Legal Status of Real World Asset Backed Tokens and Coins
What Is Real-World Asset Tokenization and How Does It Work?
Blockchain technology allows for the tokenization of traditional assets, meaning that tokens can be used to represent various types of instruments including stocks, bonds, real estate, consumer loans, art, etc. The concept of real-world assets (âRWA/sâ) encompasses both palpable and intangible assets that exist in our physical realm, such as properties, bonds, and commodities. By tokenizing these assets, we gain the ability to seamlessly incorporate them into the blockchain, unveiling a vast array of opportunities for synergy and innovative applications.
Through the process of tokenizing RWAs, market participants are able to experience enhanced efficiency, heightened transparency, and minimized instances of human errors, as these valuable assets can be securely stored and effortlessly tracked on the blockchain.
In order for RWAs to be present on the blockchain, it is crucial to establish their ownership and representation within the blockchain system. Although the specific procedures may differ, the fundamental process entails resolving the contractual terms prior to creating tokenized versions of the asset on the blockchain.
Tokenization is also an emerging trend in finance that allows for the creation of digital tokens backed by RWAs. Tokenization is based on blockchain technology, which is a distributed ledger that ensures data is secure and cannot be altered or accessed without authorization. Unlike a centralized database, blockchain has no single point of failure. Tokenization uses the secure and unchangeable features of blockchain to enable digital fractional ownership and fast settlement processes.
For example: tokenization is becoming popular in the real estate industry, with traditional real estate institutions teaming up with technology providers to explore the tokenization of debt or equity. This collaboration is expected to bring more technology-backed real estate projects to life and provide investors with greater access to high-quality property assets. Both technology providers and traditional real estate stakeholders stand to benefit from this partnership through the origination of quality assets and the financial expertise of a growing network.
Tokenized assets and securities are distinct from cryptocurrencies, utility tokens, and security tokens. While the latter represent value generated within a blockchain network, tokenized assets, and securities are digital representations of assets and securities that exist outside of the blockchain. These tokenized instruments are linked to and reliant on their off-chain underlying assets, retaining their inherent characteristics while incorporating new features from blockchain technology.
Tokenizing traditional assets offers several advantages, including improved efficiency and cost reduction, increased transparency and security, better compliance and traceability, enhanced liquidity, and facilitated innovation. These benefits stem from both the use of blockchain technology and the ability to create smart contracts and ecosystems. We will be further detailing the benefits below.
Tokenization Of RWAs and Securities
Understanding the distinctions between blockchain-based tools and platforms is crucial when it comes to using blockchain and distributed ledger technology for tokenizing assets. Different platforms like Ethereum, Solana, Binance Smart Chain, Polygon, Terra, and Stellar have varying features in terms of cost, security, transaction speed, traceability, and accessibility. The choice of platform for tokenizing an asset depends on its specific purpose and objectives.
The tokenization of assets is a new way to represent and register property, and it is important to understand its legal framework, development level, and future regulatory changes. The upcoming regulatory framework in Europe and the financial sandbox in the UK, and other countries are promising initiatives to embrace these innovative global changes.
A token is a unit of value created by an organization or private entity to empower users and facilitate interactions with their products or services. Tokens can serve various purposes, representing usage rights or ownership rights with intrinsic value. They possess characteristics such as identification, immutability, transferability, and traceability within their respective environments or markets. Each type of token has its own programming code and legal regulations. Tokens operate based on coding and consensus protocols agreed upon by the involved parties. Some tokens may also have a governance system embedded in their code, making them adaptable to changes and providing predictability and scalability. Compared to centralized registries, tokens offer advantages such as improved efficiency, liquidity, trust, and traceability through transparent information sources enabled by blockchain technologies.
Tokenization is a method of storing and utilizing tokens that represent ownership rights of digital or physical assets or rights to specific activities. Essentially, tokenization is the process of digitally representing assets, services, or activities on a blockchain network. Owning a token from a tokenized asset may mean owning a portion or all of the underlying assets registered on a blockchain infrastructure.
The owner or investor holds the tokenized asset generally in a private wallet. The investor is usually the custodian of the token unless someone else provides this service. The token may be traded directly between individuals or through marketplaces, depending on the regulations of the underlying asset.
Role of Oracles in Tokenization
In some cases, blockchains need to connect with non-blockchain systems and applications to exchange information. Oracles act as a bridge between blockchains and other information environments. They monitor and verify real-world information, such as events and identities, that smart contracts initially donât have access to. Oracles provide a trusted data feed to smart contracts, allowing them to monitor relevant information and automatically execute programmed code. Oracles play a crucial role in ensuring the reliability and versatility of smart contracts. They enable various complex scenarios, such as paying out insurance claims for canceled flights, initiating margin calls for tokenized asset loans when prices change in traditional markets, and facilitating automated betting contracts based on the outcome of sports events.
Identity oracles are used in financial transactions to prevent non-accredited investors and individuals not subscribed to a vetted whitelist or belonging to a blacklisted group from making transactions. They can also block certain age groups and residents from specific countries. Additionally, oracles can restrict transactions to users who have been ID-verified and meet compliance requirements such as KYC, GDPR, and AML.
Although oracles can accurately analyze real-world events, there are potential threats. If the data source outside of the blockchain is tampered with or unreliable, it can lead to incorrect results in the smart contract process. This is known as oracle risk. To address this, a transparent methodology and reliable data sources are needed, along with smart contracts that rely on consensus-based oracles instead of a single oracle. Consensus-based oracles involve multiple connected oracles that compare different data sources to detect and remove any anomalies, thus minimizing oracle risk.
Tokenization Process
The tokenization process may seem complex, but there are many tools and services available to help issuers and businesses. These tools make the tokenization process easier and more user-friendly, simplifying things in this evolving landscape.
The initial step in tokenization involves examining and strategizing the development of a robust network of industry experts for a particular token. Thus, companies looking to tokenize assets should evaluate the lifecycle of digital assets and ensure that each component of the network is suitable. Developers should carefully plan the technical, legal, marketing, business, and financial aspects to meet the requirements of participants and ensure that the network is capable of handling unexpected scenarios in accordance with the smart contract rules.
The RWA token goes through five main stages during its lifecycle.
1- During the initial stage of structuring a deal, it is important to make decisions about the terms and conditions of the RWA token. Deal structuring is a vital component of any token offering, regardless of the technology used. Tokenization should not be used as a way to evade legal and regulatory obligations, but rather to enhance operational processes and enable innovative financial solutions.
2- During the digitization stage, information that was previously stored in physical paper or documents is transferred to the blockchain and encoded in smart contracts, leading to the issuance of tokens.
3- Primary distribution is the method of giving tokens to investors in return for their investment capital or some other resource they provide, and the investorsâ details are stored on the digital ROM.
4- Post-tokenization management refers to the processes involved in managing corporate actions such as dividend distribution and shareholder voting. These processes may be automated through the use of smart contracts coded on the token. Post-tokenization management will be ongoing until the token reaches maturity or is redeemed.
5- The last step, where tokenizationâs benefit in improving liquidity becomes evident, is secondary trading. This is when a token owner can exchange tokens with another investor either directly or through a trading platform.
Tokens are typically given by an entity or individual and grant the holder certain rights, such as ownership or entitlement to future profits. The structure of a tokenized asset is important in determining the investorâs rights and returns, as well as how taxes should be applied. Tokenization may also impact the assetâs valuation and trading price.
Different types of assets benefit from tokenization in different ways. Asset owners and managers should consider the objectives and structure of the RWA tokens to determine how tokenization technology can enhance their purpose. For example, a bond backed by real estate would benefit from streamlined operations and automated management, while a real estate private equity fund could gain advantages from increased liquidity.
The issuer of an RWA token needs to get professional advice to make well-informed choices about which jurisdictions to involve in the product structure. The regulations and tax systems in different jurisdictions will affect the price and cost-effectiveness of the RWA token. Additionally, the issuer should also consider the location of their target investors, as this will impact the marketing and offering of the RWA token in terms of regulatory requirements.
Determining the category of a token can be complex because it can have rights or features from multiple categories, or its rights and features can change over time. Tokens can be classified as various regulated instruments, such as futures contracts, insurance products, commodities, loans, or bonds, depending on their specific features and rights. If a token is considered to be multiple types of regulated instruments, it will be subject to the regulations of each type.
Tokens that are considered âsecuritiesâ will be subjected to regulatory frameworks during their issuance, marketing, distribution, and secondary trading. For example: if a token represents ownership or the right to receive income or dividends from a real estate asset, it will most likely be classified as a âsecurityâ.
In comparison, tokenization is beneficial for individuals who own only one asset or a few assets because it greatly reduces the time and expenses involved in giving investors the opportunity to own a fraction of the asset and trade it later on.
Benefits of RWA Tokenization
Blockchain technology and tokenization provide significant benefits. Its main benefits include:
Blockchain technology offers increased efficiency by automating smart contract processes, reducing the need for intermediaries. This leads to faster settlement, auditing, trading, and other business processes, as well as improved product management control. The native tools of blockchain technology also contribute to speeding up these processes.
The use of blockchain technology can lead to significant cost reductions in various processes such as bond issuance and fundraising compared to traditional methods. Studies have shown that these cost reductions can be as high as 90 percent for bond issuance and 40 percent for fundraising.
Tokenization and blockchain systems provide increased transparency and security by recording transactions in a public ledger and storing it worldwide, it enhances reliability and minimizes information disputes. Additionally, blockchain allows for easy auditing due to its transparent nature. Tokenization also enables precise tracking of each tokenized asset.
Programming enables the integration of intricate compliance requirements into every token created. Smart contracts can automatically validate compliance with KYC, AML, age restrictions, or specific local regulations for any transaction.
Tokenization improves liquidity by allowing investors to offer their previously illiquid or non-fractionable assets in smaller units to a global market. This increases market liquidity compared to assets that can only be traded in large batches. Tokenization also reduces entry barriers for small investors with limited investment power.
Smart contracts enable innovation by being programmable and adaptable to different industries. They have been used in tokenized assets to create various financial offerings such as fractionalized real estate and dynamic ETFs. Blockchain technology has also shown great potential in creating new financing methods like ICOs, IEOs, and DeFi.
Tokenization has the potential to revolutionize the market, making investment options more accessible and global, and fostering innovation. Entrepreneurs and innovators now have the ability to tokenize various scarce assets, allowing them to benefit from innovations such as crowdfunding campaigns and ownership stakes. The combination of traditional crowdfunding and blockchain technology has led to the emergence of ICOs.
Valuation of a Tokenized RWA
Tokenized assets have the same ability to generate cash flow as traditional assets. However, tokenization offers added value by improving the assetâs liquidity and decreasing transaction and administrative costs. These advantages should be considered by investors when valuing an asset. But how do you determine the economic value of an RWA Token?
Net Asset Value (âNAVâ)
Perhaps the most common valuation method is the Net Asset Value metric. In this financial metric, the economic value of the RWA token is calculated based on the economic value of the underlying and total number of issued tokens. NAV may be categorized into two depending on the nature of the underlying asset that is referenced, namely NAV per Token and Real-Time Asset Pricing.
NAV per Token
For example, if an RWA token is referenced to a real estate, in other words, if a real estate is tokenized, then, one way to determine the economic value of each RWA token is by dividing the price of the real estate by the total number of issued tokens. Assuming that a real estate worth 1.000.000 $ is tokenized and 50.000 RWA tokens are issued, then, the price of each RWA token will be 20$.
Real-Time Asset Pricing
One of the most common usage areas of RWA tokens is the tokenization of market instruments such as commodities, shares, bonds, currencies, etc. These assets are already subject to first and secondary transactions. These assetsâ prices are generally determined in accordance with the principles of the free market. In the event of tokenizing these assets, the economic value of such RWA tokens will be determined by the actual real-world prices of underlying assets.
Income Approach
The predicted income that an asset can produce is the foundation of the income approach to valuation, which is especially important for asset-backed tokens connected to income-producing assets. This involves projecting the amount of money that the asset will yield over a specific time frame. This could be the rental income from real estate, the earnings from a business, or the interest or dividends from financial assets.
In conclusion, if the issuer prefers the income approach, then, the economic value of a RWA token will be calculated in accordance with the income that the underlying asset may generate and the amount it entitles its right owners.
Regulations Across Major Jurisdictions
USA
Due to its federal nature, there is no uniform legislation regarding crypto assets in the United States. However, there are some competent public authorities that investigate and sometimes even litigate against crypto asset projects including RWA tokens.
While there are other authorities, the leading authority in the U.S. is the Securities and Exchange Commission (âSECâ). Mainly, the SEC is concerned with the crypto assets that may fall into the category of securities.
SECâs Approach
For the SEC to be able to take action against a crypto asset, such a crypto asset has to be eligible to be regarded as a security. But how does the SEC determine if a crypto asset is a security? The answer is quite simple but at the same time rather complicated. The Howey Test.
The Securities Act of 1933 and the Securities Exchange Act of 1934 impose disclosure and registration requirements on securities, and the Howey Test was developed by the US Supreme Court to evaluate whether a transaction meets the criteria to be classified as an âinvestment contract,â making it a security. The Howey Test states that an investment contract is present if and only if: (i) there is a financial commitment, (ii) in a common enterprise, (iii) with the expectation of profit, (iv) to be derived from the efforts of others.
If these requirements are satisfied, the asset subject to the question will in fact be considered as security, and therefore, security law will be applicable.
Tokenizing real-world assets entails transferring ownership or other kinds of rights to a digital token on a blockchain. These tokens frequently stand for investments in precious metals, real estate, artwork, or other financial ventures. We may look at each need in relation to the tokenization of real-world assets and the potential applicability of the Howey Test:
Investment of Money: When real assets are tokenized, tokens representing a portion of the asset are often acquired by investors through financial contributions. Since buying tokens entails exchanging money for the rights or interests in the underlying asset, this need is typically satisfied.
Common Enterprise: Because the value of the individual tokens is linked to the performance of the underlying asset, tokenized assets frequently involve a common enterprise. If the assetâs value rises (for example, real estate or fine art), all token holders benefit proportionally. This element of the Howey Test is typically satisfied by the interdependence between the token value and the performance of the underlying asset.
Profit Expectation: Typically, investors in tokenized assets expect to profit from their investment. This profit could come from token appreciation, rental income from real estate, dividends, or other forms of return. Tokens that are marketed with the promise of profit can meet this criterion.
Othersâ Efforts: This is a critical criterion. This requirement is satisfied if the benefit predicted from the tokenized asset is mostly attributable to the efforts of the persons or companies producing, managing, or promoting the asset. For example, if a tokenized real estate investment is dependent on a management firm to remodel a building, recruit tenants, and handle upkeep in order to create rental revenue, the activities of these third parties are vital to achieving the predicted profit for token holders.
If a tokenized asset fits all four elements of the Howey Test, it is likely to be regarded as security and hence subject to the SECâs or other regulatory bodiesâ regulatory obligations, which include registration or obtaining an exemption, disclosure.
Consequences of Being Considered as a Security
When a RWA token is considered to be a security by the SEC, then, the issuance, offering, and even trading of such tokens is quite problematic. If a token is classified as a security, it is subject to the regulatory framework for securities, which is largely controlled by the Securities Act of 1933 and the Securities Exchange Act of 1934, and is monitored by the SEC in the United States.
If a token is in fact a security then, unless they qualify for an exception, securities must be registered with the SEC. Registration entails releasing thorough information about the companyâs commercial activities, financial position, and management, as well as the investment risks.
Furthermore, the mere act of offering a token that is eligible to be considered as a security may in fact result in serious violations of relevant securities law. For example, the SEC claimed Binance and BAM Trading, under the leadership and control of Zhao, were unlawfully offering essential securities market functions by operating as an exchange, broker-dealer, and a clearing agency on the Binance platforms (both Binance.com and Binance.US) without a prior registration with the SEC. The SEC claimed that the Binance side was acutely aware of the necessity to register these functions yet actively chose not to, as a means to avoid regulation.
Binance, itself was also considered to have been operating without registering as an exchange, broker-dealer and a clearing agency for the Binance.com Platform, meaning the SEC fundamentally considered the platform to be operating these functions.
The functions of operating as a securities exchange, broker-dealer, and clearing agency without respectively registering as such were in violation of Sections 5, 15(a) and 17A(b) of the Exchange Act. Further, as the control person of Binance and BAM Trading, Zhao exercised power and control over Binance, and by directing and participating in the acts that constituted Binanceâs violations of the securities laws, was also violating the same sections.
The offer and sale of BNB, BUSD, Simple Earn, and BNB Vault were claimed by the SEC to be in violation of Sections 5(a) and 5(c) of the Securities Act. The SEC claimed that without a registration statement filed or in effect as to these securities, Binance was directly in violation of the said regulation.
The EU
Asset-Referenced Tokens in the Market in Crypto Assets Regulation
The Markets in Crypto Assets Regulation (âMiCAâ) is expected to enter into its stage of application in December of 2024. MiCA yields great importance for both investors and issuers within the blockchain and crypto asset field, especially in the context of RWAs. Within Title III â Asset Referenced Tokens (âART/sâ), MiCA sets out the requirements for asset-based tokens between Article 16 and Article 47. Due to the fact that MiCA shall be implemented in the European Union member states, the field of application for the rules is comprehensive both materially and geographically. Therefore, it is important to be prepared and familiar with MiCAâs regulatory framework in the context of ARTs.
In Article 3(6) of MiCA, asset-referenced tokens are defined as âa type of crypto-asset that is not an electronic money token and that purports to maintain a stable value by referencing another value or right or a combination thereof, including one or more official currenciesâ.
MiCAâs Title III on ARTs is made up of six chapters;
Chapter 1: Authorisation to offer asset-referenced tokens to the public and to seek their admission to trading
Chapter 2: Obligations of issuers of asset-referenced tokens:
Chapter 3: Reserve of assets
Chapter 4: Acquisitions of issuers of asset-referenced tokens
Chapter 5: Significant asset-referenced tokens
Chapter 6: Recovery and Redemption Plans
Chapter 1 of Title III regulates the authorization of ARTs, requirements for credit institutions, the application for authorization, the content and form of the crypto asset white paper for ARTs, modification of published crypto asset white papers for ARTs, the liability of issuers of ARTs for the information given in whitepapers, the assessment of the application for authorization, cases of grant or refusal of the authorization, the required reporting on ARTs, restrictions on the issuance of ARTs as a means of exchange and the withdrawal of the authorization.
Chapter 2 focuses on the obligations of the issuers of ARTs; by regulating the obligation of the issuers of ARTs to act honestly, fairly, and professionally in the best interests of the holders of ARTs, aspects of the publication of the crypto white paper, marketing communications, ongoing information to holders of ARTs, complaint handling procedures, identification â prevention â management and disclosure of conflicts of interest, notification of changes to the management body, governance arrangements and own funds requirements.
Chapter 3 is on the reserve of assets which regulates aspects such as the obligation to have a reserve of assets, the composition and management of such reserves, custody, and investments of reserve assets, right of redemption, and prohibition of granting interest.
Chapter 4 is on the acquisition of issuers of ARTs, regulating the assessment of proposed acquisition of issuers of asset-referenced tokens, and the content of the assessment of proposed acquisitions of issuers of ARTs. Chapter 5 regulates the classification and voluntary classification of ARTs as significant ARTs and the specific additional obligations for issuers of such significant ARTs. Finally, Chapter 6 is on the recovery and redemption plans that must be taken into consideration.
Authorization
According to Article 16 of MiCA, only issuers of the ART can make an offer to the public or seek admission to trading of an ART and they must be a legal person or undertaking that is established within the European Union and have been authorized by a competent authority at its member state in accordance with Article 21; or must be a credit institution that complies with Article 17 of MiCA. Other undertakings, that arenât legal persons or other undertakings established within the Union and in accordance with Article 21 may issue ARTs if their legal form ensures a level of protection for third-party interests equivalent to that afforded by legal persons and if they are subject to equivalent prudential supervision appropriate to their legal form.
The aforementioned authorization requirements will not apply if, for over 12 months, calculated at the end of each calendar day, the average outstanding value of the ART issued never exceeds 5 million Euros, or the equivalent amount in another official currency, and the issuer is not linked to a network of other exempt issuers, or the offer to the public of the ART is addressed solely to qualified investors and the ART can only be held by such investors.
An ART issued by credit institutions may be offered to the public or admitted to trading if the credit institution draws up a crypto asset white paper, submits and gets approval for the white paper from the competent authority in its home member state, and notifies the respective competent authority at least 90 working days before issuing an ART for the first time. This notification should include the information listed in Article 17 of MiCA as a programme of operations (business model of the credit institution), a legal opinion that the ART does not qualify as a crypto asset excluded from the scope of MiCA, or as an e-money token and the detailed descriptions of the governance arrangements listed in Article 34 of MiCA.
Obligations of the Issuer
MiCA seeks to ensure that ARTs are issued by trustable entities that are regulated and protect investors. The regulation also seeks to ensure that ARTs have asset reserves and that will protect investors at all costs. Further, through MiCAâs regulatory framework, investors can make informed investments, and track the performance of ARTs and issuers will display a transparent operation.
In this context, MiCA holds the issuer to standard requirements. First, the issuer has to be a legal person established within the European Union, with its headquarters and office in an EU member state. The issuer must be authorized by a national competent authority within an EU member state. The issuer must also hold a credit institution authorization.
According to Article 35 of MiCA, ART issuers are required to also have funds equal to the amount of at least EUR 350,000 or 2% of the average amount of the reserve assets or a quarter of the fixed overheads of the preceding year. Further, issuers are required to publish regular reports, on the ART, the reserve assets, the number of circulating tokens, and charged fees.
The issuers handling and dealing with complaints are also regulated within the framework with issuers expected to implement governance arrangements that include clear business structures with clear lines of reporting. For example, issuers are required to establish effective procedures for the prompt, fair, and consistent handling of complaints. They are required to maintain and implement effective policies and procedures to identify, prevent, and manage conflicts of interest.
According to Article 22 For each asset-referenced token with an issue value that is higher than EUR 100 million, the issuer must report on a quarterly basis to the competent authority the number of holders, the value of the ART issued, and the size of the reserve of assets, the average number and average aggregate value of transactions per day during the relevant quarter, an estimate of the average number and average aggregate value of transactions per day during the relevant quarter that are associated to its uses as a means of exchange within a single currency area. Any material events or breaches of MiCA must also be reported to the competent authority.
Reserve Assets
Article 36 mandates that issuers of asset-referenced tokens shall constitute and at all times maintain a reserve of assets. The reserve of assets shall be composed and managed in such a way that the risks associated with the assets referenced by the ARTs are covered and that the liquidity risks associated with the permanent rights of redemption of the holders are addressed. The reserve of assets shall be legally segregated from the issuersâ estate, as well as from the reserve of assets of other ARTs, in the interests of the holders of ARTs in accordance with applicable law, so that creditors of the issuers have no recourse to the reserve of assets, in particular in the event of insolvency. Issuers of asset-referenced tokens must ensure that the reserve of assets is operationally segregated from their estate, as well as from the reserve of assets of other tokens.
To ensure the safekeeping of these reserve assets, a crypto-asset service provider can be engaged to oversee and manage the custody of crypto-assets on behalf of clients. Itâs crucial to emphasize that the custodian of an ART must be a separate legal entity from the ART issuer, preventing them from being the same entity. The custodian should possess the required expertise and a strong reputation in the market to effectively manage these reserve assets, including maintaining detailed records and providing regular reports to the issuer. The custodianâs appointment must be documented in a formal agreement that outlines the custodianâs rights, responsibilities, and protocols for managing the reserve assets.
Significant ARTs
MiCA also makes a distinction of significant ARTs wherein the European Banking Authority shall determine ARTs that are significant. Significant ARTs are determined by factors such as their size, the number of investors, and the level of risk they yield. Although ARTs may be classified as significant voluntarily, itâs important to note that significant ARTs bring additional obligations for their issuers such as complying with further European Banking Authority guidelines regarding the management of reserve assets and protection of investors. Additionally, issuers of significant ARTs are subject to being supervised by the European Banking Authority.
White Papers and Marketing Communications
The marketing aspect of ARTs is also regulated to Articles on white papers, marketing communication, and the publication of white papers. Firstly, MiCA underlines that all information provided in the white paper must be fair, clear, and not misleading, with sufficient disclosure of information that shall benefit the investors. The whitepaper must also be prepared in the official language of the member state that the issuance is being made in or in the language customary in the sphere of international finance. If any changes are made to the business model that may have influence on the purchase decisions of holders or prospective holders of ARTs after the white paper is approved, these changes must be notified to the competent authority.
Although there are no mandatory requirements for the prior approval of marketing communications before publication, it is imperative that marketing communications are presented in a transparent manner, devoid of misleading elements, and ensure that the information provided is fair. These communications should also align with the content outlined in the associated white paper. Additionally, it is essential to note that marketing communications must be promptly disclosed to Competent Authorities upon their request, promoting transparency and regulatory compliance.
In regards to the publication of the white paper, the approved white paper shall be published and made available on the website of the ART issuer. This ensures public access by the commencement of the ARTâs public offering or its admission to trading. The information provided must remain accessible for the entire duration that the ART is in public circulation. Furthermore, marketing communications should also be published on the websites of the offerors and entities seeking admission to trading. This publication should take place well in advance of the ARTâs public offering, ensuring that relevant information reaches the public in a timely and transparent manner.
TĂźrkiye
Since there is no specific piece of legislation in TĂźrkiye regarding crypto assets, relevant local legislations shall be examined according to the feature and nature of a crypto asset. Depending on the tokenized real-world asset, applicable legislation may in fact vary.
In TĂźrkiye, capital market instruments are defined as securities and derivative instruments, as well as investment contracts and other capital market instruments that are determined by the Board to be within this scope. Furthermore, excluding money, checks, promissory notes, and bonds, securities are defined as shares, other equity-like securities, and depositary receipts related to such shares, debt instruments, or debt instruments based on securitized assets and incomes, and depositary receipts related to such securities.
If a tokenized real-world asset falls into the category of any of the aforementioned assets, then, these tokenized assets as well as the offering and trading them will be most probably subject to securities laws of TĂźrkiye which in fact come with strict and hard-to-follow requirements, almost making it impossible to develop a RWA token.
One of the main usage areas of RWA tokens is actually akin to derivative instruments of capital markets. According to the article 3 (u) of the Capital Markets Law numbered 6362, derivative instruments are defined as derivative instruments that grant the right to purchase, sell, or exchange securities, derivatives whose value is dependent on the price or yield of a security; exchange rate or exchange rate fluctuation; interest rate or change in the rate; price of a precious metal or gemstone or price fluctuation; price of commodities or price fluctuation; statistics published by institutions deemed appropriate by the Board or changes in them; those that provide credit risk transfer, have measurement values such as energy prices and climate variables, and are linked to the level of an index composed of the aforementioned or changes in that level, derivatives of these instruments, and derivatives that grant the right to exchange the listed underlying assets with each other, leveraged transactions to be made on foreign currencies and precious metals, and other assets to be determined by the Board.
In conclusion, if a real-world asset falls into any of the aforementioned assets, then, the capital markets laws will be applicable. The offering of capital market instruments is strictly regulated and subject to the approval of the Capital Markets Board of TĂźrkiye. Any offering or trading of such RWA tokens without necessary compliance processes within the Capital Markets Boards may result in criminal and legal liabilities and risks.
Tokenization of lease certificates and precious metals like gold is a frequently favored practice. According to Article 61 of Capital Markets Law â6362, lease certificates are documents issued by asset leasing companies to finance various assets or rights. Those who hold these certificates receive a certain share of the income generated from these assets or rights. How lease certificates are issued and sold is determined by the Board.
Provided that the necessary permissions and approvals are obtained from the Board within the framework of the procedures and principles envisaged in the Capital Markets Law, and the CommuniquĂŠ on Lease Certificates issued by the Capital Markets Board on June 7, 2013, it appears possible to tokenize lease certificates as long as they fulfill the required conditions.
Real Estate Tokenization in TĂźrkiye
When a real estate is tokenized, aside from the consequences under capital markets law, the transfer of property ownership or rights over the property through the exchange of the token is a matter of debate under Turkish law. If the land registry is kept on the blockchain, the title deed can be tokenized and converted into a digital certificate. However, as of November 2023, there are no known studies conducted on this matter.
Real estate ownership can be acquired originally or by transfer, with registration or before registration. The transfer of ownership rights or other rights related to a tokenized real estate generally falls within the scope of acquisition by transfer and registration.
To acquire the ownership of a property through registration, firstly a valid cause of acquisition is required, and second, comes the registration process. The registration process, which must be carried out in the presence of a competent official authority and subject to strict formal requirements, currently does not result in the transfer of ownership of the property by merely exchanging a token based on the property.
For now, there is no obstacle to the debtor fulfilling the obligation undertaken with the token at the end of these tokenization and exchange transactions, which are essentially external transactions dependent on the debtorâs initiative. Although the functionality and trustworthiness of these external-character real estate tokens could potentially be resolved through structures similar to Trusts or Escrows, this solution might also lead to debates regarding the compromise of blockchainâs claim of decentralization.
United Arab Emirates, Dubai
The United Arab Emirates is one of the jurisdictions that recently made an impressive move and shows promise for the crypto asset industry. In The Chairman of the Authorityâs Board of Directorsâ Decision No. (23/ Chairman) of 2020 Concerning Crypto Assets Activities Regulation, security tokens are defined as a security, meaning shares, bonds, and financial bills issued by joint stock companies, bonds and bills issued by governments and public authorities in the UAE, and any other financial instruments accepted by SCA, to the extent issued, transferred or traded in the form of a crypto asset or a Crypto Asset that is deemed to be a security pursuant to Article (4) of this Regulation, subject to the exclusion stipulated in Article (3/ Second/ 3) of this Regulation.
For rules and regulations, issuing securities, even if done on a blockchain platform, is treated the same as any other method. Companies that want to use blockchain or other new technologies to get funding in a legal and clear way should talk to the Financial Services Regulatory Authority early in their fundraising efforts.
Therefore, the first thing to be aware of in terms of issuing an RWA token in the United Arab Emirates is examining whether a real-world asset that is aimed to be tokenized falls into the jurisdiction of capital market laws or not. If so, then, relevant capital markets law will be applicable.
UAE is one of the leading countries in terms of real-estate tokenization. We see that real estate investment funds, also known as REITs, are tokenized. If tokens representing shares in a REIT are classified as securities, they will be subject to the same comprehensive regulatory requirements as traditional securities.
RWAs as Option Agreements
What is an Option Agreement?
An option agreement is an agreement made between two parties to facilitate the potential transaction of an asset at a certain time and date. Options are financial tools linked to the worth of underlying assets, like stocks. These contracts provide the purchaser with the chance to purchase or sell, contingent on the type of contract, the selected underlying asset at a predetermined price specified in the contract, either within a specific time period or at the contractâs expiration date.
Simply, an option agreement gives the right, but not the obligation, to buy or sell a specific asset or property at a predetermined price within a specific period with the party that holds this right being referred to as the option holder/optionee and the other party is referred to as the option grantor/optionor.
Call options and put options are two common types of option agreements. Call option agreements give the option holder the right to buy the underlying asset from the option grantor at the agreed price, which is often used in financial markets. This allows investors to profit from the price appreciation of a stock, commodity, or other financial instrument without their ownership. Put option agreements on the other hand give the option holder the right to sell the underlying asset to the option grantor at the predetermined price. This is commonly used as a form of insurance against the decline in the value of assets and a protection against price falls.
A common option agreement scenario occurs when option agreements are made between landowners and developers wherein the developer is given the opportunity to purchase land from the landowner within a time frame, often with an option fee paid by the developer.
Can RWA Tokens be Considered as Option Agreements?
If an RWA token suffices the nature and requirements of an option agreement, meaning that if it entitles its owner to buy or sell a specific asset in a time with a predetermined price, then, in fact such RWA token can be considered as an option agreement.
Options are normally categorized as securities in the United States. According to the Securities Act of 1933 and the Securities Exchange Act of 1934, the definition of a security comprises a wide range of investment products. Under U.S. federal securities regulations, options are defined as âsecuritiesâ because they provide the right to acquire or sell another asset (such as shares of stock) at a fixed price before the option expires.
Options are regulated by the SEC and traded on regulated exchanges. Over-the-counter (OTC) options, which are not traded on regulated exchanges, are also considered securities and may be subject to extra regulatory requirements, such as compliance with the registration provisions of the securities laws unless an exemption is granted.
The financial markets in Turkey are governed by the CapitaĹ Markets Board and the Capital Market Law defines securities as explained above. The rule applies to a wide range of financial products, including derivatives like options. Options are considered capital market instruments in Turkey, particularly those that are standardized and traded on exchanges such as Borsa Istanbul and are regulated by CMB. As a result, they are often regarded as securities and are subject to Turkish capital market laws.
Certain forms of OTC options, which are neither standardized nor traded on a formal exchange, may yet fit under the definition of securities or capital market instruments, depending on their structure and the rights they convey.
Challenges that Await RWA Tokens
Although tokenization offers potential solutions to various challenges and aims to make investment accessible to a wider audience, it is crucial to acknowledge the early development phase of tokenization and take into account any associated concerns.
Unlike traditional asset classes, security tokens are a new and untested area of law and regulation. While some guidance has been provided by regulatory authorities, it is expected that new developments and changes will occur as technology advances and the market grows. Additionally, there is no guarantee that regulators who currently support or do not oppose tokenization will continue to do so in the future.
The laws and regulations governing security tokens may change in the future, which could cause uncertainty and hinder the adoption and liquidity of these tokens for both issuers and investors.
Some jurisdictions distinguish between security tokens and crypto assets. The main difference is how their value is determined. Security tokens are backed by real assets, such as real estate, making their value less volatile and more easily determined compared to cryptocurrencies. Security tokens are also typically regulated under existing securities regulations, even in jurisdictions where crypto assets are unregulated or banned. This means that investors in security tokens may have better protections and rights compared to investors in other crypto assets.
Letâs continue with an example of real estate tokenization. In the real estate industry, it is common for funds and transactions to be kept confidential. This is because managers and participants do not want to share sensitive information with a large number of people. Only a select group of prospective investors who agree to keep the information confidential are typically given access to this information. In certain cases, regulations may also require confidentiality, particularly if the project involves a listed or regulated entity.
In the past, it hasnât been difficult to keep real estate transactions and funds confidential because they were only available to a small group of institutional, corporate, and wealthy investors who had to wait until the project was completed to access their funds. However, with security tokens that can be traded on an exchange, it will be necessary to disclose sensitive information to a larger pool of potential investors in order to facilitate investments and transactions.
The balance between data transparency and information privacy in financial transactions will be an important focus of development in blockchain technology. Blockchain protocols, such as Zero-Knowledge Proof, can protect data privacy on public blockchains by allowing one party to prove their knowledge of certain data to another party without revealing the actual data. With continued development and careful planning, blockchain protocols will enable data transparency that safeguards against unlawful concealment of information without compromising confidential business data.
Case Studies
Real Estate Tokenization
Liquefy is collaborating with a group of wealthy Gulf families to convert a prestigious hotel in Londonâs Mayfair area, worth $600 million, into tokens.
The local Special Purpose Vehicle (âSPVâ), which is owned by an offshore SPV, is responsible for managing the property. This includes tasks such as collecting rent, hiring employees, and paying fees to the local government. The current owners will maintain a 51% ownership in the offshore SPV, giving them a 51% stake in the property and management company.
Approximately half of the shares in the offshore SPV will be converted into security tokens and distributed to smaller investors. These tokens will represent a 49% ownership stake in both the property and the management company. By participating, investors can invest in the real estate property with a lower initial capital requirement. The details of these investors will be recorded on the digital ROM.
Using blockchain technology will make the process of changing ownership and selling the London hotel quicker and safer. Additionally, investors will have the ability to transfer their real estate tokens to other investors, providing them with liquidity in the secondary market.
Fund Tokenization
Sidley provided guidance and assistance to a fund manager from Hong Kong in creating and organizing the first tokenized fund in Asia in 2019.
The Fund puts money into assets that cannot easily be converted into cash. Like other funds that invest in real estate, this means that the Fund will exist for a long time to give the manager enough time to buy, increase the value of, and sell these investments. Additionally, investors in the Fund cannot sell their shares or take their money out whenever they want.
The Fund is the initial fund in a series that the Manager plans to create for investing in illiquid assets. It has been set up as the first segregated portfolio within a segregated portfolio company in the Cayman Islands, which offers benefits in terms of time and cost.
To appeal to a larger group of investors, the Manager utilized a technology platform to convert all the equity interests in the Fund into tokens, allowing for trading and liquidity in the secondary market.
Investors in the Fund receive digital tokens that represent their ownership in the Fund. These tokens can be stored in a digital wallet that is compatible with ERC20. Although investors are not able to withdraw their investment from the Fund before it matures, they are allowed to sell their tokens to other investors on the secondary market, as long as they follow the transfer restrictions outlined in the smart contract on the technology platform.
The ownership of equity interests in the Fund is recorded in the Fundâs register of members. This register is maintained both in a book-entry ledger by the Administrator and in a blockchain-based ledger on the Technology Platform.
The creation of the Fund has opened doors for other asset managers in Asia to tokenize their funds. It is anticipated that fund managers will adopt tokenization, especially for closed-end funds, as it offers clear advantages that will make these investments more appealing to a broader range of investors.
Current Examples
Reental (Real Estate)
Real estate investments have high barriers to entry and limited liquidity. To secure mortgage financing, investors typically need to make significant down payments and have good credit scores. Unlike other investments, it is challenging to divide direct ownership of real estate among multiple investors due to the need for expensive intermediaries and legal processes.
Reental, a company based in Spain, allows individuals to invest in real estate through a tokenization process. Investors can acquire a property with a minimum amount of âŹ100 and receive monthly dividends from rental income. After two years, the property is sold, and any profits are distributed among token holders. Additionally, Reental increases the liquidity of real estate investments by combining multiple decentralized finance protocols, allowing investors to trade property-backed tokens at market value.
Agrotoken (Commodities)
Agrotoken is a platform that allows for the tokenization of commodities, such as wheat, corn, and soy. Producers deposit their products with a custodian, who then issues tokens equivalent to the amount of grain deposited. These tokens can be traded on the platform or peer-to-peer. Prices are determined by the market and monitored by oracles connected to commodities markets. Token holders can redeem their tokens for the underlying grain, resulting in the destruction of the tokens.
Stander Bank (Debt Issuance)
In September 2019, Santander Bank became the first bank to issue a bond using a public blockchain. The bond was worth $20 million and had a coupon rate of 1.98% per quarter, which was also tokenized. Santander Securities Services acted as the agent for tokenizing and safeguarding the bond. According to the bank, this new process provides benefits such as greater market transparency, faster settlement times, improved security, and reduced reliance on intermediaries.
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