An Asset Tokenization platform
Recently we repositioned ourselves from a Securities Tokenization platform to an Asset Tokenization platform. Let me explain why.
Securities are a subset of Assets. All assets are securities, but not vice versa.
For eg: A house is an asset, but it is not a security. A painting, your cellphone, your laptop, car etc are all assets which are not securities.
As a general rule of thumb things you can touch and feel tend to be assets, but not securities.
However if you invested by buying units in a fund that owns the house, then your units are a security. Same thing is applicable for a fund that buys cars, or paintings and other hard assets.
Fractionalization, or pooling together of resources by many people to acquire an asset or deploy towards a venture leads to things being deemed as a security.
However even if your asset is not fractionalized it does not mean that it is not a security. The SEC recently put out a guidance on digital assets which is an excellent read, you can find it here:
And while the SEC authority is limited to the United States, the principles outlined here are quite common worldwide so this can be taken as a good guide. And in general other regulatory agencies do tend to look to the US for paving the way before laying out their cards.
The key point in this document revolves around Active management vs Ministerial work.
For eg: John is an Uber driver but he is short on cash to buy a car. He approaches you to buy the car and tells you that he will drive the car as an Uber driver and share the proceed with you 50–50.
This one brings up an interesting set of questions.
From first impressions your returns are based on the active management efforts of John. Your returns will go up and down based on how much John drives. In this scenario despite you holding a hard asset that is not fractionalized, John will be deemed to have sold you a security.
If however it is a fixed rent rather than a share of profits, then it falls out of the securities domain. Johns active management is irrelevant to your outcomes.
Consider another example to make this clear.
Seamus is a real estate agent and he sells you an investment property. He then asks you to appoint him as the property manager, so that he will collect the rents and ensure the property is rented out etc. However this would still not mean that Seamus sold a security.
Seamus’s efforts do not constitute active management. It is not as if he does a great job your property rents will suddenly go up ten times. If he does a poor job then your return will go down, so he needs to maintain a certain standard of work to ensure the outcomes are delivered.
But the outcomes do not go up based on active management.
He needs to perform his ministerial duties to ensure outcomes, but no active management is needed.
The returns are a primary function of the property itself rather than any external parties inputs into it.
Ministerial inputs do not breach the securities threshold.
Why am I harping on this distinction?
Simply because securities carry specific disclosure requirements and their distribution has to be done in a controlled manner. They also are generally prevented from being “bearer” or “Non custodial” despite being non tangible assets. Apart from carrying tedious documentation and restrictions around distribution, they also are required to be recorded in a central manner.
Blockchain is meaningless if you want to record assets that are required to be recorded in a centralized manner. Please refer to this article for an in depth review of this issue:
An excerpt here is pertinent,
“Having your records centralized and using blockchain alongside it makes no sense. The blockchain becomes completely superfluous. While a number of corporates have jumped on the blockchain bandwagon and developed permissioned chains, this is really a nonsensical term.
If you maintain your records in a centralized manner then you do not really need blockchain. Blockchains are slow, expensive to operate and have terrible user experience. It makes no sense to use a blockchain solution unless you have a use case that cannot be addressed with a simple shared google sheet.
Blockchain should only be considered as a solution if the intent is achieving consensus in a decentralized manner.”
The term security tokens is an Oxymoron.
Tokenization is the process of recording an asset on the blockchain. You can tokenize an asset without fractionalizing it.
For eg: If you recorded ownership of paintings on the blockchain via unique digital assets such as ERC721 tokens that simply means one ERC721 token represents ownership of a particular painting.
That is tokenization.
If however you represented the ownership of the same painting using ERC 20 tokens where 100 ERC tokens together represented one painting then in essence you are fractionalizing, which takes you into the securities domain.
You can represent the painting as 100 ERC20 tokens and not breach the securities threshold by only selling all the tokens together. That way the tokens are sold as an indivisible unit and would work similar to the earlier single ERC20 token. I am leaving a gap here which intelligent observers will notice, but I will assure you that we will revisit it in the article later.
However there are 3 issues with recording an asset on the blockchain.
Assets that are centrally recorded are untokenizable
If your asset is required to be recorded legally on a centralized state approved registry, then recording it on the blockchain as well is meaningless.
Again an excerpt from an earlier article.
“ While some may argue that you can have the centralized record as the settlement layer and use the chain for transactions, that really makes the whole thing unnecessary. Why not update the centralized record directly? Or have another centralized cache which supports the secondary market and then updates the main records in a batched manner? Having a decentralized system working on top of a centralized system adds no value but it definetely makes things worse due to the costs associated with blockchain.”
Which means real estate and cars are out. Ownership of both is already with state approved registries. If the scenario was involving a developing country where records are shoddy, you would be competing against the state and its monopoly of force to establish your system. Better plug gaps rather than try to replace.
Assets whose possession is everything are again untokenizable
Cash, mobile phones, iPads and other electronic items are assets that do not lend themselves well to tokenization. If you had a record of mobile phones on your decentralized register, but the device got stolen and the new holder wiped it clean then your ownership register is meaningless. Same goes for cash, possession is the law. While in both cases there are serial numbers that can be used to maintain a record, these use cases are not a low hanging fruit.
Assets within a centrally owned eco-systems
Collectibles within video games could have been a good asset to tokenize, but their existence is dependent on the ecosystem of the game which is centrally controlled. If the game operator allowed decentralized registers this would work or if it was some sort of a Dapp game then it would also work, but not likely to work within something like the “World of warcraft” for the simple reason Blizzard can switch you off anytime they want.
Replacing single point of control is important, just because your single point of control was not the state does not mean it is now decentralized.
Lets pedal a step back before we go forward.
While securities require centralized registers, certain types of securities can maintain their own records. For eg: Public unlisted companies in Australia maintain their own registry and this need not be with a central party. A decentralized register for this can work, but a decentralized register is only meaningful if the ownership of the assets recorded on it can be transferred freely.
Exchange of securities requires securities market licensing, which again restricts the transfers across national boundaries and sophistication of investors. And the need for licensing means your market is at the mercy of the state or the central actor who can shut you down at any time they want.
At this point some people may argue that I am beginning to sound like a crypto anarchist.
Why even decentralize?
While I am generally in favour of a small government, I am not a pure crypto anarchist. I believe in the rule of law and recognize the value of a well regulated system. In the sector of securities in particular, the scams that have seen again and again have pointed to the paucity of regulation in this domain and the value of checks and balances.
However the reality of today's world is that we do not live in a borderless world. We have almost 200 sovereign country with their own set of rules and regulators. Getting sign offs from each one of them and having an offer that is open to everyone is a near impossibility. Add to it market licensing and then you have something whose probability is simply next to zero.
While you can create fragmented systems and have varying degrees of central control, blockchain by its very nature is a new promise. It promises the exchange of value without discriminating where you are. It seems patently unfair that someone born in middle Africa does not have access to the same opportunity as someone in Australia.
We do not choose where we are born, we do not take applications to god asking him (or her) to ensure we are born in a specific country. Our location of birth is a roll of dice.
And yet too often our access to opportunity is a function of this roll of dice.
We do not wish to offer freebies or charity, but we definetely want to work towards a world in which everyone willing to work hard and smart has the same odds of success. And that should not be dependent on where you were born.
Where you come from should never get in the way of where you want to go.
As someone who had to move across continents in pursuit of a fair go, this is something very close to my heart.
Our mission at Konkrete is to, “ To accelerate value creation by providing a fair, transparent and accessible framework to all”. And all our actions are guided by this mission.
Any systems we develop will be built around censorship resistance as its core premise. Censorship resistance and well regulated frameworks are not mutually exclusive and in coming articles we will discuss this important aspect in detail.
Coming back to our original discussion, so far our venn diagram looks like this.
The only assets that can be meaningfully tokenized are the ones in which the contracts are between 2 or more parties (peer to peer) and there are no centralized state approved records of this. In addition to avoid the securities trap the outcome of the contracts should not rely on active management efforts of the either parties. This is the yellowish green shaded section above. I am color blind, so I could be completely off here but it is this section,
To tokenize these assets is to record these contracts on the blockchain, and program them into being self enforcing.
Several assets that satisfy come to mind. Invoices in particular are a great starter asset and you can read all about our thoughts on it here:
Music royalty licensing, software licenses etc are others. Ownership of virtual assets on a decentralized game is another example. Real estate can be tokenized but not in the manner people generally think:
On Konkrete we are building a decentralized asset registry for Assets that fall under the criteria that is discussed here.
We will be maintaining the ownership of these assets as an indivisible asset in a one asset, one owner fashion.
While these assets in turn can be fractionalized to achieve liquidity and allowing people to participate with smaller amounts, that would involve securitization. Others may form syndicates, securities that would then pool resources together to acquire assets on our platform. But ownership of assets on Konkrete would not be for fractions.
We could in theory assist these pooling efforts separately by helping someone draft a prospectus or PDS on request but that would be outside Konkrete’s primary business case.
Konkrete is a distributed registry for Assets. In time we intend to enable programmability of these assets on this distributed registry so that the utility of this platform goes beyond record of ownership to an enabler of predefined programmed actions.
