Here we go. You’ve heard about blockchain, about tokens, tokenization of illiquid assets. What does all of this mean for real-world businesses, consumers and investors?
With the first jurisdictions starting to list regulated security tokens on their national stock exchanges (big shout-out to Seychelles), time is ripe for a real discussion of what is.
Simply put, tokenization means digitalization of an asset through blockchain. Any asset with real-world value such as real estate, land, arts and trademarks can be converted into a digital representation by issuing a token. A common token used to represent an asset is the Ethereum-based ERC-20 token modified to comply with security laws. Therefore legally speaking, these assets are securities.
Say you’re a property owner. Your property is your asset. Tokenizing that would mean issuing a number of tokens to represent the value of that asset. You can slice your asset into a million pieces and trade them on the market for greater liquidity and asset appreciation.
Simple and easy, right?
Not so fast.
While in theory, the benefits of tokenizing assets come with multitude: increased capital, greater liquidity, immutable tracking and streamlined transactions… in reality, we still have a long journey ahead before achieving any compliant tradability on the market.
In order to tokenize any asset, these are mandatory processes that need to happen one way or another. In minimum, we need to be able to answer these questions:
Easier than sounds. In real estate, there are numerous different types of ownership rights from direct property ownership to rental income rights. What does your token legally represent: the right to use the property or perhaps shares in a SPV (Special Purpose Vehicle) that owns the property?
This will not only affect the type of security laws or tax implications you are subject to but also your direct claims rights and legal issues caused by those different rights.
What we’re talking about here is essentially programming securities. Smart contracts can automate processes such as paying out dividends with built-in compliance. Therefore, pre-conditioned terms and agreements, market conditions and complications need to be taken into consideration.
As an asset class, securities are some of the most regulated types in the world today. This limits access from the issuer side and the sizes of investments being placed. In a tokenized world, any asset could literally be sliced down into tens of millions of fractions which are no longer limited by fiat currency decimals such as US$0.01. Bitcoin today has 8 decimals and Ethereum-based ERC-20 tokens follow Ether’s 18 decimal standard. This may seem irrelevant today but the ability for such fractional ownership is crucial for future asset value appreciation and depreciation.
The governing, voting and structuring of these instruments would then ultimately also need to reflect those possibilities and scalabilities.
This is where things start becoming tricky. One way or another, you need to have a blockchain platform that has the legal authority to store those rights to the assets. A regulated marketplace, if you will. OR you will need a license to issue security tokens, which is a whole another chapter.
Being able to legally store assets on blockchain is one thing. To achieve greater liquidity, you also need to be able to transfer ownership to investors and other stakeholders in a compliant way.
To date, we still don’t have a single regulated security token exchange to enable this for mainstream use, for unaccredited investors.
Tokenizing an asset makes no sense if you have no place to sell, buy and ultimately convert the represented value into a real-world figure such as fiat currencies.
We already have a number of unregulated marketplaces and crowdfunding platforms where all types of trading happens, but in order to legally trade security tokens, we’re looking at a set of not-so-easy processes from ownership, investors and other stakeholders, private valuations and AML/KYC (Anti-Money Laundering/Know-Your-Customer) requirements which are all different per country.
To most of the above questions, we simply don’t have answers yet.
Having been at the heart of this development and seen the play between blockchain and regulations, something seemingly simple like an e-signature may take a lifetime to get legally approved.
Therefore tokenizing assets to be tradable by the mainstream on a global scale is still very, very new.
That said, however, there is another way.
Like in anything in life, there is always an alternative.
Just like tokenizing assets such as real estate, why not tokenize an entire company?
If you don’t know what a Smart Company is, learn more here.
In essence, this means that corporate shares of a legal entity can be converted into tokens. Similar to tokenizing illiquid assets, tokenized corporate shares are a digital representation of assets owned by the company.
So instead of tokenizing real estate, you’d tokenize the legal entity that owns the real estate.
In our case, we convert corporate shares into ERC-20 tokens modified for security laws per each jurisdiction we operate in.
And why would anyone want to do that?
Simple. To get real legal ownership over tokenized assets. And to be able to manage all things related to those assets directly on Ethereum.
Here’s what’s happening. Due to lack of regulations in this field today, the currently used method to tokenizing real estate is this: real estate → security tokens → unregulated trading → OR regulated trading only for accredited investors.
Frankly, to trade with accredited investors, we don’t even need blockchain in place. We have perfectly established ways of doing that already through regulated vehicles like REITs (Real Estate Investment Trust) for instance. So what exactly is the purpose of tokenizing an asset in the first place?
But if you tokenize the legal entity that owns the real estate, you have compliant ownership over the asset, direct custody. Therefore, you can sell, buy, trade and merge — virtually anything that you can operate as any legal entity.
- Legally own, store, buy and sell tokenized corporate shares
- Tokenize anything of value in the form of a limited company such as real estate, land and yachts or IP rights and trademarks. And then convert those shares into fiat currencies the same way companies would do today on the real markets.
- Track, manage and vote with all shareholders digitally on an Ethereum-powered dashboard with immediate legal validity
- Tokenize certain corporate assets with pre-conditioned terms that are placed on an automated smart escrow
And the list goes on… you get the point. We like this ocean of possibilities.
Now, of course, tokenizing entire companies makes things easier navigate from legal point of view today, but this certainly raises other set of challenges such as entity governance, dividends and misaligned incentives. These all belong to corporate governance, which we’ve talked more extensively about in our previous post.
From all aspects, we are still in early days. In diapers.
Tokenization of illiquid assets has transformative potential in simplifying today’s complex procedures in the world of investment. But for now, a good deal of regulatory consensus and reform is still needed before things will leap forward.
The good news is that we’re starting to see more and more jurisdictions jumping in the bandwagon and making serious effort in passing blockchain-friendly bills. One of our favorite examples on this has to be the state of Wyoming, U.S that has been pioneering in this movement bill after bill (total 13 to date). Others taking giant leaps have been the Seychelles government as well as Malta — opening doors for regulated security tokens.
So a long journey ahead — but one thing is for sure, with the crazy community of ours and progressive lawmakers in the game, impossible is nothing!
We are team Korporatio. To learn more about tokenizing companies, drop us a hello at email@example.com
PS. We love feedback! Give us your yay’s and no’s. We promise to come back with real action.