Tokenization – Legal Models and Token Consistency

If you’re interested in tech, blockchain or crypto, you have most likely heard of tokenization. In a previous post, we broke down tokenization and what type of assets can be tokenized.

This time, we’re diving deeper into how tokenization can be applied. Read on to find out the possible legal models and some examples.

Ownership Transfer vs. Limited Rights Transfer

There are several different types of transfer of assets and different varieties of asset rights. In some cases, only limited rights linked to an asset are transferred, such as the lease to use land for a limited period of time instead of a full transfer of land ownership. Thousands of years of property ownership has resulted in a wide variety of ownership types and control including holding property on behalf of another person, a practice known as “bailment.”  The details will depend upon the jurisdiction, the type of law, whether it’s civil law or common law, assets, as well as the rights that are meant to be transferred.

Some of the intangible assets can be given to millions of people all at once, like for example music rights. For instance, if a customer purchases a song from iTunes, they won’t gain the ownership of the song. They are merely buying the right to listen to that music under certain conditions.

Blockchain projects are usually divided among those that involve tokenizing partial rights, such as music licensing, as well as those that involve tokenizing the full ownership. An example is a real estate.

Token Consistency

In digital systems like Bitcoin, consistency is always present. Transactions need to follow the rules of the software, and there are no exceptions to this. However, in the real world, there are exceptions. For instance, gold bars may get stolen, real estate properties burned, or diamonds not delivered.  Furthermore, humans may not always abide by the rules. Therefore, the biggest challenge for a system that requires tokenizing real-world assets is to ensure that the digital token will remain linked to the real-world asset.

Imagine a particular token representing a fractional interest in a set of gold bars kept in a vault. If the gold bars will be taken out of the vault, how will this affect the digital token? Who can make sure that the token value remains linked to the gold bars that are kept in the vault? Who’s going to bare the risk?

If the person who buys the token cannot be certain that the token is linked properly to the real-world asset, then the value of the token is going to fall, or it may become zero.

Tokenization Legal Models
  1. Licensing

Licensing music relies heavily on trust and paperwork. After recording music, musicians hope that the sales of their work will be properly calculated and reported back to them. Since digital streaming and downloads eliminate the need for physical sales of media that contain songs, the music will have better chances for tokenization. If music ownership is represented on the Blockchain technology, people who are involved in creating the music will have to set their shares electronically.

The goal is to require unlocking and payment every time someone listens to their music, and the payment will have to be distributed to the appropriate holders. Then the holders could possibly transfer their interest in music. For instance, the drummer would like to convert his ownership to the down payment of a house, etc., or to someone else who will then get the payment stream.

More accurate reporting could benefit everyone. However, there are certain changes that the tokenization may trigger. The tokenization of the ownership of music allows new business models like investing in music created by the public. If, for instance, a new band could sell 20% of their song to fans, what will this do to the production of music? How can this affect the intermediaries?

One good example of the tokenization of music ownership or licensing is the SingularDTV.

  1. Trading Systems

For instance, a group of companies that want to trade oil with one another. They would normally exchange paperwork to maintain their own lists of trades. If they are able to move the transaction to a Blockchain-based system to trade their oil, it’s possible for them to minimize paperwork while maintaining a more robust record-keeping potentially.

There have been plenty of consortiums sprouting up that have aimed to replace the traditional paper trading systems with the Blockchain trading system. Generally, they don’t want to tokenize real-world assets directly. Instead, they are aiming to use the Blockchain system for the trading of real-world assets. This is basically a combination of the traditional paper record and the new Blockchain approach.  The tokens will only have value in the context of a contractual system that involves past and future participants.

One example of this tokenization is the oil-trading project of Natixis, IBM, and Trafigura. There are also tokenization schemes that would require minimal use of property implemented for by digital locks.

  1. Redemption

Just think of an art print made by a famous artist consisting of 1,000 prints. These art prints can be tokenized by getting ownership that’s held by a company with a standing offer to the public to redeem tokens for a single printing of art or if the redeemed tokens happen to be less than a particular threshold, which is usually a fraction of the art prints’ assessed value.

Delivering the prints physically can be made to a certain location or shipped to a certain address. By doing this, buyers are able to obtain a token that’s easy to transfer, and it will be possible for third-party markets to transact in a fraction of the art prints. This can be a good source of financing for the artists making the print an easy way for the broader public to be able to take part in the art industry.

The model above relies mainly on the company that’s holding the art to continue offering token redemptions. An obvious risk for the token holders is when the company doesn’t adhere to its commitment to exchange the tokens for real-world goods in its possession. Another possible issue is on how the company that’s holding the artwork will be compensated on the cost of storage.

A good example of this is Tether, although take note that the terms of service have indicated that redemption won’t be guaranteed.

  1. Vaults and Smart Contracts

Think of a vault of gold owned by a company that we will call the Goldowner Inc. while Vault Inc. owns the vault. Vault Inc. has a good reputation, and they have third-party auditors who can verify the amount of gold kept in the vault.

Goldowner Inc. can provide a digital token to the public, which represents ownership of the gold. A smart contract made with Vault Inc. will maintain a public off-chain registry that will relate fractional interest of the gold using the tokens. For every token that’s sold, Goldowner Inc. will transfer the ownership to Vault Inc. who will hold the gold in behalf of the token owners. Vault Inc. will guarantee the redemption of the gold to anyone who can prove his or her ownership using a digital signature.

Goldowner can benefit from the fact that Vault Inc. is a trusted company and they have third-party auditors. The owners of the token will merely rely on the representation of Vault Inc. and not with Goldowner Inc., although it’s Goldowner that issues the token.

It’s clear to see that there are many risks involved in the example above and none of the risks would exist if the gold were a digital item that could be transferred electronically. Furthermore, gold requires physical storage, which will also cost you more money.

 

So why is there a need to tokenize gold?

One advantage to this is that the buyers of the tokens will know that they are the only ones who have received the token unlike with a paper certificate where they have no way of knowing that another certificate has been issued to other people.

There are already gold tokenization startups like Orebits and Vaultoro. Several related projects are underway, which are looking to use the digital tokens to track physical items through supply chains, while the token will be used for provenance instead of value.

 

Tokenizing items on the blockchain can solve many security, trust and visibility issues, as well as improve time and productivity efficiency. The BLOCKLOAN token ecosystem will use a number of key features of blockchain technology to create a global real-time credit market.

 

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