In the past, cryptocurrency companies were operating comfortably in the United States. In that quaint, bygone era, they often run fundraising events called “early coin products” and use those raised funds to try and do things in the real world of blockchain.
Now they are doing this “offshore” through foreign organizations, primarily geofenced in the United States.
The effect of this change was dramatic. Virtually every major cryptocurrency issuer launched in the US includes several offshore foundation divisions. These entities create important national challenges. They are expensive, difficult to operate, leaving behind many important questions about governance and regulation.
Many in the industry dream of “returning shore,” but until this year there was no way to do so. But now, that could change. The new encrypted registrations are on the horizon, with Trump family members popping up the idea of ​​eliminating capital gains tax on cryptocurrencies, and many US federal agencies have repealed enforcement measures against crypto companies.
For the first time in four years, the government has shown that trades are open to the cryptocurrency industry. There may be a way back to the US soon.
Crypto companies tried to comply in the US
The US offshoring story dates back to 2017. Crypto was still young, and the Securities and Exchange Commission took a practical approach to regulating these new products. That all changed when the committee released a document called “The Dao Report.”
For the first time, the SEC argued that homemade cryptocurrency tokens, which had been developed since the 2009 Bitcoin White Paper, are actually a regulated instrument known as securities. The ban was not complete – around the same time as the DAO Report’s launch, SEC Director William Hinman publicly expressed the view that Bitcoin (BTC) and Ether (ETH) are not securities.
To clarify this distinction, the committee published the Digital Assets Framework in 2019. This identified relevant factors for assessing the security status of tokens, saying, “The stronger their presence, the less likely the Howey test will be satisfied.” Relying on this guidance, many speculated that the use of functional “consumption” of tokens would segregate the project from security concerns.
In parallel, the complex tax effects were crystallizing. Unlike traditional financing instruments such as future stock (safe) and simple contracts for preferred stock, tax advisors have reached the consensus that token sales are fully taxable events in the US. A simple contract for future tokens (SAFTS) – a contract to issue future tokens – faced better tax treatment, with taxable events being deferred until the token was released. This meant that sales of tokens by US companies created large tax obligations.
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The project has tried in good faith to adhere to these guidelines. The lawyer extracted the principles and advised the client to follow. Rather than contributed to creating a foreign presence for US projects, some people charged a little bullet and paid taxes.
How Secv. Did Lbry make the water muddy?
All this rang out for several years. The SEC has brought several major enforcement measures, such as the moves against Ripple and Telegram, and has shut down other projects like Diem. However, many founders still believed that if they stuck to the script, they could work legally in the US.
Then they conspired to disrupt this unsettling equilibrium. SEC Chairman Gary Gensler entered the scene in 2021, Sam Bankman blew the FTX out in 2022, and Secv’s unwritten opinion from Judge Paul Barbadro. He came out of sleepy US District Court in the New Hampshire area in a case called Lbry.
The Lbry case is small and affects minor crypto projects with every account, but the application of the law that emerged from it has dramatically impacted cryptocurrency law practices and, in turn, paves the way open to founders.
https://www.youtube.com/watch?v=OKMHJ01EXG8
Judge Barbadoro admitted that tokens may have consumer uses, but found that “nothing suggests that tokens with both consumer and speculative use cannot be sold as investment contracts.”
He went on to say, “Lbry could not reject the SEC’s claim that Lbry provided (tokens) as security simply because some (tokens) purchases were made with consumer intent. Because of the “economic reality,” Barbadoro determined that it was not a question of whether he “may have acquired an LBC for consumption purposes.”
This was devastating. Retention of LBRY is essentially that the factors proposed in the SEC framework are rarely problematic in actual securities disputes. In Lbry, Judge Barbadoro found that while consumer use could exist, expectations for the buyer’s interests dominate.
And this meant that virtually all token offerings could be considered security. That meant you could use evidence against you that the token was being sold as a potential benefit. Even it could be fatal that people thought they were likely to have bought it for profit.
Regulation and hope have driven businesses offshore
This had a cold effect. Lbry’s case and related case law have destabilized the situation on cryptocurrency projects. Instead of a potential framework working internally, there was only one trace of hope that it would legally operate in the United States.
Even the SEC has admitted that Bitcoin and ETH are not securities as they are decentralized. They didn’t have promoters that could be held responsible for sales, they were products of diffuse networks that were not caused by anyone. There were few options left for the 2022 and 2023 projects other than attempting to decentralize.
Related: Ripple celebrates the reduced charm of SEC, but no cryptographic rules have been set yet
Inevitably, the business will begin in the United States. A few developers create projects in small apartments. They wanted to raise funds because they were successful – and when you raise funds, they are in the crypto, and investors demand tokens. However, selling tokens in the US is illegal.
Therefore, their VCs or lawyers will advise them to establish a foundation in more favorable jurisdictions such as the Cayman Islands, Zug, Switzerland, and Panama. The foundation can be set up to “wrap” a decentralized autonomous organization (DAO). This includes governance mechanisms related to tokens.
Through that entity or another offshore entity, they will either sell tokens under the U.S. Securities Act regulations exemption, or simply hand them out in airdrops.
In this way, the project hoped to be able to develop liquid markets and substantial market capitalizations, and ultimately achieved “decentralization” that could be legally operated as a US entity.
Several crypto exchanges were incorporated into friendly jurisdictions in 2023. Source: Coingecko
These offshore structures not only provided compliance features, but also provided tax benefits. Because the foundation does not have owners, it is not subject to the “controlled foreign companies” rules in which foreign companies are indirectly taxed in the United States through US shareholders.
The well-known foundation ensured that they engaged in business activities in the United States and maintained their “offshore” status.
PRESTO: They’ve become an incredible tax law. They operate offshore only and are protected from indirect US taxation due to their lack of ownership, so they cannot bear direct US tax burden. Better yet, this arrangement often gives them a veneer of legitimacy, making it difficult for regulators to pinpoint a single ruler.
After formation, the US companies will become “labs” or “development” companies that earned income through licensed software and IP to these new offshore entities. Waiting for all different days, checking the Wells notification emails and twitching a bit.
So it wasn’t just regulations that drove cryptography offshore. That was hope. Offshore decentralization was the only way out of the way because a thousand projects wanted to find a way to run legally in the US.
Slowly turn
Now that may change. Once President Donald Trump takes office, the corridors at 100 F Street in Washington, DC may just thaw. SEC Commissioner Hester Perth takes the mantle and leads the SEC’s Cryptographic Task Force.
In recent weeks, Peirce has expressed interest in providing future retroactive relief to Token issuers and creating a third regulatory method in which token launches are treated as “unfair” through the SEC Section 28 exemption authority.
At the same time, the evolution of law is beginning to open the doors for athletics and field businesses. David Kerr of Cowrie LLP and Miles Jennings of A16Z have pioneered the Association of Non-Decentralized Nonprofit Organizations (DUNA), a new form of business that could enable autonomous organizations to function as legal organizations in the US, such as Wyoming.
Eric Trump suggests a favorable tax treatment for cryptocurrency tokens. And without waiting for an official shift in regulations, tax lawyers came up with more efficient funding approaches, such as token warrants, to help projects navigate existing systems.
As A16Z recently put its meeting with Commissioner Perth’s Cryptographic Task Force, “If the SEC provides guidance on distribution, it generates only (tokens) tides.
Maybe this time they’ll hear it.
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