Offshore: Jurisdictions race to regulate cryptocurrencies
10 Apr 2018

The explosive rise of Bitcoin and other cryptocurrencies has kicked off a race between offshore financial centres as they compete to offer the most appealing regulatory frameworks for the emerging cryptocurrency industry.

The cryptocurrency market presents a highly lucrative opportunity for offshore tax havens, particularly as tax authorities around the world level sharper scrutiny on cryptocurrencies and investors begin looking for alternatives to reduce their tax burdens.

However, regulatory authorities are faced with the need to balance maintaining a competitive edge with managing the money laundering and financial crime risks associated with cryptocurrency investments.

One clear example of the race to regulate is between Gibraltar and Bermuda. Each of the two British overseas territories claims to be developing the “world’s first” Initial Coin Offering (ICO) regulations. ICOs, also referred to as token sales, offer investors the chance to buy into new cryptocurrencies.

They are considered especially vulnerable to fraud and money laundering risks, with an estimated $400 million lost through fraudulent ICOs as of January 2018.

Gibraltar has been well ahead of the curve on cryptocurrencies for several years. The Gibraltar Stock Exchange traded Europe’s first regulated Bitcoin product in July 2016.

The small island is now planning to open an entire stock exchange subsidiary, the Gibraltar Blockchain Exchange (GBX), for trading cryptocurrencies.

“GBX has to date been approached by up to 200 applicants seeking to launch their [Initial Coin Offerings] through the Gibraltar Blockchain Exchange,” chief executive Nick Gowan told the Financial Times.

The Gibraltar Financial Services Commission has been moving fast to keep up with the fraud and financial crime risks which the growing industry brings with it.

Under new regulations implemented as of January 1st 2018, firms in Gibraltar are required to apply for a license if they are using distributed ledger technology (otherwise known as blockchain) to “store or transmit value belonging to others”.

On March 16th, the Government of Gibraltar amended the Proceeds of Crime Act to include “businesses that receive proceeds from token sales”, obliging cryptocurrency businesses to comply with AML obligations including customer due diligence, transaction monitoring and risk assessment.

The next step will be the GFSC’s planned “world-first” regulations for Initial Coin Offerings (ICOs).

“One of the key aspects of the token regulations is that we will be introducing the concept of regulating authorized sponsors who will be responsible for assuring compliance with disclosure and financial crime rules,” GFSC senior advisor Sian Jones said.

Gibraltar faces competition from Bermuda, however, which also recently announced its intentions for the world’s first ICO regulations.

“Bermuda has an opportunity to become a global leader in the Fintech space by being one of the first countries in the world to specifically regulate ICOs,” Finance Minister David Burt told parliament in his statement announcing the draft Bill.

“We recognize that there is concern within well-established industries in Bermuda about digital assets such as Bitcoin, and that Governments around the world are wrestling with ever growing threats related to these new products.

“However, we cannot remain in what we think is a comfort zone and miss out on an opportunity to be a world leader in an emerging industry.”

The Minister also sounded a note of caution, however, saying “Let me be clear, the Government is well aware of Bermuda’s obligations to maintain adherence to global standards. And we are well aware of the results of the recent OECD assessment and the imminent FATF assessment. As such, we are taking a measured approach to entering this space.”

Which of these two territories will win the race to regulate remains to be seen, but it is evident that both are actively considering the financial crime dimensions of new cryptocurrency regulations. This is less clear in other cases of regulatory competition.

The US states of Wyoming, and Nevada, which have often faced accusations of operating as onshore tax havens, have each passed a rapid-fire series of legislation designed to make their jurisdictions more appealing to cryptocurrency investors.

In June 2017, Nevada passed a law banning local governments from taxing the use of blockchain technologies.

Senate Bill 398 effectively guarantees that cryptocurrency transactions will remain tax-free. Observers have noted the broad wording of the legislation may also leave it open to a variety of other uses.

Wyoming has taken a different route, becoming the first jurisdiction to create an entirely new asset class for cryptocurrency tokens.

House Bill 70, which was signed into law on March 8th 2018, exempts cryptocurrency tokens from state securities regulations.

It may also have the effect of bringing cryptocurrencies in Wyoming further under state rather than federal control.

“The state of Wyoming is the first elected body in the world to define a utility token as a new type of asset class different from a security or commodity,” said Caitlin Long, co-founder of the Wyoming Blockchain Coalition, in an interview with Forbes.

“This has been a hot topic in Washington D.C. recently, as the SEC considers cryptocurrencies to be securities, FinCEN says they’re generally money, and the CFTC views them as commodities. Now, however, you have a state coming out and defining utility tokens as a new form of property, and property is generally the purview of state law.”

This the fifth law on cryptocurrency to be passed by the Wyoming state government in recent weeks.

The other bills include exempting cryptocurrencies from property taxes, exempting them from money transmitter laws and regulations and enabling the creation of series LLCs, which are especially appealing to cryptocurrency investors. Permitting series LLCs is likely to help Wyoming compete with Nevada, which already allows this form of registration.

The impact of this rapidly passed legislation on financial crime risk remains to be seen, however.

In the rush to exempt cryptocurrencies from securities and money transmitter laws and to create this new asset class, it is unclear how due diligence and financial crime compliance obligations will be managed.

There are undoubtedly positive aspects to competition between jurisdictions. Competition drives progress, spurs regulatory innovation and provides a path for others to follow.

However, regulations designed and implemented in haste can lose sight of important issues or fail to thoroughly account for the risks.

Regulations which are too narrow, too broad or vaguely worded (such as Nevada’s Bill 398 which prevents local government entities from imposing “any other requirement relating to the use of a blockchain by any person or entity”) can create unanticipated loopholes which may be difficult to close.

Although there are advantages to being the first mover, authorities in offshore jurisdictions may find that in some cases it is better to focus on getting regulation right rather than simply getting it first.

KYC360 contacted authorities in various offshore jurisdictions for a comment, however they did not respond with a comment on the subject by press time.

Melbourne-based Elise Thomas has a background in international affairs and a strong interest in financial crime, data and technology issues.

Read more:

The compliance and KYC link between banks, bitcoin and exchanges

Regulation: Switching over bitcoin to mainstream financial services: key points

EU Fifth Anti-Money Laundering Directive: Can banks handle it?

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