Jurisdiction for Web3 Companies

 

In order to assess the jurisdiction of a company in the Web3 ecosystem, we ought to evaluate the company based on its function and the following potential factors while evaluating the jurisdiction for setting up a company. Accordingly, the factors involved would be – (i) the Possibility to accept payments in crypto; (ii) the Possibility to issue tokens; (iii) Special licenses for crypto exchanges / custodial services; (iv) Authorizations in Financial State Authorities; (v) KYC requirements for crypto-related services; (vi) Friendly taxation for virtual assets; and (vii) Affordable price for legal setup.

Further, it is imperative to be updated on the financial laws, securities laws, consumer protection laws, and specific legislations for Virtual Asset Service Providers. At an appropriate place in the analysis, we compare the international jurisdictions based on their regulatory foundation for virtual asset services businesses.

Basis on the factual background, we will look at crypto companies with functions such as — (i) crypto exchanges and DeFi; (ii) crypto wallets; and (iii) NFT marketplace.

(a) Crypto Exchanges and DeFi Cryptocurrency exchanges around the world can be divided into centralized and decentralized exchanges.

• Centralized exchanges store users’ virtual assets centrally and administer the cryptocurrency trading process on their platforms.
• Decentralized exchanges are those based on a smart contract that does not provide for centralized storage of cryptocurrencies but instead independently changes one cryptocurrency to another under the rules laid down in the smart contract and following the trading orders that users create.

In most of the countries operation of centralized exchanges requires obtaining special licenses or authorizations. We can further divide the licenses required into the following —

(i) Global Fintech — a. Money Transmitter License (USA); b. Electronic Money Institution License (Lithuania and England) and (ii) Special Cryptocurrency Licenses — a. DLT License (Gibraltar); b. Registration in the ADGM Zone (UAE);

(b) Issue Tokens Companies generally issue tokens for one of two reasons (i) to incentivize an active usage of a company’s product or service, usually achieved by staking and airdrops; and (ii) to grant voting rights, in order to decide on the development and operation of a project, usually achieved by turning the project into a DAO.

Issuing a token would classify a company as Virtual Asset Providers (VAP), thus a special regulatory regime for Virtual Asset Service Providers (VASP) in the jurisdiction of incorporation would be material in fixating on any jurisdiction.

Jurisdictions with special regulatory regimes for VASPs — Gibraltar, Lichtenstein, Cayman Islands, and Singapore have adopted specific laws. Whereas, Switzerland and Hong Kong have issued relevant regulatory clarifications.

(c) Crypto Wallets Depending on the principle of operation crypto wallets are divided into custodial wallets(providers tend to store users’ virtual assets in their wallets controlling the private key) and non-custodial wallets (allows users to independently generate a private key and fully control their virtual assets).

Since the providers of custodial wallet control users’ virtual assets, they need to obtain special authorizations from financial monitoring authorities (FinTRAC — Canada; Financial Intelligence Unit — Estonia; Bureau of Fraud Investigation — Ireland). Whereas, for the non-custodial wallet as of now there are no regulatory requirements unless the company decides to launch a token swap function.

(d) NFT Marketplace NFTs qualify as digital goods in most of the countries and their properties including ‘non-interchangeability’ allows their legal status same as collectible goods. Selectin jurisdiction for an NFT marketplace must depend on the business model vis-à-vis, if the operations involves an IP-related income or an auction format. In case of IP receivables, we must choose an IP friendly jurisdiction that has special tax regimes. However, for an auction format, will have to obtain an auction license/authorization to operate in the country of registration.

Comparison of jurisdictions based on potential factors

Based on the laws and regulations of the jurisdictions discussed above, it is possible to set up a token-issuing company in a jurisdiction where the regulator has adopted a “wait-and-see” approach and no token-specific legislation has been issued. These would be Jurisdictions like the British Virgin Islands, St. Lucia, and Panama.

The advantages are that the virtual asset activity isn’t overly regulated in these countries and often doesn’t imply additional obligations for authorization, licensing, KYC/AML implementation, etc. However, special regulations for virtual assets can always be introduced in the future. This exposes a company to a rather high degree of risk due to the uncertainty of newly-adopted regulations.

Both the Cayman Islands and Dubai have similar regulations for taxation and AML laws. However, no KYC requirement, affordable legal setup, and no special license for crypto exchange makes the Cayman Islands an attractive jurisdiction when compared to Dubai for the holding company.

Feel free to reach out for any specific queries at sultaniagarv@gmail.com