Asset Tokenization Legality & Regulations: Industry Insiders Overview

Mar 16, 2020

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Asset tokenization at present faces a number of challenges on the legal and regulatory front. These challenges arise due it its novelty and disruptive nature.

Asset tokenization refers to the process of issuing a token based on the distributed ledger technology (DLT) that digitally represents a real tradable asset. The token could represent a share in a company, real estate or any other asset and can be traded on a secondary market as described in our previous article.

The two main legal challenges that asset tokenization faces are slow legislation and compliance issues.

1. Slow Legislation

Most countries have financial regulations and laws that cater to the conventional financial system, asset tokenization being a new concept doesn’t fall within the ambit of current regulations and it has been observed that law makers are struggling to issue financial laws and regulations that sufficiently address the nature and scope of asset tokenization.

“Technologists are not policy writers and policy writers are not technologists, and they’re not speaking the same language,”
– Loretta Joseph, senior consultant, government affairs at Medici Ventures. [1]

Lee Schneider, general counsel at states that the divide between the policy makers and technology experts is a challenge that stands in the way of tokenization. [1]

Germany for example, was put on the forefront of tokenization due to a clear willingness to facilitate tokenization nationwide, but legislation is slowing the process down according to a report published by the German Federal Ministry for Economic Affairs and Energy. [2]

German MP Thomas Heilmann said “This, however, will not work, if legislation cannot keep up with the pace of digital change.” . This suggests that legislators in Germany are frustrated by the speed of legislation regarding asset tokenization. [3]

When interviewed by CNN Money, Ralf Kubli, director at CV VC said that blockchain investors and companies Switzerland and Liechtenstein over Germany where the regulations are much more favorable and evolving to keep up with technological change. [4]

2. Compliance Issues

John Salmon, technology partner at Hogan Lovells believes that large proportion of regulation within financial services can be applied to the digital asset space, but there is still a small proportion that needs to be changed. [1]

A report published by OECD on the tokenization of assets and potential implications for financial markets states that one issue facing tokenized assets is the need to comply with local regulatory requirements, especially those regulatory requirements that overlook financial stability and consumer right protection. [5]

The report also claims the gaps and loopholes in regulation may lead to arbitrage and thus policy makers need to understand the technology that is behind tokenization and then formulate new regulations that can address the existing gaps in a sufficient manner.

An important issue that policy makers will need to address is the link between the token and the tokenized asset. What happens if the asset is stolen or impaired in value? How will the buyer or the investor be convinced that the value assigned to the token is the fair value of the asset? This is what the regulatory authorities and policy makers now need to address, this will require not only policy making at the national level but also coordinated policy making at the level of various financial regulatory bodies like the IAASB and IFAC[6]

Future Potential of Asset Tokenization

Market Size for Tokenized Assets in the European Union

Projection tokenized market size European Union from 2018 to 2024 in EUR bn

The chart above that was published in a report by Benjamin Schaub and Stefan Schmitt from Plutoneo, shows that compared to cryptocurrencies, tokenized assets are expected to grow significanlty by 2024, corresponding to a 26% year on year growth. The above graph sheds light on an interesting trend for investors interested in the future earning potential of tokenized assets. [7]

According to the research and survey done by the World Economic Forum, Chain Partners and R3 almost 10% of the global GDP could be tokenized in the next seven years. This predicted growth will however be achieved when countries  especially those in the European Union  pass regulations at the earliest to facilitate tokenization of assets. [8]

The report also aruges that Europe is expected to take the lead in tokenization since it already has 30% of global cryptocurrency market share. Additionally, the report anticipates that the size of security token market in Europe is expected to be approximately $0.22 trillion by 2021.

According to Russia Business Today, the bank of Russia is developing a centralized blockchain pilot, centered around their own regulations. [9]

“Based on the results of the piloting, the Bank of Russia proposed to include in the draft federal law ‘On Digital Financial Assets’ the provisions necessary for the introduction and development of such decisions in the emerging digital assets market”
– Ivan Zimin, Director of the Bank of Russia Financial Technologies Department.

Norilsk Nickel, the current market leader in palladium extraction, intends to use the Russian bank’s blockchain pilot to tokenize its commodities as asset based coins.

Following the example of the Bank of Russia, the Central Bank of Singapore is also developing multiple blockchain pilots, centered around their own regulatory framework. iSTOX, has been recently authorized in Singapore to trade tokenized securities. Thus blockchain companies are in a race to develop products catering to the needs related to tokenization of assets. [9]

Concluding Thoughts

The benefits that come along with tokenization far outweigh the current drawbacks that are mainly focused around legal and regulatory challenges. A projection done by Finance Talks estimates the tokenized asset market to be worth $27 trillion by 2027.  [10]

“Despite the obstacles, the future is bright”
– Forbes on Tokenization [11]

Asset tokenization is still in its infancy, as countries develop their regulatory frameworks to cater for this emerging phenomenon, the market for tokenized assets is not only expected to expand but also revolutionize the way financial assets are currently seen.

At elivise, we help investors realize the potentials of asset tokenization by providing tailored advisory services and insights into the world of blockchain, digital assets and tokenized financial markets.

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