Asset Tokenization & Legal Implications

From the beginning of blockchain technology appearance there were many discussions about transfer possibilities of ownership rights to the blockchain. It came true by developing asset tokenization and issuing security tokens. Tokenization as such is the process of converting an asset, or ownership right over an asset into a token that can be moved, recorded, or stored on a blockchain system. [1]

In other words, by using tokenization people strive to gain more liquidity of its property. Given to blockchain technology which makes possible the trading of items that don’t really lend themselves to easy trading now tokenization of even huge assets it is real. At the same time depending on jurisdiction there can arise certain issues mainly about the legal link between the ownership rights over asset and digital tokens.

What is Asset Tokenization?

The idea behind asset tokenization is very simple allowing to convert the legal rights to assets with economic value into a digital Token. Such digital tokens can be stored, recorded and managed on a blockchain network. Due to its nature this kind of Tokens are treated by authorities as Security Tokens which in case of tokenization represent shares in a company, interest in a fund or trust, a home, an art collection, a farm, or essentially any asset that a person can own. In very simple words tokenization of assets and issuing of security tokens representing that assets is to take something that is on paper, and start tracking ownership of it digitally.[2] Security tokens are a digital representation of value that are subject to regulation under security laws of many jurisdictions.

Given to very promising capacity of greater transparency, liquidity, data integrity and exchange potential, so many investors are interested in asset tokenization and on how to move real world assets into a blockchain aiming to make their lives easier by getting investment process quicker. Digital tokens backed by tokenized assets can represent participation rights in form of decentralized protocols and this way allows investors of all sizes to purchase shares, rights etc. in given resources.[3]

How does it work?

Imagine, that you take an asset and tokenize it, thus you create its digital representation that is transferred on Blockchain distributed network and now it lives its own life without being altered or hacked, at the same time potential investor has guaranty that the ownership information is immutable. Such technology makes possible to “liquify” millions worth assets into certain number of digital tokens which make easier investment process. For instance, imagine you want to invest in real estate, but you don’t have enough amount of money to buy that building or apartment. Tokenization allows investors to invest gradually by investing 5000 or 10000 per month by purchasing digital tokens which represents a share of the tokenized assets and not property over the entire the building (asset). In other words, you cannot buy 5 o 10 square meters in a building or apartment, but you can buy a limited number of tokens backed by tokenized property.

Due to the fact that tokenization is a method that converts rights to an asset into a digital token[4] it can transform the building or apartment, for example, into 1,000,000 tokens, each token representing a 0.0001% share of the underlying asset. Following that, tokens shall be issued on an online platform supporting smart contracts, so that the tokens can be freely bought and sold on different exchanges. [5] When you buy one digital Token, you actually buy 0.0001% of the ownership in the asset. Buy 500,000 tokens and you own 50% of the assets.

Tokenization

Concerns

The tricky thing is that even if you buy all tokens, you are not becoming a legal owner of the property. And this is the moment when legal issue appears, due to its nature of security tokens investor can claim his rights in court if offering papers are properly drafted and tokens purchase transaction was completely legal. Nevertheless, there are many jurisdictions where such offerings and even tokens are not regulated by authorities, so investors rights are completely not protected, and this fact can lead to scams.

Benefits of assets tokenization

To understand why the market will move towards this technology, we need to understand the benefits that tokenizing an asset brings[6] the features that could be very attractive for investors. Assets tokenized on blockchain are:[7]

Immutable –  once an investor buys tokens, nobody can “erase” the ownership.

Accessible  – tokens can be accessed from any place in a world, 24/7, via laptop, smartphone app etc.

Divisible  – tokens hold a promise of greater liquidity which increases the expected value from trade and eliminates the need for minimum investments.

Cost-effective – tokens eliminate the middlemen, which often limit investment accessibility by e.g. restricting investments to accredited investors only, demanding high fees and requiring an access to stock-trading accounts.

Transparent – tokens eliminate asymmetry of information present during the transfer of ownerships.[8]

Legal issues

As mentioned above there are some legal concerns and problems need to be solved before business environment will successfully tokenize assets on Blockchain. But even nowadays there are jurisdictions where tokenization is perfectly legal, and investors are protected by law.

Ownership – The main problem is still the same – lack of regulation. Despite some authorities across Europe have undertaken certain steps to regulate tokens given to some categories are treated as securities, in most of cases smart contracts are still unregulated. At the moment in European Union only Malta has fully adopted legal framework related to smart contracts, blockchain and tokens. Other countries usually regulate Security Tokens through recommendations and opinions of financial market supervising authorities. For example, what happens if a company that handles tokenization sells the property? Token owners just own tokens. They have no legal rights on the property and thus are not protected by the law. Therefore, legal changes are needed to accommodate these new business models in more jurisdictions in order to get more reliability.

Legal linkOne of the most important issues is to create a legally binding connection between tokenized asset and generated security tokens. This brings new challenge due to its new and unregulated nature.

Lack of judicial practiceThe lack of comprehensive judicial practice given the early stage of its development and the insufficient number of business decisions based on aforementioned legal practice makes difficult creation of a legal framework related to this field.

Nature of Tokens – In case of tokenization of assets digital tokens typically are issued. This type of digital tokens represents an asset, equity or a stake of value, giving rise of a debt or claim on the issuer. Asset tokens are backed by a promise to get a share in future company earnings or capital. In other cases, this type of tokens is backed by company’s equity or certain material goods. A security is a tradable financial asset which commonly refers to any form of financial instrument[9] that holds some type of monetary value, representing an ownership position in a company (stocks), a creditor relationship with a governmental body or a corporation (bonds), or rights to ownership as represented by an option (option).[10] Legal regulations of securities are intended to ensure that market participants can make their decisions whether to invest or not in stocks of companies, bonds, shares etc. on predictable, reliable and transparent set of information.

References*:

[1] https://blockonomi.com/tokenization-blockchain/

[2] https://hackernoon.com/tokenized-assets-security-tokens-and-stos-ae72dc0e275e

[3] https://blog.softwaremill.com/asset-tokenization-on-blockchain-will-disrupt-the-asset-management-landscape-befbd71639b1

[4] https://medium.com/coinmonks/asset-tokenization-on-blockchain-explained-in-plain-english-f4e4b5e26a6d

[5] https://medium.com/coinmonks/asset-tokenization-on-blockchain-explained-in-plain-english-f4e4b5e26a6d

[6] https://hackernoon.com/tokenized-assets-security-tokens-and-stos-ae72dc0e275e

[7] https://blog.softwaremill.com/asset-tokenization-on-blockchain-will-disrupt-the-asset-management-landscape-befbd71639b1

[8] https://blog.softwaremill.com/asset-tokenization-on-blockchain-will-disrupt-the-asset-management-landscape-befbd71639b1

[9] https://en.wikipedia.org/wiki/Security_(finance)

[10] https://www.investopedia.com/terms/s/security.asp

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s