Asset tokenization reveals urgent need for better blockchain and crypto regulation
22 June 2021
Ever since the arrival of Bitcoin in 2009 kicked off the blockchain and crypto revolution, the sector has been shrouded in regulatory uncertainty. At first, regulators around the world simply ignored the nascent space, as the crypto market was still pretty niche and undeveloped. However, as blockchain and crypto started gaining momentum, governments around the world began to realize that this new and rapidly growing space couldn’t be supported by existing regulatory frameworks.
The children of asset tokenization
One factor that brought into focus the need for regulatory response was the asset tokenization boom that contributed, directly and indirectly, to that rapid growth of the crypto market. Asset tokenization not only led to a dramatic increase in the total number of cryptocurrencies, but it also enabled the creation of many different types of tokens, serving different purposes. One of the earliest products of asset tokenization came in the form of initial coin offerings (ICOs), which provided a novel way for start-ups to fund their blockchain projects. The practice sparked a lot of controversy, as it not only attracted many bad actors to the space, but was also seen by watchdogs as a way to circumvent existing securities regulations. This led some countries like China to clamp down on ICOs, while other jurisdictions issued stirn warnings about the practice.
ICOs’ questionable reputation and the regulatory backlash it garnered led to the emergence of security token offerings which gave birth to a new category of crypto-assets called security tokens. You can read more about the difference between utility and security tokens in our article on the subject, but to put it simply, while the former are meant to facilitate operations within DLT systems, the latter represent tokenized assets or rights, thus they are generally considered to be financial instruments. As such, security tokens are typically subject to existing financial markets regulations in different jurisdictions.
Stablecoins – cryptocurrencies that are pegged, either programmatically or through physical holdings, to a fiat currency or other assets to maintain stable price – are another product of tokenization that prompted a reaction from regulators. Last year, the Financial Stability Board, an international body that monitors the global financial system, issued a warning about the potential risks that “global stablecoin (GSC) arrangements” could pose to the global economy”.
Need for regulation
The continued maturation of blockchain technology has made it possible for virtually any type of asset or right to be tokenized. In fact, there are already jurisdictions that are taking this into account. Liechtenstein, for example, allows for every right or asset to be tokenized under the Liechtenstein token act. Meanwhile, Switzerland, which is known for its blockchain and crypto-friendly regulatory approach, earlier this year introduced a new law allowing tokenized securities to be traded on a blockchain with the same legal standing as traditional assets.
However, these and other legislative initiatives on a national level do not make up for the lack of a more general solution to the problem. We need regulatory frameworks capable of defining the legal status of digital assets across larger regions and, eventually, on a global level. Only that way the blockchain revolution can continue unimpeded.
EU leads the way
The European Union, one of the front runners in the blockchain race, has been trying to bolster the technology’s adoption across the region through investments and initiatives such as the European Blockchain Services Infrastructure. The EU’s blockchain aspirations are also evident from its recent efforts to create robust regulatory frameworks for tokenized assets.
As it has become clear that existing financial services rules could not sufficiently cover tokenized assets due to their unique nature, the European Commission has spearheaded the effort to come up with a better regulatory regime for the new asset class. Following a lengthy consultation period that started in late 2019, last September the commission proposed a new law that would introduce new rules for crypto assets, replacing existing EU and national regulations. The proposed Markets in Crypto-Assets Regulation (MiCa) is designed to “support innovation while protecting consumers and the integrity of crypto-currency exchanges”.
Separately, the EC proposed a pan-European regulatory sandbox that will bring together regulators, companies and tech experts to test blockchain solutions and identify obstacles that arise in deploying them.
Navigating a fragmented regulatory landscape
While efforts like those of the EC mark an important step in the right direction for tokenized assets, they are not representative of the predominant reality, which sees many countries tackling this complex regulatory challenge on their own. And as the borderless nature of blockchain and crypto continues to clash with the regulatory patchwork that exists on a national level, having an expert capable of navigating this ocean of uncertainty is crucial for any blockchain-related project.
At LimeLegal we have deep knowledge of the technical side of blockchain and crypto, as well as the legal implications the technology has in various jurisdictions around the world. This unique perspective is what fuels our comprehensive portfolio of advisory services.
Security tokens are a crypto asset type that represents an ownership stake in an asset or a business. A security token essentially serves a similar role to traditional securities such as shares so it warrants the same regulatory scrutiny as those types of financial instruments. At the same time, they can bring the benefits of the blockchain revolution to traditional financial markets and help create liquidity in typically illiquid sectors. This makes security tokens a very powerful tool for bridging traditional finance and DLT-powered fintech. It also makes them an interesting case from a legal standpoint.
Regulation of the blockchain and crypto space has been notoriously hard to work out, especially after cryptocurrencies like Bitcoin and Ether rose to prominence and kicked off a larger crypto boom in the latter part of the previous decade.
The majority of legal hurdles come as a result of the inability of current financial rules and regulations to cover the various aspects of the blockchain sector, as well as from the lack of a unified approach when it comes to blockchain and crypto regulation.