Tokenization focuses on transforming real-world assets, such as stocks, bonds, real estate, art, or even intellectual property, into digital tokens that can be stored, transferred, and traded, with the help of blockchain technology. Tokenization has the potential to democratize access to capital markets, reduce intermediation costs, enhance liquidity, and create new business models.
However, tokenization also might pose significant regulatory challenges nowadays, as different jurisdictions have different rules and standards for defining, issuing, and trading tokens. Moreover, the legal status and enforceability of tokenized assets are not always clear, especially when they involve cross-border transactions or complex contractual rights.
In this article, we explore the current state of the global regulatory landscape for tokenization, focusing on three main aspects: classification, compliance, and coordination.
Tokenization Regulations: Classification
One of the key issues for tokenization is classifying tokens according to their economic functions and legal implications. Depending on the characteristics and features of the token, it may fall under different regulatory categories, such as securities, commodities, currencies, utility tokens, or non-fungible tokens (NFTs).
The classification of tokens has significant consequences for both issuers and investors, as it determines the applicable rules and obligations for registration, disclosure, reporting, taxation, anti-money laundering, consumer protection, and dispute resolution.
Currently there are different approaches towards classifying tokens depending on the region and various jurisdictions. Some countries, such as EU countries, Switzerland, and Liechtenstein, have adopted their own specific laws or guidelines to define and regulate different types of tokens or created new regulations [1]. The European Union is adopting the MiCA regulation that is harmonizing the approach towards tokenized assets and cryptocurrencies across the members of the European Union, which is a huge step towards creating a unified approach use case. You can read more about the MiCA regulation in our dedicated blog post about Cryptocurrency regulations in EU. Others, such as the US, the UK, and the EU, have relied on existing laws and regulations to assess tokens on a case-by-case basis, using criteria such as the Howey test, the FINMA token taxonomy, or the European Securities and Markets Authority (ESMA) advice [2].
Tokenization Regulations: Compliance
Another major challenge for tokenization is how to ensure compliance with the relevant laws and regulations in each jurisdiction where the token is issued, traded, or held. This may involve multiple and sometimes conflicting requirements, such as obtaining licenses, conducting due diligence, verifying identities, disclosing information, auditing transactions, paying taxes, and adhering to standards.
Compliance can be costly and complex, especially for small and medium-sized enterprises (SMEs) that want to tokenize their assets and access global markets. To address various challenges, some solutions have been proposed, such as using smart contracts to automate and enforce compliance rules, using oracles to provide reliable and verifiable data sources, using decentralized identity to verify and protect identities, and using self-regulatory organizations to establish and follow best practices [3].
Tokenization Regulations: Coordination
A third and related challenge for tokenization is how to coordinate and harmonize the regulatory efforts and initiatives across different jurisdictions and stakeholders. This includes regulators, policymakers, industry associations, standard-setting bodies, academia, and civil society.
Coordination and harmonization are essential to avoid regulatory arbitrage, fragmentation, and uncertainty, and to promote innovation, competition, and cooperation. However, sometimes it’s easier said than done, and coordination and harmonization are not so easy to achieve, given the diversity and complexity of the tokenization ecosystem and the lack of global authority or consensus.
Some steps have been taken to foster coordination and harmonization, such as creating international forums and working groups to exchange information and views, developing common principles and guidelines to align regulatory approaches, and establishing mutual recognition and equivalence mechanisms to facilitate cross-border transactions [4].
Conclusion
Tokenization is a promising and disruptive phenomenon that has the potential to transform the financial system and the economy. However, some challenges presented by tokenization require careful and collaborative responses from all the relevant actors, in order to balance the risks and benefits of tokenization, and to ensure its legal certainty, legitimacy, and sustainability.
