by Omri Marian
Over the past few years, small jurisdictions that are known as “tax havens” have been engaged in a race to become leading hubs for blockchain technology. In a recent article, I explore the extent of this phenomenon, its drivers, and its regulatory ramifications. In short, I argue that the traditional tax havens model is in decline due to recent coordinated international efforts to shut down abusive tax havens practices. Blockchain technology, however, offers similar commodities as offered by tax havens jurisdictions. Blockchain technology is not (yet) subject to coordinated international regulatory efforts. Tax havens seem to have identified the opportunity to offer their traditional regulatory commodities’ via the medium of the blockchain technology. I argue that the rise of so-called “Blockchain Havens” presents significant regulatory challenges that can only be addressed via coordinated global efforts.
The Decline of the Traditional Tax Havens Model and the Blockchain Alternative
There is no clear definition of what constitutes a “tax haven.” Generally speaking, however, jurisdictions that are traditionally referred to as “tax havens” possess the same key characteristics: very low (or no) taxes on foreign residents, and robust financial secrecy laws. Moreover, the regulatory environment is very lenient. Tax havens’ business model is essentially to sell access to these commodities in exchange for fees, such as incorporation fees. The key draw of tax havens is that they enable taxpayers to avoid taxes and regulation in other jurisdictions.
In recent years, developed economies have instituted a multitude of laws, and engaged in multiple international initiatives, to undo the perceived damages caused by tax havens. For example, in 2010, the United States adopted the Foreign Accounts Tax Compliance Act (“FATCA”), forcing certain financial institutions to deliver information about their account holders to the IRS, or face debilitating financial consequences in the United Sates. The FATCA framework was adopted by the Organization of Economic Cooperation and Development (“OECD”) to develop the “Common Reporting Standards” (“CRS”), which include an international standard for automatic exchange of taxpayer information between governments. The European Union has also adopted several measures over the past few years to facilitate automatic exchange of taxpayer information between member states. These international and national actions undermine the main value the tax havens offer to tax evaders: no taxes and financial secrecy.
It is meaningful that these anti-tax-haven actions are not targeting—at least not directly—tax evaders or avoiders themselves. Rather, these measures target intermediaries that are in a position to collect information about tax evaders: tax havens’ governments and financial institutions.
In this environment, the rise of blockchain technology is a godsend for tax cheats and tax havens. Blockchain, in its very essence, is a decentralized ledger that documents ownership and transfers, but does not require transacting parties to identify themselves to one another. Secrecy is back in play, but this time with no need for intermediaries. The blockchain financial ecosystem may thus offer similar advantages to the ones traditionally offered by tax havens.
The Blockchain-Tax Havens Synergy and the Rise of the Blockchain Haven
Blockchain technology, however, cannot simply replace tax havens. Any application, even if it is decentralized, needs to start somehow, somewhere, by someone. There needs to be an initial entrepreneur, some sort of initial infrastructure (computers, servers, programmers), and most importantly, there is a need to raise initial capital. Even if blockchain itself is “immune” from regulation, the creation of a blockchain venture and the process of fundraising may themselves be regulated. This is where blockchain havens come into this new financial ecosystem.
Instead of offering regulatory refuge themselves (because they no longer can), traditional haven jurisdiction offer regulatory refuge to blockchain startups. Stated differently, the new havens offer regulatory refuge to the technology that offers regulatory refuge. In a sense, blockchain havens are “meta tax-havens” or “meta offshore financial centers.” As developed economies act against haven governments, it seems that haven jurisdictions are responding by becoming hosts to technologies that offer traditional haven-like benefits.
Indeed, recent statistics on Initial Coin Offering (“ICO”) clearly demonstrate the disproportionally large role played by tax havens in the ICO market. ICOs are blockchain-based crowdfunding platforms. In an ICO, a promoter issues a blockchain-based digital token in exchange for value. A recent survey of geographical distribution of ICOs finds that that the top 25 jurisdictions in the ICO world (both in terms of funds raised an in terms of number of ICOs), include known tax havens such as Switzerland, Singapore, Gibraltar, Lichtenstein, Luxembourg, and Myanmar, far outpacing many developed high-tax economies. Another Survey finds that, by number of ICOs, the 10 leading jurisdictions for ICOs include Singapore (#2), Switzerland (#4), Hong Kong (#5), and Gibraltar (#8), with a share of global ICOs that completely outweighs the proportional size of these jurisdictions in world economy. A third survey reports that Singapore, Switzerland, Hong Kong, Netherlands, and the British Territories, account—in the aggregate—for 36.7% of all global ICOs in 2017-2018 in nominal terms, again, far outweighing the size of these jurisdictions in the world economy.
Tax havens, so it seems, are gradually transforming into blockchain havens.
One might ask, is this necessarily a bad thing? The answer is absolutely not. Blockchain technology offers many potential benefits. However, it also possesses unique risks. Blockchain transactions are not only intermediate-less and rather anonymous. By the nature of the technology, they are also temper-resistant. They cannot be undone. Moreover, blockchain can serve as a platform for automated execution of code. Thus, when haven governments offer very light regulatory touch, they may attract bad actors who may utilize the regulatory leniency to misuse blockchain technology. In such a case, even if the illicit act is identified, there is little that can be done. The bad actor can get the illicit gain and disappear thanks to anonymity features embedded in the technology, and the victim has no recourse given the permanent nature of blockchain transactions. Even if participants become aware that an illicit action may take place using blockchain, there is nothing that can be done (short of, maybe, shutting down the internet). Execution of blockchain application is decentralized, and no one actor can just “shut down” the network. Inherent to the stricture of blockchain technology is that the majority of network participants must agree to change the network design and operation. This task is nearly impossible with millions of anonymous participants are scattered around the world.
To summarize, by allowing blockchain entrepreneurs practically unregulated entry point into the system, tax havens are effectively creating regulatory loopholes that cannot be amended in retrospect.
A good example can be found in a recent paper by Cohsey et. al., which explored whether ICO code actually delivers on promises made in the ICOs’ white papers (white papers function as an unregulated prospectus of sort). Cohesy et. al. find that “ICO code and ICO disclosures do not match.” For example, they find that almost all ICO white papers promise restrictions on token supply, but only about 2/3 of the ICOs that made such promise actually coded the promise into the ICO code. Another promise frequently made by ICO issuers, is that the issuers’ own holding will vest over time, to prevent a pump and dump schemes. The researchers have found that the majority of ICOs that promised vesting had no vesting coded into the program. In addition, Cohesy et. al. find that some ICO issuers had the ability to change the code, even though such fact was not disclosed in the white paper. Another recent study finds that as much as 80% of all ICOs in 2017 where fraudulent schemes. These shortcomings cannot be corrected with a commanding rule from any government. The software of these offering will contribute to operate as executed, unless the majority of (anonymous) network participants agree to make corrections.
What Can be Done?
Given the unique nature of blockchain technology, it seems prudent to regulate blockchain applications before they are released. Only at that point in time, there are still intermediaries susceptible to regulation: The entrepreneurs, and the jurisdictions in which they operate.
But in order for such regulation to be successful, an internationally coordinated approach must be taken. As in the case of tax havens, any one jurisdiction that breaks ranks can serve as an entry-point of unregulated blockchain software to the World Wide Web, in which case damage control efforts may prove futile.
But what might such a coordinated approach include? A compressive plan for international regulation of blockchain based applications is well beyond this blog post, but some key points to consider follow.
The problem of inability to regulate decentralized networks is addressed by the very meta-framework offered here: ex-ante regulation. This means regulating the issuers of ICOs, the programmers and the venture capitalist financing such ventures at the early stages of the project. In any case, before the application is turned on.
The problem of pseudonymity can be addressed by subjected jurisdictions or financial institutions that host blockchain ventures, to certain “know your costumer rules”. Such rules must enable the jurisdictions in which blockchain ventures operate to identify the individuals involved with the venture, and to report their identities to interested authorities in other jurisdictions.
The problem of irreversibility of transactions is partly remedied by disclosure and identification rules, as it may enable victims of fraud to identify the wrongdoers. Another way to address such issues is to require blockchain ventures to underwrite the risk of their venture. This can be achieved by insurance requirements, or by writing some sort of an escrow into the code. Such escrow would be automatically activated to compensate victims under certain circumstances.
In the case of ICOs, it is prudent to come up with a standard disclosure requirement, and a requirement for a regulator to compare the disclosure with the actual code.
What the best forum is for such a coordination remains to be seen. In the global battle against tax havens, the best was, for the most part, the OECD. The OECD has recently launched the blockchain policy forum, and this may be a proper venue to initiate such a project. But wherever it happens, it needs to happen sooner rather than later, before multiple malicious blockchain applications take hold. Any delay is likely to bring about the worst in blockchain, and prevent the best in it from ever materializing.
 Wulf Kaal, Initial Coin Offerings: The Top 25 Jurisdictions and their Comparative Regulatory Responses (as of May 2018), 1 Stan. J. of Blockchain L. and Pol’y 1,1 (2018).
 Dirk Zetzsche et. al., The ICO Gold Rush: It’s a Scam, It’s a Bubble, It’s a Super Challenge for Regulators, (Univ. of Lux. Law, Working Paper No. 11, 2017).
 Winifred Huang, Michele Meoli & Silvio Vismara, The Geography of Initial Coin Offerings, Univ. of Bath (forthcoming 2019).
 Shanaan Cohney et al., Coin-Operated Capitalism, Colum. L. Rev. (forthcoming, 2019).
 Id. at 6.
 Ana Alexandre, New Study Says 80 Percent of ICOs Conducted in 2017 Were Scams, Cointelegraph (July 13, 2018).
Omri Marian is a Professor of Law, and the Academic Director of the Graduate Tax Program at the University of California, Irvine School of Law.
The views, opinions and positions expressed within all posts are those of the author alone and do not represent those of the Program on Corporate Compliance and Enforcement (PCCE) or of New York University School of Law. PCCE makes no representations as to the accuracy, completeness and validity of any statements made on this site and will not be liable for any errors, omissions or representations. The copyright of this content belongs to the author and any liability with regards to infringement of intellectual property rights remains with the author.