What is Tokenisation?
The word ‘token’ conjures up various images and ideas. A token can be a gift — a ‘token of my affection’ — or it could be as simple as a plastic chip that you insert into a parking machine. But in the world of blockchain, a token is a shorthand term for a piece of data that stands in for another, more valuable piece of information (potentially an asset).
When we think of tokens in the physical world, for example, poker chips, we can see that in themselves they have no particular value but they are nevertheless useful because they represent something of value. Instead of putting huge piles of cash on a poker table, players use chips as placeholders, which is more efficient for the game. In the digital world, tokens are useful on blockchains in the same sort of way, for example, when a digital token represents a physical asset such as a property, artwork or share in a company. Tokenisation is already being deployed across a range of areas including real estate, equities and artwork and is likely to expand into new use cases as well.
Despite this development, governments and others have struggled to see beyond tokens as simply cryptoassets. This has been reflected in regulations that have come into play over the past few years. When a token is created, however, we really need to start by seeing how it can be utilised and valued, not just from a regulatory point of view. Policy and regulation then needs to be made based on a deeper understanding of the nature of the token and its ultimate purpose.
Creating a token classification system
In an attempt to address this dilemma, leading blockchain lawyer Lee Schneider, along with colleagues at the industry body Global Blockchain Convergence, has attempted to create a sensible token classification system, which is partially summarised below:
Physical asset tokens: Physical asset tokens are a digital representation of real-life assets such as gold coin physical asset tokens or Air Jordan physical asset tokens.
For example, when buying a pair of trainers from a shop, your decision on which one to buy may be influenced by the brand, and/or if it is a limited or vintage version. However, if you just want a pair to casually wear around town, you may only pay attention to the size and colour. Purchases can usually be done either in-store or through shopping online which represents a detailed digital representation where you can see the price, picture, and reviews of the pairs of shoes but you cannot use your senses to work out how the shoe may feel and fit on your foot. Therefore, in a sense, trainers already have digital representation. Turning this into a token, which will make it easier to trade, will not make much of a difference from a legal, utilisation or valuation standpoint. It would just represent a new digital expression or representation of what we have already been doing for years.
Services tokens (includes music, digital art): Services tokens are any digital representation of services to be provided by one or more persons/entities to another person/entity. (e.g., personal performance tokens versus concert tokens, legal services tokens, etc). This is no different from a digital representation of a ticket.
Intangible asset tokens: These represent any traditional non-physical asset. (e.g., bond tokens or security tokens, real estate ownership tokens etc). For example, shares of stocks are not physical but they represent a human idea of owning another human idea as a legal identity through the share of stocks.
Native DLT tokens refers to cryptocurrencies such as Bitcoin, Ether, EOS, etc. They represent a bundle of rights, for example, to the ownership of a digital form of money with no physical item involved (although some cryptocurrency networks with native tokens may also provide services).
Stablecoins: A narrow category of tokens that do not fall within any other category and are designed to maintain a stable value against some underlying, reference or linked asset or pool/basket of assets.
How are policy choices being made regarding tokens?
According to this system, while all jurisdictions are making policy choices regarding digital assets on blockchains, they are not necessarily thinking about it broadly enough by classifying them into various categories. Instead, most jurisdictions are viewing crypto assets as a homogeneous asset class that goes against centuries-old laws.
Deeper thought needs to be given to the categorisation, rules and regulations concerning digital assets. Positive steps are being made with the UK Law Commission doing some deep thinking about smart contracts and examining whether digital assets are property. Headway is also being made in the European Union due to discussion surrounding the Market in Crypto Assets (MiCA) regulation. Likewise, in the US an executive order from President Biden has mandated federal regulatory agencies to do some thinking regarding crypto assets.
On the downside, the EU’s take on the Anti-Money Laundering measures tries to simply group all the cryptoasset classes together as a whole. Japan created the first dedicated cryptoasset regulation back in 2016 but, once again, it was homogeneous as they failed to recognise the different types of crypto asset classes.
Failure to recognise these distinctions could lead to wider legal and economic implications if the nuances and distinctions are not taken more closely into account by policymakers.
You can read more about the ‘Sensible” Token Classification System’ in Chambers and Partners’ Fintech 2022 guide.
To learn more, listen to our podcast series, The Gage Episode 5 — How is Tokenisation Driving Financial Innovation?