TOKENIZATION OF ASSETS - DECENTRALIZED FINANCE (DEFI) VOLUME 1 SPOT ON: FUNDRAISING & STABLECOINS IN SWITZERLAND - EY
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Tokenization
of Assets
Decentralized Finance (DeFi)
Volume 1
Spot on: Fundraising &
StableCoins in Switzerland
Tokenization of Assets
01
Table of Contents Introduction
Introduction
Switzerland – A Favorable Jurisdiction 04 In today’s digital and globalized world, companies such as fi-
Switzerland is a global DLT / Blockchain Hub 06 nancial institutions are experiencing a strong pressure on cost
The benefits of tokenizing assets are manifold 08 reduction and business optimization, therefore businesses try
to explore digital solutions to create new revenue streams and
Tokenization Basics 10 optimize existing legacy systems with the support of emerg-
ing technologies.
From metals to licences – the world gets tokenized 12
Precious Metals 14
While some digital solutions can simply be adopted by busi-
Central Bank Digital Currency 16
nesses and existing regulatory frameworks, others require a
How to tokenize real-world assets? 18
deeper understanding of the underlying technology itself and
Tokenization requires a solid infrastructure 20 implications associated with them.
Technical approach to tokenize assets 22
The tokenization process marks a promising solution in con-
Focus Fields 26 verting rights to an asset into a unique digital representation
Spot on: Fundraising 28 - a token.
New Capital Markets need faster trading options 30
The regulator’s point of view is technology-neutral 32 Throughout this publication, a high-level introduction into a
Are STOs cost-efficient and secure solutions? 34 world with Tokenization is given, and it marks the beginning of
Legal questions related to Security Token Offering 36 a series of EY publications to shed light on possible applica-
tions of Tokenization from a legal, regulatory, compliance,
One token – different perspectives 38
business, accounting and technology perspective. To start
Selection process in a different context 40
with, two established focus fields from the financial world
Spot on: StableCoins 42
were selected, to walk the reader through the complexity of
Conquest of the established asset trading market 44 creating digital representations through Distributed Ledger
International response to new challenges 46 Technologies (DLT)-based Token and to explore the possibility
The lifecycle of StableCoins is decisive 48 to reinvent the way companies perform business.
The concept behind StableCoins 50
Getting Started 52
Close up & Appendix 56 Authors
Conclusion 59 Darko Stefanoski | Orkan Sahin | Benjamin Banusch
Abbreviations 60 Stephanie Fuchs | Silvan Andermatt | Alexandre Quertramp
Sources 62
Your multidisciplinary team at EY in Switzerland 64
Tokenization of Assets 03
“ The innovational spirit, quality of life, size , available highly educated workforce and supportive tax and regulatory environment make Switzerland an attractive hub for innovative endeavours. SWITZERLAND – A FAVORABLE JURISDICTION Why to choose Switzerland to launch the tokenization of assets business? 04 Tokenization of Assets
Switzerland is a global
DLT / Blockchain Hub
Switzerland is one of the most advanced countries in the world in terms
of Blockchain adaption. It is an international Hub for DLT / Blockchain
companies comprising a wide network and profound expertise. Within
this development especially the Finance industry plays a key role to pro-
mote a sustainable growth of the DLT / Blockchain market in Switzerland.
Historically, a local financial center has reducing the risk of abuse. The Swiss
been established in Switzerland with a Financial Market Authority (FINMA)
dynamic spirit and a highly developed published ICO guidelines in 2018 and
bank infrastructure. Accordingly, this its supplement regarding StableCoins
provides access to equity and venture in 2019.
capital for companies. As example of the
technological orientation of the Swiss fi- High educational standards have sup-
nancial world the Swiss Stock Exchange ported the development of a knowledge
(SIX) is working on a fully integrated and innovation hub in Switzerland. With
infrastructure for trading settlement and its leading technical universities and
custody of digital assets (SDX). business schools skilled, diverse and
!
knowledgeable human capital is locally
Infrastructure is one key factor when available.
deciding where to locate a company “The Federal Council wishes to exploit the opportunities offered by
digitalisation for Switzerland. It wants to create the best possible frame-
offering digital services (or similar). In Social and political stability of a
work conditions so that Switzerland can establish itself and evolve as a
Switzerland a reliable and sophisticated country are a key decision factor in the
leading, innovative and sustainable location for fintech and Blockchain
highspeed network provides for a high search for the location of a company.
companies.” (Official press release of the Federal council of 14 Decem-
and reliable broadband internet cover- Switzerland’s modern democracy has ber 2018)
age allowing global connections. been characterized by political stability
and international neutrality for de- https://www.admin.ch/gov/en/start/documentation/media-releases.msg-
Consistent laws and regulations cades. The country exhibits a stable id-73398.html
recognizing the potential of DLT / Block- and growing economy providing
chain and of other digital developments for a high standard of living.
are one feature that has been promot-
ing Switzerland as DLT / Blockchain hub
for years. In 2019 the Swiss Federal
Council adopted the dispatch on the
further improvement of the framework
conditions for DLT/Blockchain, which
has been object of detailed consultation
in May 2020 by the Commission for
Economics and Taxation of the National
Council, prior its expected entering
parliamentary consultation in summer
2020. The proposal is aimed at increas-
ing legal certainty, removing barriers
for applications based on DLT and
06 Tokenization of Assets Tokenization of Assets 07
The benefits of tokenizing
assets are manifold
From higher cost efficiency to leaner trade financing options there are
different opportunities arising from the tokenization of assets. At the
same time, certain challenges have to be kept in mind.
Single source of truth 0x10e6c7a9
Operational efficiency
Block 0xaf013c45 Assets
Block fractionality Block
0x43a5fc78 0x10e6c7a9
Block 0xaf013c45 Block Transparency
Block0xaf013c45
0x43a5fc78
Block 0xaf013c45BlockBlock
0xaf013c45
Block0x43a5fc78
0x10e6c7a9
Block 0x43a5fc78Block Block
0x43a5fc78
Block 0x10e6c7a9Block
0x10e6c7a9
for extended ecosystems
• By streamlining IT systems, sharing the infrastruc- • By allowing to fractionalize assets and to own and • DLT / Blockchain introduces transparency by de- • In the past and current world, corporates obtain
ture between all participants and without requiring perform actions over only a portion of an asset, fault, as all transactions occurring on a Blockchain a significant amount of data for each asset, but it
the involvement of a central third party, transaction DLT / Blockchain enables a greater liquidity. By cutting infrastructure are accessible to all its participants appears to be constantly challenging to map and
costs are significantly reduced. The digitalization and down barriers to investment, a wider range of people (limited to the perimeter of a DLT / Blockchain, inter-link data points such as intellectual prop-
automation of manual work along with the reduction can buy / invest in assets. In traditionally rather illiquid meaning that everyone can see it on public erties, rights, licenses, ownership to individual
of a part of the reconciliation / compliance work also markets (e.g. real estate, fine art) this technology Blockchains while only authorized participants can products. Thereby, mostly fragmented data points
enable to cut inefficiencies. can help sellers to find more easily an counterpart to have access on private Blockchains). This property are accessible. These fragmentation makes it eco-
perform a transaction is inherited by all tokens representing assets on nomically un-manageable and generates avoidable
• In addition, simple send / receive transaction Blockchain. efforts.
settlement and clearance can be automated and • It also supports inclusive finance by opening up the
allow fast transactions of down to seconds, where invest market to a wider range of investors. As no • For physical assets, this transparency allows to an • As DLT / Blockchain introduces a single IT layer of
traditionally hours or days were required. intermediary function is required any more, investors improved traceability and to provide trust over the trust for allowing business partners or competitors
have now access to investing opportunities whose provenance and origin, by allowing any user to to share together their data, multiple actors of an
• Both options lead to an increase in efficiency of participation used to be limited due to geographical review the whole history of activities performed ecosystem can interact with the same digital rep-
single transaction handling and allow an optimiza- and infrastructural reasons or due to high minimum over the asset. Ownership over a given asset, and resentation of an asset, driving efficiency all along
tion of the market itself. Handling tokenized assets investment thresholds. Now, the access to financial the associated chain of ownership can therefore be the value chain or industry and introducing new
creates a more efficient market and optimizes the markets and a variety of new kinds of assets has been easily be identified. ways of collaboration.
way assets and services can be exchanged. enabled regardless of the location of an investor and
with much lower minimum capital requirements. • However, transparency is not systematically ac- • For instance, multiple initiatives have emerged in
ceptable, and is even antagonistic with the mere the trade finance industry over the last few years
• Fractioning assets also introduces the notion of shared goal of some use case, for instance in the asset to enable companies to share information about
ownership where multiple people can buy together an management industry or when competitors use the assets that are being transferred around the
asset and use it, which is key in a society where usage same infrastructure. In these cases, some priva- world, automating and simplfying the process for
is more and more supplementing ownership. For cy-enhancing technologies can be used to avoid high volume trading through smart contracts.
instance, people can buy together a holiday house and leaking any sensitive information to other partici-
decide between themselves who will use it which week. pants to a network.
08
08 Tokenization
Tokenizationof
ofAssets
Assets Tokenization of Assets 09
“ Tokenization can be described as the creation of a unique digital representation of an asset. While the concept of digitalization is not new, DLT/Blockchain technology adds an additional dimension to it. TOKENIZATION BASICS What is tokenization and how does the technology work? 10 Tokenization of Assets
From metals to licences –
the world gets tokenized
CHF - Swiss Franc
SNB / SIX (Digital Franc PoC)
The process of tokenization creates a bridge between real-world SGD - Singapore Dollar
Central Bank Digital Currency (CBDC)
assets and their trading, strorage and transfer in a digital world.
Fiat
The corresponding basis is built by using the Blockchain technology. (Governmental issued legal tender) Banque de France –
Euro digital payment solution
EUR - Euro
In the most abstract form, tokenization A digital token can thereby be de- the aggregation of otherwise frag-
converts the value stored in tangible scribed as a piece of software with mented information into one digital PAYMENT OPTIONS
or intangible object into a token that a unique asset reference, properties token. Moreover, all parties can update
usually can be manipulated along a and / or legal rights attached. Even information seamlessly and verify their
DLT / Blockchain system. In simple though, similar pieces of software can correctness. Meal points
words, tokenization can turn almost be done the fact that a token runs on Bitcoin
any asset, either real or virtual, into DLT / Blockchain differentiates it from Loyalty points
a digital token and enables the digital other digitalization methods. Using Cryptocurrencies
transfer, ownership and storage with- a DLT / Blockchain to create a digital Corporate points
out the necessary need of a central token enables the collaboration of dif- Ethereum
third party / intermediary.. ferent companies, which in turn allows
Digital Fiat
Fine Art
Automobiles Virtual collectables e.g., CryptoKitties*
Tokenization can turn
Collectables / Devices (unique objects)
Medical devices almost any asset,
Electronic devices either real or virtual,
Silver
PHYSICAL into a digital token
OBJECTS & FINANCIAL Precious Metals Licenses
Various rights
PRODUCTS
Platinum Patents
Certificates Gold
Trademarks
Real Estate
INTANGIBLE ASSETS
Financial instrument
Food & Beverages
Equities Copyrights
Fixed Income Intellectual property
Consumables Royalties
Coffee
Pharmaceuticals
*CryptoKitties are virtual collectibles on the Ethereum Blockchain
12
12 Tokenization
Tokenizationof
ofAssets
Assets Tokenization
TokenizationofofAssets
Assets 13
13
Precious Metals
PHYSICAL
OBJECTS & FINANCIAL
PRODUCTS
The market for gold is rather liquid, eral towards multilateral trades. While
however other precious metal markets this is burdensome in the traditional
(e.g., palladium) tend to be illiquid. world, DLT supports smart contracts
In illiquid markets larger corporates and atomic swaps, allowing for secure
may settle bilateral agreements, and near instant settlement of even
limiting price discovery and fostering complex multiparty trades. The legal
information asymmetries. High entry enforcement of smart contracts is not
barriers (i.e., minimum investments) yet clear globally but there are circum-
limit market access to few participants. stances offering legal set-ups circum-
Furthermore, international regulation venting this from being a deal-breaker.
increased and thus the need for tracing
the metals from production to custom- Recent market developments vary.
er over the whole supply chain. The communication in the ecosystem
could be enhanced with solutions such
Tokenization allows for fractionaliza- as Komgo, offering a secure, decentral-
tion, therefore reducing entry barriers ized solution enabling seamless data
and boosting access to new markets communication between commodity
for smaller players. The increased trade institutions, corporations, in-
market participation may result in ad- spection companies, and third parties.
ditional market liquidity. However, the
larger number of market participants
would require an evolution from bilat-
! The Italian legislator introduced the Law Decree No. 135/2018
– which defined legally binding smart contracts. The UK
Jurisdiction taskforce issued “legal statement on cryptoassets
and smart contracts” smart contracts may under certain cir-
cumstances be treated as in principle not being different from
conventional contract.
14 Tokenization of Assets Tokenization of Assets 15
Central Bank
Examples of CBDC projects:
Who Project
Digital Currency
Bank of Canada Project Jasper - is a collaborative research initiative between the public and
private sectors to understand how DLT could transform the wholesale payments
PAYMENT OPTIONS system.
Banque de France, European Cen- Are quite open for experiments together with the ECB and other central banks of
tral Bank (ECB) the Eurosystem, in particular with regard to a wholesale CBDC.
Central Bank Group The Bank of Canada, the Bank of England, the Bank of Japan, the European Cen-
tral Bank, the Sveriges Riksbank and the Swiss National Bank, together with the
Bank for International Settlements (BIS), have created a group to share experienc-
es as they assess the potential cases for central bank digital currency (CBDC) in
their home jurisdictions.
The use of banknotes is declining in advanced economies, 70% of Central Banks are (or will soon be) engaged in some
questioning the Central Banks’ role in payment intermedia- type of CBDC exploration. The adoption of CBDC depends on Central Bank of Brazil Project Salt - is exploring DLT for an interbank payments contingency and resiliency
system as well as a decentralized information exchange platform (Project PIER).
tion. At the same time in developing countries alternatives a perceived net benefit of its introduction. Digital currency
are emerging with the development of technology, such as can fulfill to a certain extent the traditional roles of money Central Bank of Iceland Rafkróna - is exploring
mobile payment, accessible even for previously unbanked. (unit of account, means of payment and store of value), how- Central Bank of the Bahamas Sand Dollar - was introduced on 27.12.2019 with the intent of accelerating pay-
Furthermore, progress is pushing for exploration of DLT/ ever Central Banks may also support public policy goals. ments system reform, admitting new categories of financial services providers and
using the digital payments infrastructure to make the supply of traditional banking
Blockchain implementation by Central Banks.
services accessible to all segments of the population. Most of the benefits of
Currently, most researches being performed cover the introducing a digital currency are still unquantifiable. However, they may include a
Central Bank Digital Currencies (CBDC) are a new form of challenges faced by the introduction of CBDC, for instance potential suppression of economic costs associated with cash usage, and benefits
money issued digitally by the Central Bank. Basically, money how to balance privacy concerns, bank secrecy laws and to the Government from improved expenditure and tax administration systems.
is a special form of a promise to pay and serves as store of transparency improvement. For the time being Denmark and Central Bank of Tunisia E-Dinar - is used to study the opportunities and risks inherent in these new technolo-
value, a medium of exchange, and a unit of account. Physi- Switzerland have determined that the costs of a retail CBDC gies, particularly in terms of cyber security and financial stability.
cal cash offers a certain level of privacy that digital money would outweight the benefits. The traditional systems have ECB, Bank of Japan Project Stella - explores whether DLT / Blockchain technology can improve domes-
does not. been optimized over time and may already deliver upon tic interbank payments and settlements and facilitate rapid interbank trading and
demand. Fast Payment Systems (FPS) allowing for almost settlement of securities for cash.
CBDC could be account or token based, issued centrally or real time capabilities, are already present in 55 jurisdictions. German Central Bank BLOCKBASTER prototype and other efforts are exploring DLT for multiple pur-
decentrally, and are generally split into two major catego- In 2019 SWIFT demonstrated that cross-border payments poses including for improving efficiency and reducing risk in interbank securities
settlement processes.
ries, based on a slightly different business purpose: can be completed in less than 25 seconds (source: https://
www.swift.com/news-events/press-releases/swift-sees-suc- Monetary Authority of Singapore Project Ubin - is a collaborative project with the banking sector, exploring the
use of DLT for clearing and settlement of payments and securities, as well as new
Wholesale CBDC cess-with-global-instant-cross-border-payments-with-singa- methods of conducting cross-border payments using CBDCs.
shall mainly increase efficiency for financial transactions pore_s-fast).
Peoples Bank of China Digital Currency Electronic Payment (DCEP) - is proposed a two tier system, cen-
among selected participants, albeit early experimentation trally issued, backed 1:1 by fiat currency
has not yet proven significant benefits. Wholesale CBDC aim However, the UK FSP, which has been operating for 10
Republic of the Marshall Islands Introduced a new DLT / Blockchain based currency called the Sovereign (‘SOV’) in
at processing large volumes with few transactions, some- years, processed only around 30 payments per capita in February 2018 after issuing the Sovereign Currency Act of 2018.
times on specific dates. 2018.
Sweden Central Bank E- Krona - a one year project launched in 2020 adressing concerns regarding the
oboslecense of physical cash in Sweden and its consequences.
Retail CBDC CBDC is often associated with DLT/Blockchain technology,
Swiss National Bank The Swiss Exchange (SIX) and the Swiss National Bank (SNB) are working on a
are deemed for wider adoption in the general public, for however, it does not necessarily mean that it could not be proof of concept to explore how digital central bank money could be used in the
instance to facilitate retail payments, this would e.g. raise built using a more conventional centralized technology. settlement of tokenized assets between market participants.
AML / CFT concerns and requirements. Such CBDC need to
accommodate large number of transactions with relative low
!
volume.
A study of late 2019 by the International Monetary Fund Possible benefits of CBDC
(IMF) and the Central Bank of England explored additional,
design options: • Lowers issuance cost
• Easier distribution than fiat currency
• Either with zero-interest to avoid direct competition with
• Programmability (more efficient and flexible)
retail bank deposit
• Real time transfer (at low cost)
• With positive or negative interests that could generate a • Better clearing & settlement process
direct competition for cash and deposit but could open a • Enhanced traceability and monitoring
new way to handle monetary policies • Real time data collection, such as creation, bookkeeping and circula-
tion of money, providing useful reference for monetary policy makers
• Addressing the consequences of a decline of cash
• Improving the availability and usability of central bank money
16 Tokenization of Assets Tokenization of Assets 17
How to tokenize
real-world assets?
Non-fungible tokens representing real-world assets like art or real
estate gain an increasing momentum.
Today the most common application of The financial industry, and especial-
!
tokens that exist on DLT / Blockchains ly the asset management sector, is
are tokens that are fungible of nature, demonstrating a lot of interest on how Read here how
like cryptocurrencies or ingots of gold. NFTs can be used to engineer or repre- NTFs can create value
Fungible means that each unit of a sent investment products. Real estate for enterprises:
good or commodity is interchangeable is a particularly good example of re-
with any other unit. So, for example al-world asset that can be represented https://www.
ey.com/en_us/fi-
one kilo of pure gold is interchangeable using NFTs as there are no two parcels
nancial-services/
with any other kilo of pure gold. which are the same or have the same
how-non-fungible-to-
address. Accordingly, direct ownership
kens-can-create-val-
However, a new application concept of of land could be represented on an NFT ue-for-enterprises
DLT / Blockchain technology is causing under the condition that the regulatory
a lot of buzz and gaining momentum: environment is shaped accordingly.
the tokenization of real-world assets.
Opposite to the above-mentioned However, in light of the market focus-
fungible tokens these new so called ing on oeuvres by “Old Masters” as
non-fungible tokens (NFTs) repre- alternative investment vehicle NFTs
sent assets and items which are per start to awaken interest. By repre-
definitionem unique, irreplaceable and senting the art pieces on tokens the
non-interchangeable. respective transactions can comprise a
broader group of investors. Moreover,
The attributes which are represented authentication procedures, tracking of
by NFTs can vary comprising unique transport and restoration processes as
serial numbers on the one hand but well as their trade can be simplified as
also more dynamic information like will be explained in more detail in the
location, size or consistency of the following chapters.
product itself on the other hand.
As most of this world’s assets are
Early examples of products represent- unique their representation, NFTs will
ed on a DLT / Blockchain by NFTs are play an increasingly important role in
physical items like bottles of wine, jew- ushering in the next era of the digital
elry or pharmaceuticals which are part economy and supporting enterprise
of a standardized supply chain from adoption of DLT / Blockchain to digitally
manufacturer or producer to consum- represent their assets.
er. The tokenization of the items allows
for a real-time tracking of the products
and enables the producer to identify
possible fraudulent use.
18 Tokenization of Assets Tokenization of Assets
19Tokenization requires
a solid infrastructure
Tokenization triggers changes in the securities trading value chain.
While the sequence remains unchanged the individual steps may vary.
Major differences are related to the characteristics of the underlying
DLT /Blockchain technology allowing new business models and market
participants to enter.
1 2 3 4 5 6 7
Origination Distribution Trading Clearing Settlement Safekeeping Additional
Financial Services
Issuance Trading (Buy / Sell) Additional Banking Services
• Issuance market of • Distribution handled by • Secondary market handled by • Ensure that involved parties • Transfer securities from seller • Store securities in a safe • Basic additional financial ser-
securities is restricted and issuing institution stock exchanges and regulat- fulfill obligations as set out in to buyer against payments to location either self-directed or vices such as tax, reporting,
Traditional handled to a large extent by
investment banks
• Primary market access only
ed institutions e.g., invest-
ment firm and broker
the contract fulfill contractual obligations at a custodian, e.g. financial
institution or a depository
accounting, corporate actions
and collateral management do
Value Chain • Mature methodology to issue
to authorized investors
• Trading execution only pos-
• Match buyer and seller data
for every transaction
not differ in principle between
the traditional and new reality
securities sible through specific time
frames e.g., opening hours • However, new services
bridging the traditional and
• Issuance not limited to tra- • Distribution can be handled • Stock and Digital Asset • Based on the core characteristics of DLT and Blockchain tech- • Digital Token can be stored tokenized world arose e.g.
ditional players, instead new without intermediaries via Exchanges are still an im- nology clearance and settlement do not require central third either by trusted 3rd party / Token-Equity Swaps
player arise such as consul- digital channels portant market participant, parties. Instead both is handled by the technology itself custodians or by owners itself,
New Reality: tancies, technology SMEs and but trading is not limited to institution or individuum
• Further technology related
• Primary market access only services based on the Block-
Tokenization corporates them selves
limited based on regulatory,
established institution due
to the peer-to-peer nature of
• Various ways of Token storage chain infrastructure itself can
Value Chain • DLT / Blockchain based Smart
Contract enables new launch
but not technical environment
DLT / Blockchain based Token
are possible distinguishable
between online or offline, de-
appear in the future since
subject to research e.g. hard
methods e.g., DeFi • 24h trading execution possible pendent if the Token is stored fork related services, gover-
on a device which is connect- nance risks
ed to the internet or not
1 2 3 4 5 6 7
One common DLT / Blockchain Infrastructure
20 Tokenization of Assets Tokenization of Assets 21Technical approach to
tokenize assets
Blockchain technology allows the creation of a digital representation of assets through their tokenization. This process does For instance, let’s consider a car.
not differ greatly from other IT projects whereby data models are created to represent assets or goods; however, some
precautions need to be taken in order to account for DLT / Blockchain technology specificities. • If we look at the car production process, one will be interested in the assembly of the multiple components of the car, its
associated information and the operators acting on the production chain.
In simple terms, asset tokenization consists of creating an informatic code presenting the key characteristics of the asset • If now we consider the leasing of cars, one will pay more attention to who owns the car, who has financial interest over it,
while exposing some functions allowing the user to interact with the digital representation of the asset. On the Ethereum how the insurance is managed, etc. without being interested in the components of the car
Blockchain, this informatic code is developed in Solidity.
From a technical standpoint, this process can be broken down into 4 key steps:
! Swiss Pioneers - Tokenization of existing shareholdings
The same principles from the car industry example apply • Free transfer of share tokens. However, a potential
to the Swiss financial services industry. The Swiss entity acquirer of shares is required to apply to the issuer to be
A. Selection of the model for representing assets Mt Pelerin Group SA1 was one of the first companies to registered on the shareholders’ register including a full
issue all of its shares in tokenized form, i.e. in the form of AML / KYC identification process.
Several token standards have emerged from the Ethereum A token standard consists of a set of predefined functions Ethereum tokens.
community to allow for the representation of different and / or attributes that can be intentionally implemented It was no coincidence that one of the first companies to
kinds of assets. The introduction of these standards eases to represent the specificities of each asset but need to be In this case, the tokenization process had a strong focus tokenize its company shares is located in Switzerland. In
the DLT / Blockchain adoption and enables interoperability present in all cases. To consider which token standard to on capturing the information about the purchasers of the 2018, the Swiss Capital Markets and Technology Associ-
between multiple DLT / Blockchain initiatives. This allows choose, the key characteristics of the asset (for instance tokenized shares. Accordingly, the following basic process ation (CMTA)2 published a blueprint on the tokenization of
tokens inheriting from the same token standard (from the fungible or non-fungible) should be assessed. The most steps were integrated: shares of Swiss companies using the Distributed Ledger
same ‘family’) to use some generic smart contracts or to widespread token standards are the following: Technology3. In this blueprint the CMTA provided detailed
be stored in some widespread wallets enabling the storage • Individual registration of purchasers in the shareholder’s guidelines on how equity securities of Swiss entities can be
register of Mt Pelerin upon completion of the sale tokenized and how the process should be structured. The
of ownership information.
• Full AML / KYC identification blueprint focused on shares that have already been issued
• Maintenance of a private shareholders’ register that has in accordance with Swiss corporate law in uncertificated
not been replaced by the DLT / Blockchain (although the form. This way the shares and the digital tokens remain
tokenization would allow to digitize many of the cor- closely linked and the shares shall only be transferred
ERC-20 standard ERC-1400 standard ERC-721 standard
Fungible tokens (e.g. Ether, Augur, etc.) Security tokens (e.g. data protection and privacy) Non-fungible tokens (e.g. crypto-kitties, assets) porate processes), from the registration of share trans- together with the corresponding token.
Transfer of ownership of a fers and shareholder identification to certain corporate
Transfer of ownership over a actions.
Transfer of value between users security token between users,
specific asset between users
requiring a certificate
Authorize someone to spend For same security token, split Authorize an operator to transfer
value on one’s behalf between several partitions a specific asset on one’s behalf Depending on the use case, the same asset will be represented use requires the completely revision of how assets will be rep-
Authorize an operator to transfer Authorize an operator to transfer differently, potentially using different token models. resented. EY developed a protocol based on zero-knowledge
a security token on one’s behalf all assets on one’s behalf proofs allowing the performance of private transfers of own-
Manage the documentation Another crucial consideration when choosing how an asset ership on Ethereum main net, called Nightfall4. It was released
associated with a security token should be tokenized is the management of privacy. DLT/ to the public domain in 2019 as a tool to assist enterprises
Force the transfer or redemption Blockchain introduces transparency by default but this trans- with the adoption of DLT / Blockchain technology.
of an asset (by a controller) parency is not acceptable for all use cases and industries. In
fact, in some cases there are regulatory constraints in this It is key to assess how privacy will be managed from the
regard (e.g., anti-trust regulation). In such cases, there are beginning to consider the right model for representing assets
privacy-enhancing technologies that can be used to mitigate and avoid the need to rebuild everything from scratch if this
It is important to note that the way an asset is tokenized does not depend only on the asset itself but should integrate the busi- the transparency and obfuscate information to allow compa- dimension has not been considered sufficiently early.
ness process that is digitized through DLT / Blockchain. An asset could be tokenized differently depending on the intended use. nies to perform DLT / Blockchain transactions in a trustworthy
way but without leaking sensitive information. https://www.mtpelerin.com
1
https://www.cmta.ch
2
Zero-knowledge proofs is one of the technologies allowing OECD: The Tokenisation of Assets and Potential Implications for Financial Markets
3
the performance of private Blockchain transactions, but its 4
OECD: https://www.ey.com/en_gl/news/2019/12/ey-releases-third-
generation-zero-knowledge-proof-blockchain-technology-to-the-public-domain
22 Tokenization of Assets Tokenization of Assets 23C. Technical and security review of
B. Modelling of the asset the informatic code D. Deployment of the informatic code
Before implementing the token model chosen for repre- on the kind of assets considered. For instance, if financial Before deploying a token in live, some precautions need After security review have been performed, the code can
senting assets, one must ask several questions that will assets are considered, their issuance, the management of to be taken due to the immutability of Blockchain and the simply be deployed on the DLT / Blockchain considered,
impact which information will be embedded on chain and the liquidity or the way they will be valued on both primary irreversibility of the development. Indeed, once the code either public or private depending on the use case and
which will remain stored in off-chain databases. The follow- and secondary markets should be properly engineered. ruling how your asset will behave on DLT / Blockchain has perimeter considered.
ing points should at least be considered: been released, it is not possible to turn back.
It is also important to note that the documentation of the These tokens will be able to be issued following the design
• Are there any legal or regulatory constraints (e.g. data behaviour of the token is key for ensuring the adoption and An example to bear in mind is what happened in June 2016 implemented, automatically or manually, by only one user
privacy and protection, sector-specific regulation, etc.)? the use of this asset: especially in the case of the issuance with The DAO which was a digital decentralized autono- or by multiple ones. Users will be able to interact with
• What is the level of trust required on the data? of financial assets, a term sheet is frequently released to mous organization raising funds through crowdfunding and these tokens using the exposed function, by instance to
• What is the business process? Which information are es- help investors and / or users understand the functioning acting as a venture capital. After raising more than 150 transfer them. They will also store these assets in their
sential for the process to happen properly and which have and the underlying key concepts of the asset. This term millions of $, some hackers took advantage of vulnerability wallet, and possibly on DLT / Blockchain custodians to han-
an informative purpose? sheet may also be required by regulators to approve the issues and stole more than the equivalent of 50 millions of dle the custody of their assets.
• What are the requirements in terms of scalability (volume- issuance of the digital asset, that is the case in some STO $ at the time.
try of data)? for instance. In order to follow the lifecycle of these assets, and depend-
It is then very essential to perform some security reviews, ing if and how privacy has been implemented, it is possible
https://ey.blockchain.com
5
This tailoring can include the management of permis- either using standardized tools or mandating specialized to rely on DLT / Blockchain monitoring tools. EY has devel-
sioning to call specific functions, adding some additional https://www.ey.com/en_gl/blockchain/blockchain-platforms
6 third-parties (e.g. Trail of Bits) to perform a review and oped a Blockchain Analyzer6 allowing to track the lifecycle
functions to be consistent with business requirements, the provide a stamp before going live. EY has developed a of assets and have access to dashboards and analytics tools
personalization of some generic functions, etc. smart contract review tool allowing using to test their code to understand what is happening on the DLT / Blockchain.
Some additional considerations may be needed to develop against a standard set of checks5 and offers a spectrum
the specific code and behaviour of the token, depending of IT cyber offerings to minimize evolving security risks
related smart contract applications.
A Token Model B Asset Model C Review D Deployment
Technical A B C D
Getting started
Business
Figure: Illustrative historic development of
money by keeping the core functionality unchanged
24 Tokenization of Assets Tokenization of Assets 25“ Tokenization has many facets. However, technological innovations require a holistic view comprising the technological, legal, regulatory, tax, accounting and business perspective. FOCUS FIELDS In light of the manifold opportunities the tokeni- zation provides what does your organization need to know? 26 Tokenization of Assets
Spot on: FUNDRAISING How does token-based fundraising compare to traditional set-ups? 28 Tokenization of Assets
New Capital
Markets need
faster trading
options
The rise in popularity of asset tokenization bridges the gap between
traditional and new capital markets. A Security Token Offering (STO)
is an evolution of fundraising. What is it about and how is it different to
Venture Capital (VC), Initial Public Offering (IPO), or Initial Coin Offer-
ing (ICO)?
Earlier, start-ups had the opportunity of angels may also serve to open doors with traditional fundraising methods
reaching out to venture capital firms or for new investors or partners if they and offers various advantages (e.g., the
angel investors while more established are well-connected in the company’s global reach to a digital distribution of
businesses had the privilege of going business. Similar to VCs, it is essential tokens, the quick realization of STO-
public through an IPO. to choose angels who suit the business based financing) and disadvantages
and do not come up with excessively (e.g., legal and regulatory uncer-
VCs usually seek to invest in promising demanding investment terms. tainties, untrustworthy early-stage
start-ups as well as small and medium- projects).
sized businesses that they believe will By “going public” via an IPO, in ex-
have the potential to go public or be change for new capital, a company sells Contrary to when an investor
likely acquired by a larger company. To stocks to investors. To undertake an purchases traditional stocks, their
founders, thus, venture capital funding IPO, a corporation would usually have ownership information is kept in a
can be a blessing or a curse, as VCs are to first work with an underwriter (e.g. a physical document and issued as
known to also have terms and condi- bank) to support it with the public offer- a certificate. In contrast to tra-
!
tions that are often more beneficial ing. The corporation would then have ditional sources of financing
to themselves than to the business to go through the vetting to ensure that a STO does not necessarily
owners. it is permissible to have its stocks listed require a financial interme- What is a Securtiy Token Offering
on the public stock exchange. For a suc- diary, but can rather be
Angel investors are becoming more cessful IPO, a corporation would then designed as a pure peer- A Security Token Offering is a public offering token that is representing
relevant and better connected, increas- usually need to undertake extensive to-peer mechanism. a security. The owner of the token obtains e.g., rights in a company or
contractual claims to assets as promised by the security. Essentially,
ing their reach at the start-up level as road shows with its underwriter(s) and
tokenization enables startups to raise money without going through an
VCs become more risk-averse and turn attract as many institutional investors
intermediary.
their focus to later-stage investing. as possible. As IPOs are highly regulat-
Technology has enabled new mecha- ed they are very costly and time-con-
nisms such as crowdfunding, which is suming and therefore not suitable for
changing the funding environment at smaller and medium-sized businesses.
the early seed stages. Angel investors
can be a valuable source of funding for Financing through an STO has signifi-
early-stage start-ups, because the right cant structural differences compared
30 Tokenization of Assets Tokenization of Assets 31The regulator’s
point of view
is technology-
neutral
Although tokenized assets are represented in the digital world, their The FINMA ICO Guidelines for enquiries regarding the regulatory frame-
work for initial coin offerings (ICOs) of 16 February 2018 and the
true nature and purposes are what counts for the Swiss regulator. Supplement to the guidelines for enquiries regarding the regulatory
framework for initial coin offerings (ICOs) of 11 September 2019,
differentiate between the following tokens:
With the advent of DLT the Initial Coin guarantee for the investors to get a It is crucial to note that Initial Coin
Offering (ICO) appeared. The number financial ROI on the short, medium or Offerings (ICO), Securities Token Offer- • Payment tokens synonymous with cryptocurrencies, having
of ICOs and the volume of funding long term. ings (STO), Initial Exchange Offerings no further functions or links to other development projects.
grew rapidly7.Finally a large number (IEO), Initial decentralized Exchange Tokens may in some cases only develop the necessary
of individuals and organizations were A key difference between traditional Offering (IDO) or other are all meant to functionality and become accepted as a means
able to participate with even very little fundraising method and these new be token issuances. The Swiss financial of payment over a period of time.
capital, therefore splitting the risk and DLT / Blockchain-based fundraising markets regulation is principle-based
permitting a differentiation even within solutions is that the latter addresses and technology-neutral. Therefore, • Utility tokens are tokens which are intended to pro-
small portfolios. Access to a stock-ex- early stage projects requiring high FINMA’s treatment of tokens under vide digital access to an application or service.
change was no longer required and investment amount that in many cases supervisory law follows the existing ap-
trading was possible from almost any cannot be provided solely by bank- proach taken to DLT / Blockchain-based • Asset tokens representing assets such as partici-
device connected to the internet with loan or VC. In fact, Projects such as tokens, meaning that the focus is on pations in real physical underlyings, companies,
very little fees to be paid. In Q3/2017 Ethereum, Telegram or Binance aimed the economic function and the purpose or earnings streams, or an entitlement to
the ICO volume had already more than at building global technology infra- of a token (“substance over form”). dividends or interest payments. In terms of
double the volume of Venture Capital8. structure, i.e. targeting a new scale by their economic function, the tokens are anal-
leveraging decentralization and peer- ogous to equities, bonds or derivatives.
EY life of a coin, EY research on ICO 2017
7
One of the key drivers for the ICO to-peer financing.
EY research on ICO 2018
8
token issuers was the difficulty to find • Hybrid tokes which combine elements of
early stage cash as options were quite While a security token is akin to a payment / utility / asset token.
limited to bank loans, public and pri- digitized stock - whereby the investor
vate grant and VC. When the ICO mar- that purchases the token becomes a • StableCoins (token with specific
ket emerged, the main token scheme shareholder of the entity from which underlying assets (e.g., curren-
used was the so-called utility token, they purchased the token - the value of cies, commodities, real estate or
offering access to a potential product the ICO token is derived from the use securities).
or services to its owner. However, this of the token within the ecosystem set
kind of token does not provide any up by the organization.
32 Tokenization of Assets Tokenization of Assets 33Are STOs cost-
efficient and Exemplary comparison of IPO, STO and ICO – since the
structure of this fundraising options may vary an exhaus-
secure solutions?
tive comparison is not possible. For demonstration purpos-
es an ICO is treated as the issuance of a utility token in the
table below.
When comparing IPOs, STOs and ICOs it becomes IPO STO ICO
evident that cost efficiency and security of the
endeavour do not always align. Risk
Costs
Issued
!
Shares Token representing securities Utility token
IPO vs. STO vs. ICO Issuer Start-up, public company,
Public company Start-up, public company, SMEs
SMEs, large companies
The first issuance of tokens may come in sev- Platform Digital (e.g. website of issuing company Digital (e.g. website of issuing company
eral facettes and names, such as Initial Digital Regulated Stock Exchange
or on crypto exchange if IEO) or on crypto exchange if IEO)
Offering) IDO, Initial Exchange Offering (IEO) Participation
and many more will follow. From a Swiss legal & Generally, via Broker (e.g. Bank) Directly Directly
regulatory perspective, applying the principle
Accepted Funds
of substance over form, a classification is es- Generally, Fiat only Fiat and/or crypto-assets Fiat and / or crypto-assets
sentially based on the underlying. In this regard
we support the classification of FINMA in the
Initiated Generally, Investment bank Generally, direct launch to the public with- Generally, direct launch to the public with-
to underwrite the IPO out a centralized third party (except if IEO) out a centralized third party (except if IEO)
“ICO Guidelines”.
Documentation Requirements Prospectus, Filings, Registration Prospectus, Filings, Registration
Whitepaper, website
with the regulator with the regulator, website
Investor rights Generally, Voting rights, dividends Generally, Limited to digital access to
Generally, Voting rights, dividends
(if structured similar to e.g., shares) service / application
Controlling Authority Regulator Regulator None
Underlying
Asset Asset None
Dividends
Yes Depending on Token structure None
Credibility
High Medium Low
Global Top 4 IPO, STO and ICO by raised funds (March 2020)
Top IPO Top STO Top ICO
1. Saudi Aramco (25.6bn USD) 1. tZero (134.0m USD) 1. EOS (4bn USD)
2. Alibaba (21.8bn USD) 2. Proxima Media (100.0m USD) 2. Telegram (1.7bn USD)
3. SoftBank Corp (21.3bn USD) 3. Bolton Coin (67.8m USD) 3. Dragon Coin (320m USD)
4. NTT Mobile (18.0bn USD) 4. Nexo (52.5m USD) 4. Huobi (320m USD)
Source: renaissancecapital.com Source: blockstate.com Source: Techworld
34
34 Tokenization
Tokenizationof
ofAssets
Assets Tokenization of Assets 35Legal questions
related to Security
Token Offering
How are security tokens classified under
Swiss financial market law? What further legal developments need to be considered?
The swiss regulator FINMA uses the term “asset token” and enable physical assets to be traded on the DLT/Blockchain STOs may not only trigger the application of the Swiss • the Swiss Code of Obligations, the possibility of an elec-
not “security token”. Asset tokens represent assets such as also fall under this category. Once a token qualifies as asset financial market laws as contemplated above. Rather, every tronic registration of rights is to be created, which can
debt or equity claims on the issuer. Further, they promise respectively security token, it is classified as security under STO must be analyzed also in view of further financial guarantee the functions of securities. This is intended
e.g. a share in future company earnings or future capital Swiss financial market law by FINMA. market law provisions. Such provisions include the banking to increase legal certainty in the transfer of DLT-based
flows. In terms of their economic function, they are thus legislation, the relevant provisions for securities dealers as assets.
analogous to equities, bonds or derivatives. Tokens which well as aspects beyond the prospectus duty of the collective
investment schemes act and the FinSA. • In the Federal Act on Debt Collection and Bankruptcy,
the segregation of crypto-based assets in the event of
On 27th November 2019 the Swiss Federal Council adopted bankruptcy is to be expressly regulated, also to increase
Do prospectus requirements apply to STOs? a dispatch regarding the further improvement of the frame-
work conditions for DLT/Blockchain. Due to the technology
legal certainty.
neutral approach of Switzerland, the legal framework is al- • In financial market infrastructure law, a new authorisa-
ready well suited for DLT, therefore the amendment impacts tion category for so-called “DLT trading facilities” is to
The Swiss Financial Services Act (FinSA) provides for a sional investors, (ii) offerings to less than 500 investors, (iii) mostly already enacted federal acts: be created. DLT Trading facilities shall allow multilateral
public law prospectus duty. According to such duty issuers offerings to investors that invest more than CHF 100,000, trading of standardised DLT securities among regu-
of securities must, as a rule, publish a prospectus to be (iv) offerings of securities that have a minimal denomination lated financial market participants as well as private
reviewed and approved by a reviewing body authorized by of CHF 100,000 and (v) offerings which are limited to a total customers. Furthermore, it shall permit the provision of
FINMA. This does not apply where the FinSA specifies an amount of CHF 8 Mio. custody services9.
exception. The exceptions include (i) offerings to profes-
• It should also be possible in future to obtain a licence
to operate an organised trading facility as a securities
firm. This requires an adaptation of the future Financial
Do KYC / AML requirements apply to STOs? Institutions Act.
Beyond, particularly contract, corporate, data protection
According to FINMA issuers of asset respectively security and tax law issues arise in relation to STOs.
tokens do generally not fall under the Swiss AML regulation.
However, this must be assessed on a case-by-case basis, https://www.admin.ch/gov/en/start/documentation/media-releases.msg-
9
id-74420.html
inter alia since the tokens in question may also qualify as
payment tokens with the consequence that the AML regula-
tion would apply.
36 Tokenization of Assets Tokenization of Assets 37One token
– different
perspectives
Different fundraising options are based on different tokens. Each token
has its own characteristics. Depending on whether an accounting, tax
or indirect tax perspective is applied, the same token can be subject to
different classification.
The character of a token is in the eye of the beholder. This lyrical phrase takes aim at the following: The correct accounting
and tax treatment of a token depends on its classification, terms and conditions as well as on its underlying case (sub-
stance over form). This is of high relevance as fundraising can be accomplished in different ways such as IPOs, ICOs, STOs
or with hybrid forms of the beforementioned. In other words different fundraising options are based on different tokens.
In order to understand how tokens are treated for accounting and tax purposes it is decisive to first identify its character-
istics. However, as already mentioned, the character of a token is highly dependent on the viewpoint of the observer. An
accounting or direct tax specialist would typically focus on the underlying business case represented by a certain token. On
the contrary, A VAT expert will base his or her evaluation of any indirect tax consequences of a token on the actual cash
flows and the turnover derived from the transactions associated with a certain token. Finally, the intentions of the investor
will be decisive in determining the accounting treatment of a token.
Hence, it is not surprising that in certain countries like Switzerland separate qualification guidelines have been issued by
the respective authorities for accounting10, for direct tax11 as well as for VAT12 purposes. Unfortunately, this adds to the
already high degree of complexity surrounding tokens, as classification grids tend to be rather rigid and thus limited to a
certain range of token variations. In practice, therefore, a token classification can be a daunting task, which is however
absolutely crucial for the determination of the proper accounting and tax treatment.
Swiss tax classification of tokens13
Swiss Direct Tax Categories Swiss Indirect Tax Categories
ExpertSuisse FAQ for accounting under Code of Obligation
10
FINMA for accounting under FINMA accounting ordinance
/ FINMA circular 2020 / 1
! In an unofficial hearing with the SFTA in November 2019, in which EY was present, the tax treatment of projects apply-
ing DLT/Blockchain technology has been further discussed. While there is still room for interpretation in different areas
the following official publications may provide some guidance. However, it has to be noted that for any project involving
Equity-like Token Swiss Federal Tax Administration. Working Paper on
11
Cryptocurrencies and Initial Coin / Token Offerings as part DLT/Blockchain Technology it can be beneficial to reach out to the respective Cantonal and Federal tax authorities to
Loan-like Token of income and capital taxes, of withholding taxes and of discuss the set up and the tax treatment of tokens. Further guidance can be found in the following publications:
stamp duties.
Bond-like Token • June 2019: Update of the VAT Information 04 on services relating to Blockchain and Distributed-Ledger-Technology
1 Asset Token Swiss Federal Tax Administration. VAT Information 04
12
Fund-like Token on services relating to Blockchain and Distributed-Ledger- • August 2019: Working Paper on Cryptocurrencies and Initial Coin/Token Offerings as part of income and capital taxes,
Other underlying / reference Technology of withholding taxes and of stamp duties.
value Token (e.g. commodity) Although the FINMA terminology as mentioned in the
13
In addition, FINMA published new guidance on the Accounting Treatment of tokens in circular 2020 /1
chapters before are not binding for direct tax and VAT
2 Payment Token Payment Token purposes.
3 Utility Token Utility Token
Categorization into the
4 Hybrid Token
above listed categories
38 Tokenization of Assets Tokenization of Assets 39You can also read
