entities to structure ICOs, it is paramount to ensure that the jurisdiction only attracts the kind of business we want.”
Whatever the future looks like, offshore financial centres will continue to do all they can to ensure their jurisdictions remain as ICO-friendly as possible while creating an environment that respects Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations. The eyes of the world have been firmly on offshore jurisdictions as global debates around financial transparency continue, so every effort is and will be made to make sure the burgeoning potential of offshore ICOs cannot be tarnished by a few bad actors.
2019 is set to be another bumper year for ICOs, and even as the market matures and regulations are set in place, it’s likely that more crypto entrepreneurs will set sail for offshores issuances.
Lorna Smith, OBE, is currently the Interim Executive Director of BVI Finance, having previously held the position between 2002 and 2004, and 2005 and 2013. Mrs. Smith is responsible for establishing and maintaining sound relationships with the industry and engaging collaborations when appropriate on marketing and promotional strategies for the British Virgin Islands. Other responsibilities include the organisation of promotional tours in key markets, including the US, Hong Kong, Europe, Latin America and other emerging markets to promote the industry’s key messages to potential clients and international investors. Mrs. Smith has more than 30 years of experience at the highest levels of public service in the BVI. Over the course of her senior-level service, she has developed extensive relationships with leaders from the business community, international non-governmental organisations and government leaders from around the world. She previously served as the founding director of the BVI London Office and BVI House Asia. Currently, amongst other areas, she serves as the Chairman of the Financial Services Business Development Committee which provides government with strategic advice on Financial Services policies. She was honoured with an Order of the British Empire (OBE) for her ‘outstanding public services’ to the Government of the British Virgin Islands in 2011.