Where to set up a Crypto Exchange – Part 4: Setting up an Exchange in the Americas
Flag Theory Weekly Letter – Friday, September 7th, 2018
After discussing the fundamental aspects when choosing the jurisdiction to establish your crypto trading platform, and taking a look at some jurisdictions in Asia-Pacific and Europe, we conclude with the “Where to set up your cryptocurrency exchange” article series with some of the most interesting jurisdictions in the American continent to start and operate a cryptocurrency exchange.
Set up an Exchange in Bermuda
Bermuda is home of many Fortune 500 companies which have chosen the island to set up a tax-exempt vehicle as a holding company, and for trading, manufacturing, inter-group financing, shipping, aircraft leasing and holding of intellectual property rights, among others.
Bermuda is also an insurance leader, with 900 captive insurance companies and almost half of the world’s leading reinsurers.
Bermuda has also been a pioneer in enacting a legal framework for Initial Coin Offerings, which currently need to seek permission from the BMA (Bermuda Monetary Authority).
Following the Companies and Limited Liability Company (Initial Coin Offering) Act 2018 (the “ICO Act”), Bermuda passed the Digital Asset Business Act, which came into force on September 10th.
DABA will cover centralized crypto exchanges, custodial wallets and digital assets service vendors including custodians, brokers and market makers.
The BMA will grant two types of licenses – a class F license, for an indefinite period; or a class M license, for a defined period determined by the BMA, which will be renewable.
In order to obtain the license, a business must keep its head office and the place of effective management in Bermuda and must appoint a local representative who will have certain statutory duties to report matters to the BMA.
The BMA will assess officers’ backgrounds, and whether the platform is adopting the appropriate measures and systems related to prevention of money laundering and terrorist financing and has the appropriate KYC/AML policies in line with its strict AML/ATF legislation.
Exchanges and other Digital Asset Businesses will be required to maintain at least US$100,000 of net assets or a higher amount is determined by the BMA.
They will need to have the proper risk mitigation measures and insurances to cover such risks, internal audit requirements, as well as other requirements that the BMA may consider appropriate according to the nature, size, complexity and risk profile of the business.
Depending on the structure of the exchange, other licenses may apply. For instance, the Money Service Business License may be required in cases where the exchange provides money transmission services or exchanges with fiat currencies. In cases where the exchange is brokering security tokens, an investment business license may be necessary.
Bermuda is a very interesting option to run a world-class exchange in a no-tax jurisdiction that has an excellent reputation for its political and economic stability, its robust KYC, AML, and CTF controls, high technology infrastructure, a pragmatic regulation, and a sophisticated business ecosystem.
Bermuda is a tax-neutral jurisdiction, free from individual and corporate taxes, and its main corporate vehicles are the LLC, the exempted company and domestic company limited by shares.
Exempted companies and LLCs do not have foreign-ownership/directorship restrictions and enjoy protection from any newly enacted taxes on income or capital gains until 2035.
Start an Exchange in Canada
Last June, Canada approved a bill that amends the law on money laundering and terrorist financing to include exchanges, brokers and other cryptocurrency operators.
Exchanges will be regulated as Money Service Business (MSB) and must obtain the respective approval from FINTRAC (Financial Transactions and Reports Analysis Center of Canada) in order to operate.
They must implement the proper KYC / AML policies and procedures, including the disclosure and reporting of suspicious transactions, terrorist properties and large transactions to FINTRAC.
Transactions of more than CAD 10,000 should be reported, and KYC will be mandatory for individuals who transact more than CAD 1,000.
Regulations apply to both exchanges operated from or incorporated in Canada and foreign exchanges which offer their services to Canadian residents.
The amendment is not yet effective and sub-regulations have not yet been issued. We expect that they will come into force shortly.
However, since 2015, exchanges that operate in Quebec must be registered with the AMF (Autorité des marchés financiers), Quebec’s financial regulator, and must obtain a license as a Money Service Business.
Setting up in Canada means operating from one of the most stable and reputed regions in the world, however, it comes at a high tax cost.
Canada levies taxes at the federal and provincial level, with a combined effective tax rate between 26.7% and 31%, with Quebec and British Columbia being the two provinces with the lowest rate. 50% of Capital gains are usually included in the income tax base and taxed at standard rates. In addition, there are several payroll taxes and social security contributions both in the federal and provincial level, and a withholding tax up to 15% for any remuneration paid to non-residents.
Cryptocurrency Exchanges in Mexico
Last March, the Law Regulating the Financial Technology Institutions (known as the Fintech Law) was approved and entered into force. The Fintech law provides a regulatory framework for financial services that are provided through new technologies and/or IT platforms, including cryptocurrencies exchange and trading platforms.
Exchanges will be regulated as Financial Technology Institutions (ITF) and will require authorization by the National Banking and Securities Commission (CNBV).
ITFs will need to demonstrate to the CNBV that they have the appropriate infrastructure and internal security controls, the proper account segregation and risk disclosure and anti-money laundering policies procedures, among other requirements.
Subject to the approval from the CNBV, exchanges authorized as ITF’s will be able to hold fiat and crypto funds on behalf of their customers and offer exchange and trading in their platforms.
The Central Bank of Mexico will establish what are the cryptocurrencies that ITF is allowed to operate with, according to their public acceptance and their features.
This means that the Bank of Mexico will decide what cryptocurrencies can be listed in an exchange. This could represent a barrier for exchanges wishing to list newly created tokens or their own token (via ICO, for instance).
ITFs will be subject to the existing KYC/AML & CTF legislation as any other financial institution.
In addition, an amendment to the Federal Law for the Prevention and Identification of Operations with Proceeds Derived from Illicit Sources has classified the provision of services related to cryptocurrencies as vulnerable to money laundering, so any transaction over approximately US$2,800 has to be reported to the relevant authorities.
Although the Fintech Law has entered into force, the CNBV has not been issued yet sub-regulations, provisions, and guidelines, which will provide more details on the requirements.
In the meantime, exchanges are allowed to operate without the authorization for up to 12 months after the issuance of the first secondary regulation of Fintech Law, which is expected to be published shortly.
This secondary regulation will establish requirements regarding the minimum capital, limits on resources held on behalf of the clients, KYC and AML guidelines, and other operational and governance requirements.
Other regulatory provisions are expected to be published during the next months, which will set further conditions, and restrictions applicable to cryptocurrency transactions.
In terms of structuring, exchanges may elect to be incorporated as an SRL (limited liability companies) or an S.A. (joint-stock corporation), and there are no significant restrictions for foreign ownership and directorship.
With regard to taxation, companies in Mexico face a considerable high tax burden, corporate income and capital gains in Mexico are taxed at 30% flat rate, besides significant payroll and withholding taxes.
Set up an Offshore Exchange
The Caribbean and more specifically traditional offshore jurisdictions, such as BVI, Cayman, Belize or Saint Vincent are home of a considerable number of exchanges, including some of the most popular in terms of trading volume at the time of publication.
The tax-neutral status together with pro-business and laissez-faire policies have attracted much of the unregulated players of the sector over the past several years.
Setting up an unregulated exchange in an offshore jurisdiction may be the most affordable efficient and hassle-free option to get the ball rolling quickly.
That being said, these self-regulated exchanges should, at a very minimum comply with the anti-money laundering legislation of the relevant jurisdiction they are operating from, especially if they support fiat currency transactions, or plan to in the future. It is worth noting that obtaining (and keeping open) a fiat gateway for an unregulated exchange is challenging.
As for exchanges which state they do not need to do KYC because they only perform crypto to crypto, are running a significant legal risk. Firstly, by accepting money from a sanctioned person or entity, secondly by providing a platform used for illicit purposes and thirdly by not reporting suspicious transactions are just some of the actions which could be considered a crime.
In addition, it is not only where your exchange is located or incorporated, but with whom you do business, for instance supporting a fiat currency wallets or exchanges for residents of X country would potentially place you under the requirement for Money service, brokerage or money management businesses regulations within that country X. You must seek the proper advice and obtain authorization if any of the services offered are subject to licensing.
Some exchanges in the region supporting fiat currencies are opting for partnering with duly regulated institutions to delegate the management of funds and the execution of deposits and withdrawals. This is partly because wiring funds place a company at significant risk of being charged with ‘wire fraud’ which is quite an easy crime to be charged and adjudicated for.
Others carry out fiat transactions in-house in jurisdictions where the activity is not regulated, however, interruptions, and poor customer experience is common.
One of the main hurdles for these offshore exchanges is the difficulty in finding sound transactional banking options. Being regulated helps greatly in this regard, but won’t fix the problem overnight. Maintaining and adhering to robust KYC/AML policies and procedures is the key to developing and keeping fiat gateways.
There have already been movements in several jurisdictions to give legal coverage and establish minimum standards in the industry. The Cayman Islands, Barbados or Antigua, among others, have publicly stated that they are working on a legislative and governance framework for the sector, and it is likely that during the coming months’ significant regulatory developments will take place. It ’s worth looking at the KYC laws in various jurisdictions because this can provide an insight into what KYC policies will be required.
The Bottom Line
If you are seeking to set up a regulated global exchange in a reputable, but tax advantageous jurisdiction, Bermuda is perhaps one of the most attractive jurisdiction.
Costs and ongoing requirements involved are considerable, and it might not be for everyone, but if you have the resources in place, you should strongly consider it. Bermuda will provide you regulatory certainty under a crypto-friendly legislation.
Solid banking options may be more limited than in Europe, but there has been a considerable sign of progress on this matter during the last months and the landscape is changing quickly.
If you are targeting Canadians and are enabling CAD pairs, then a Canadian operating entity is likely required as this goal could not be easily achieved otherwise. Regulators have been considerably open with this new industry and are regulated as a Money service business will not only provide you more credibility and boost confidence amongst the audience, will also provide you better banking options and will oblige you to run your exchange in accordance with the highest compliance standards.
If you are targeting the Latin market, then you could consider Mexico, or perhaps, Chile or Costa Rica.
We have not covered Chile in this article, but as a quick note, Chile is one of the most active South American countries in the crypto space. The fact that several exchanges have been registered voluntarily with the Financial Analysis Unit and other regulatory bodies and adhered to anti-money laundering rules and reporting requirements, has brought a degree of legitimacy to the sector.
For instance, after the two most important exchanges in the country saw their bank accounts closed, Chile’s antitrust court ruled that there was no substantial reason for the closure and that the accounts should be reopened.
After having reviewed some of the American countries, we conclude our “Where to set up your cryptocurrency exchange” article series. If you have missed any of the previous parts you can check them at the following links:
Whether you are setting up a regulated or unregulated crypto exchange, or funding it via an ICO, Flag Theory can help you set up a sound corporate structure choosing the most suitable jurisdictions and legal entities according to your requirements, priorities, and goals and help you obtain licensing and bank accounts, as well as assisting in compliance matters. Contact us, it will be our pleasure to assist you.
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