The rise of crypto and token business
Dominic Lawton-Smith (pictured) is head of Private Client & Private Equity at Cayman-based boutique fund administrator, trustee and corporate services firm JP Integra Group. The company is 11 years old, has Cayman trust, fund administration and corporate services licences, enabling it to work with private, institutional and sovereign clients and has over USD6 billion under administration.
It specialises in the provision of administrative and fiduciary services to clients with international investment, offering and estate planning projects in the long or short term. JP Integra leverages its offering and its legal and accounting skills with Cayman’s position as a key global crossing place for trade.
“When establishing funds and organising ICOs and token offerings it pays to have a professional team in a fiscally neutral, high quality jurisdiction involved,” Dominic says. “We provide full services in compliance with the highest international standards of AML/CFT and CRS/FATCA reporting without adding an extra layer of entity tax which would reduce the returns for investors and originators in their home jurisdictions.”
Cayman is proving a very popular jurisdiction for ICO, token and cryptocurrency vehicles; in fact, what is believed to be the largest ICO to date was hosted on Cayman – the EOSIO blockchain platform raised USD4 billion over the six months ending in June this year.
Lawton-Smith reports that JP Integra has considered a high number of related approaches during the last two years but only took their first step into the business at the end of 2017 after watching the sector begin to mature, so that the proportion of well-considered and advised projects became dominant; at the same time, more complimentary service offerings were developed so that it became more practical to deliver compliant solutions.
“As a fund administrator and trustee, we are used to doing the full sweep of anti-money laundering (AML) checks as well as know your client (KYC) and other due diligence type work; for us, a crypto asset has a lot in common with some of the more exotic derivatives or options”.
Token or coin offerings can be likened to private equity style investments, Lawton-Smith says. “These are very exciting new structures for raising money to fund exciting new ideas, often characterised as an alternative to an Initial Public Offering. The impact of token offerings internationally is expected to be huge, they will provide the capital enabling many of the next generation of medium to large business ideas to become reality. However, while the potential for great new business ideas to be funded is very exciting, it is important to remember that a token can convey any collection of rights or privileges determined by the issuer which often do not include an equity interest in the business. For the investor to do well, the token sale has to be successful, the management team have to be successful and the benefits of the token have to be sufficient to warrant the risk of investment – if any of these components are missing the investor/purchaser might be facing a complete loss.”
“The most in-demand services in the sector from us are either full service fund administration for funds investing in crypto assets or ‘AML/KYC only’ compliance services for token offerings. The latter is often a requirement of the bank offering a custody solution. It is very important not to underestimate the risk of a project being used to launder money, it could threaten the project and help unpleasant people achieve unacceptable goals. By providing an institutional quality service level we are protecting the purchasers /investors as well as the client company and its directors.”
Cayman is not a retail fund environment and Lawton-Smith says that his priorities when looking at token offerings or other cryptocurrency schemes include ensuring that the scheme is only open to qualified investors who have the means and experience to make their own investigations as well there being a solid law firm and clear disclosures about the offering or investment.
Lawton-Smith observes that a lot of token schemes originate from a team in the US (often with Silicon Valley connections) who seeks to raise money internationally. Apart from Cayman’s reputation for funds and the high quality and number of its resident professionals, the trusted court system attracts businesses to Cayman where there are concerns about patent trolls and other frivolous litigation risks.
“Patent trolls send out volumes of baseless lawsuits which an innocent client has to either settle (if cheaper) or engage a law firm to deal with. It would be very difficult for patent trolls to make these attempts economic where the legal situs for the claim is a Cayman court.”
A second strength of Cayman for the token offering and cryptocurrency industry, Lawton-Smith says, is that it is the default investment jurisdiction for businesses from the US generally, being in the same or adjacent time zone as well as being compliant with US and international standards of financial regulation and reporting.
“If a capital raise is taking place outside the US on behalf of entrepreneurs based in the United States, the requirements are different to a domestic, US capital raise and so the default is to come to Cayman. Apart from US anti-money laundering laws, US lawyers in related sectors increasingly highlight the potential for US federal wire fraud charges if enough care is not taken – making sure the right checks are done is essential”
Lawton-Smith observes that token issuances are a fast and relatively informal way to raise money: “You might be funding a business that is yet to be built, subject to the nature of the tokens you have purchased; should the company be successfully launched, participation may allow you to buy services for delivery in the future at an enormous discount. Tokens are a crucially important way to raise money and I can only imagine that the use of them as a way to raise capital will continue to grow.”
“In an age where it’s difficult to borrow money from banks, ICOs and token offerings are an important financing option for business; it’s very important that they are allowed to take place although we all need there to be safeguards.”
One of Lawton-Smith’s concerns is that anonymity lies at the heart of the cryptocurrency and blockchain world and that this does not fit well with the need for any participant in the institutional finance industry (internationally) to know who they’re dealing with and be satisfied that currency (fiat or crypto) is from an acceptable source.
“Anonymity is attractive from a ‘privacy for honest people’ perspective but it’s no use to us in a regulated services environment. Blockchain, the distributed ledger, is revolutionary but it doesn’t include counterparty identification so there is no reference as to who is the buyer and who is the seller.”
“If we are going to make full use of the enormous potential of blockchain/distributed ledger technology, it must be fit for purpose in a compliant setting – how else do we know we’re keeping the bad guys out of the system and make the smart contract revolution possible?”
Lawton-Smith and others in the sector are aware of initiatives (including some based in Cayman) that will enable private data, fit for KYC / AML purposes to be secured on the blockchain or other distributed ledger system so that the person who is the subject of the data will be able to choose to release it to defined counterparties for defined periods of time and that this will be a much more efficient way to exchange the required information.
“Some liken the meeting of the crypto & token concepts with the international financial services sector to dragging the Wild West into the regulated world – or at least the elements of it that are needed to do business. There’s still some way to go before we have a really efficient and compliant investment process but it is important that we get there and that good quality ICOs/token offerings are able to flourish efficiently.”