Tokenization of Assets – How does that Legally Work?

(For German version click here)

 

With the rise of blockchain-based smart contracts, the subject of tokenization also gained in relevance. The decentralized issuance of tokens, which are transferable between users of a network without an intermediary enables the digitization of all kinds of objects from a technical point of view. Tokenization rapidly became a prominent topic in the field of capital markets. However, the possibilities of tokenization are not limited to the digital representation of financial instruments. Equally feasible and already realized in the past is the tokenization of real-world tangible assets, which enables the completely digital transfer of property of real-world objects and with that a proof of property for these objects. But what has to be observed from a legal point of view when it comes to projects dealing with tokenization and can an inextricable legal link between token and tokenized object be created?

Legal Requirements Depend on the Object to be Tokenized

A generally applicable blueprint for the legal implementation of tokenization projects does not exist, because the legal requirements of each individual project result from the specifics of the object that is intended to be tokenized. The regulatory characteristics of the specific object as well as the implementation specifics, resulting from the applicable private law must be observed. Should it be intended to tokenize e.g. medicals or special wastes, the regulatory requirements would differ from those that would be applicable to the tokenization of art objects or cars. Should it be physical objects that are intended to be tokenized, there is always the problem that it must be ensured that the connection between the object and the token that represents it, respectively the ownership of it, really is an inextricable link. Moreover, there is a legal difference between a physical object that is represented by a single, non-fungible token and a physical object that is represented by a number of fungible tokens. In the latter case, the tokens could merely represent a co-ownership, respectively fractions of the ownership instead of a full-fledged sole ownership of the object.

Inextricable Link between Token and Object as Central Legal Challenge

The German private law only provides for the establishment or transfer of property in the legal sense on physical objects. For virtual objects such as business ideas or tokens it does not foresee the possibility of establishing property in the legal sense. Therefore, a mechanism must be developed that ensures that the bearer of a specific token is also the property-owner or co-property-owner of the tokenized object, which is represented by the token. In enclosed exchange relationships such as online platforms, there is e.g. the option to determine via terms and conditions that are mandatorily accepted by all platform users upon registration, that the transfer of a token to another platform user is simultaneously connected to an offer to reassign the (co)-property-ownership of the tokenized object to that user. The acceptance of the token - possibly after confirmation of an implemented acceptance-feature - would then also represent the acceptance of the offer to reassign (co)-property-ownership of the tokenized object. Outside of such enclosed platform solution, the attempt of a contractual transfer-of-ownership fiction will regularly fail, because the law allows for the transfer of the tokenized object via an agreement and the handover of the actual, physical object, meaning that a transfer of ownership of the object would still be possible without the transfer of the connected token. In such case, the bearer of the token would not be the owner of the object. The two legal constructs would be separated with the result that the tokenization of the object would end.

 

Attorney Lutz Auffenberg, LL.M. (London)

 

I.  https://fin-law.de

E. info@fin-law.de

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