The coming of age: Converting real assets to digital tokens

Last of 2 parts

AS discussed last week in the first part of this article, asset tokenizing is the process of converting real assets to digital tokens through the use of a tamper-proof distributed ledger technology, or the “blockchain.” Shares or interests in real assets, such as real estate properties, businesses, equity shares in a business or works of art, may now be broken down into smaller parts and traded in the form of a digital unit called “tokens.”

In general, the process for asset tokenization regardless of country and jurisdiction is said to involve the following activities: Defining and identifying the asset; conducting legal and regulatory assessment; consulting legal professionals; establishing an investment vehicle or company; securing technology service providers; creating the business model for the token offering, issuance and distribution; and ensuring the compliance and governance upkeep of the system. Running the tokenization of assets, business would ideally include periodic audits, financial reporting and adherence to regulatory changes.

Just as it is in any new technology, one real missing piece of the tokenization puzzle is the strong regulatory framework. The question on who should be regulating the industry, or even more, on which parts of asset tokenization should actually be regulated. One of the appealing characteristics of asset tokenization to many in the trading community is the decentralized character of getting your illiquid assets funded or capitalized. This simply means that, through the use of the secure technology of the blockchain, owners of real-life assets like real estate, businesses and works of art may now be directly linked to investors and potential shareholders without the need of going through the “centralized financial” systems of the banks and other more established financial institutions. Simply put, technology has now taken the place of the elaborate chain of financial middlemen (banks and financial institutions) between asset owners and the true financiers, thus, simplifying the process and saving more money for the principals and the project.

However, the downside is the volatility of the market and the possible exposure of asset owners and investors to fraudulent transactions. Although the “decentralized financing” dream of many of us is indeed a worthy one, nonetheless, certain regulations and government regulatory institutions are still needed to police the system.

Two national government agencies pay attention to the development of digital finance technology, and they are the Securities and Exchange Commission (SEC) and the Bangko Sentral ng Pilipinas (BSP).

Their jurisdictions over the digital finance industries are sometimes not that easy to delineate. In broad strokes, the SEC steps into the regulatory plate when the digital token is issued as a “security” that falls within the definition of the Securities Regulation Code of the Philippines. This often applies to asset-based tokens or tokens issued

in consideration of a real-world asset. On the other hand, the BSP’s jurisdiction kicks in when the tokens or digital coins are used as a medium of exchange for payment or trading. These types are more common for cryptocurrencies like Bitcoin. Likewise, any services or platforms being used for the trading or exchange of cryptocurrencies are likewise regulated by BSP especially if it converts cryptos to fiat and vice versa.

There have been several firms and businesses that have successfully applied with the BSP for licenses to engage in the crypto-to-fiat business. One recent news was the granting of a license to Direct Agent 5 (DA5) Inc. In December 2022, DA5, which is an authorized direct agent of Western Union in the Philippines, secured central bank approval to operate as a non-bank electronic money issuer (EMI), virtual assets service provider (VASP), and Type A advanced electronic payment and financial services.

With its new licenses, DA5 said it is now the only money service business to offer remittances, foreign exchange, crypto exchange and e-money facilities.

As to the SEC, the memorandum circular for the guidelines of the “initial coins offering,” or ICO, has already been drafted and circulated for the inputs and comments of the industry. Sources from the grapevine told me that the commission targets to issue the same before the year ends.

As mentioned earlier, the SEC steps in when the tokens are used as “securities” for investments. A common formula being used by the commission and the other countries to test whether a token is indeed security is the “Howey test.” This is a test based on American jurisprudence.

Accordingly, the Howey test is significant in determining whether certain investment schemes, such as initial coin offerings (ICOs), crowdfunding campaigns, or other investment arrangements, are subject to securities regulations in the United States. It provides a framework for assessing whether a particular investment qualifies as a security and helps ensure investor protection and regulatory oversight.

This market still has a long way to go and is indeed developing at a lightning pace. Many of the naysayers and the skeptics have now given asset tokenization a second hard look and consideration.

It is just a matter of time before the world’s economies embrace the tokenization of real assets.