Boom of NFTs – tokenization is entering a new wave: which assets can be tokenized without complex legal schemes with intermediaries?

Many projects on tokenization of real-world assets have been launched: tokenization of real estate, shares of businesses, financial products, works of art, even events or contractual rights and obligations. Under tokenization of assets, we understand creating a representation of a real-world asset on the blockchain in the form of cryptographic tokens. Those tokens uniquely represent the specific asset and are hence not interchangeable. For this reason, they are widely referred to as non-fungible tokens, or shortly, NFTs.

@camila_was (Unsplash)

A transaction regarding such tokens – digital representations of the underlying asset – corresponds to a transaction with the underlying asset itself. This offers many benefits, such as increased liquidity, possibility of transparent fractional ownership, digital certification of authenticity of the underlying asset etc.

However, tokenization of assets often comes with complex legal structures entailing intermediary entities since today’s legal systems often fail to recognize such on-chain holdings and transactions as fulfilling the “off-chain” legal parameters needed to give such holdings and transactions legal effect. A school example are real estate transactions, where legal systems usually require the change of ownership to be duly entered into the land register with the cooperation of a public notary.

Clearly, this is incompatible with the principles sought by tokenizing an asset, such as increased liquidity via simple and fast blockchain transactions. However, if the off-chain requirements are not met, a transaction will not have the desired legal effect. Therefore, in such cases, ordinarily a bridge is built in the form of an intermediary special-purpose vehicle (SPV), usually a business legal entity. Such SPV operates as an official holder of the legal title related to an asset, fulfilling all off-chain legal requirements. For example, if a token embodies quasi-ownership of a real estate that gives its holder’s the right to the profits arising from rents collected from the tokenized real estate, such SPV acts as the real-world legal owner of that real estate and is entrusted with carrying out the necessary actions to honour the claims of the token holder (to receive the profits from rent).  Such mechanism can be rather complicated and, save for high-value assets, often economically unviable.

But, hang on. Is it impossible to avoid the need for such intermediaries?

In this article we explore the situations and asset types where no intermediary should be necessary.

I draw the conclusions below from the background of a Slovenian lawyer. However, the logic should in principle be translatable to many other jurisdictions. Before we continue, we should yet emphasize that this piece does not deal with the questions of the laws on securities.

In some cases, intermediaries indeed are indispensable given the current standpoints of the legal system. Without doubt, they are necessary regarding assets in relation to which the individually named title holder shall be entered into public registers (e.g. real estate, car or vessel fleets) or where one must act as an individually named title holder in order to exercise their rights (e.g. due to the specifics of the corporate law). The same applies to the rights regarding assets where their establishment and disposal of requires a qualified form which the token-related arrangements do not at least equate to (e.g. a notarial deed or wet ink signature).

On the other hand, to establish which assets generally should be suitable for a direct, intermediary-free solution, we must consider the following:

  • electronic form should suffice and no other specific formal legal requirements should apply to acquire, hold and dispose of the legal right/title (e.g. land register entry);
  • in order to acquire, hold and dispose of the legal right/title it shall suffice under the law that the title holder is “only” identifiable, rather than necessarily individually named (e.g. “the title holder is considered to be the holder of the [defined] tokens”);
  • the name of the title holder is not subject to an entry in a public register, regardless of whether such entry is considered declaratory only (since even in that case, either legal certainty or asset liquidity could deteriorate vis-à-vis transactions).

On the technology side, the design of the process of tokenization must be such to enable the identification of a token holder in order to secure court enforceability of the token-embodied rights. When the above is observed, along with the adequate background legal arrangements, there seems to be no compelling reason not to recognize the legal rights based directly on holding a particular asset based NFT.

Under adequate legal arrangements examples could be:

  • ownership of movable property that is not subject to entry into public registers;
  • intellectual property rights that are not subject to entry into public registers (e.g. copyright, unless mandatory collective management is prescribed);
  • various contractually-based rights related to assets.

Of course, there is no clear-cut general conclusion, which arrangement might be legally feasible. Each arrangement must be assessed and designed on a case-by-case basis to ensure its legality and enforceability. I know, that is a whole lot of theory. Next time we will touch upon potential real case scenario and try to illustrate some of the aspects we talked about above.

Anze Skodlar, legal specialist | SKOZAR Legal & Venture

Posts from similar categories

No Results Found

The page you requested could not be found. Try refining your search, or use the navigation above to locate the post.

Stay updated

Subscribe to useful content

Follow us on social media