In Part 1 of our series on Blockchain and the Solidarity Economy, we explored ,decentralized finance (“DeFi”).
For Part 2 we’re going to explore tokenization, and whether participating in a tokenized economy would benefit the ,solidarity economy. Why write an article on this subject? Because The World Economic Forum projects that ,10% of the world’s GDP will be tokenized by 2025. So if blockchain-enabled tokenization will increasingly become an important part of the global economy, then it’s worth addressing what impact it may have on the solidarity economy.
In this article we’ll cover:
- What are tokens and what do they have to do with blockchain?
- What is tokenization and what does this have to do with the solidarity economy?
We’ll then take a deeper dive on whether tokenization of certain types of assets may support the solidarity economy.
- Real estate tokenization
- Tokenizing products and services
- Tokenizing equity
What are tokens?
A token is a digital asset recorded on a blockchain. There are primarily two classifications of tokens:
- Layer-1 tokens, which are built on and used to interact directly with a blockchain. Known as currency tokens (“cryptocurrency’), native tokens or protocol tokens, these tokens are used to pay miners “gas fees” which cover the costs of processing and long term storage of transactions.
A developer creating a “dApp” (decentralized application that operates on a blockchain using ,smart contracts) would exchange fiat money, such as US dollars or Euros, for cryptocurrency native to the blockchain being used. For example, Ethereum blockchain gas fees can only be paid in ,Ether (ETH) and Cardano blockchain gas fees can only be paid in ,ada.
- Layer-2 tokens, which are built and used on top of an existing blockchain network. The main goal of Layer-2 solutions are to solve cryptocurrency networks’ scaling difficulties, with slow transaction speeds and high gas fees preventing growth. Security tokens and utility tokens are Layer-2 tokens.
,Security tokens are offered through a security token offering (“STO”), and can be used to acquire an interest in real financial assets. Security tokens are not the same as “tokenized securities,” which would be the digitization of an existing security, such as tokenizing a stock certificate.
Utility tokens are offered through an ,Initial Coin Offering (“ICO”), and allow a user to perform some action within a specific ecosystem on a certain blockchain network. Whereas a security token can represent a share in a business, utility tokens are purchased to gain access to a service. For example, a ,decentralized autonomous organization (“DAO”) will create a token that grants holders the right to submit and vote on new developments, while a security token holder would have rights to a business’s profits. We’ll explore DAOs in a future article.
What is tokenization?
Tokenization is the process of converting ownership or licensing interests into tokens (digital assets recorded on a blockchain). Blockchain-enabled tokenization facilitates the securitization of traded and non-traded assets. Thus tokenization potentially broadens an investor base, increases liquidity, reduces settlement times, lower costs for reconciliation and trading, and increases available collateral.
There are four main categories of assets that can be tokenized:
- assets (any item of value that someone can transform into cash, such as real estate),
- equity and debt – the token represents the financial instrument
- investment funds – each investor allotment of tokens represent their share of the fund, and
- products and services.
Tokenization and the Solidarity Economy
The ,solidarity economy rests on unifying principles which include promoting solidarity and social equity within society in order to build mechanisms for economic justice and social liberation on behalf of society’s marginalized communities. Would the ability to tokenize assets within the solidarity economy help support its sustainability or growth?
Looking at tokenization through this lens, we’ll explore:
- Whether the ability to tokenize real estate could create more affordable housing, homeownership, or increase investment by historically marginalized groups.
- Will tokenization increase sales of products and services by businesses?
- Will tokenizing shares increase access to capital for emerging businesses?
Real Estate Tokenization
Real estate tokenization is a mode of:
(a) fractionalizing ownership by dividing a property or an asset into fungible tokens, and
(b) creating a digital representation of asset ownership using ,non-fungible tokens (“NFTs”). We’ll tackle the use of NFTs as a way of digitizing proof-of-ownership in a later article.
So when looking at real estate tokenization we’ll consider whether fractional ownership can build a more equitable economy that increases homeownership or wealth-building investment opportunities for communities historically excluded from these opportunities.
In the United States, real estate development and property ownership is rooted in racial exclusion and exploitation. Specifically, predatory lending by individuals and financial institutions, lending apartheid caused by government-sanctioned redlining, and systematic devaluation of Black-owned residential assets by biased real estate appraisals, have all decimated opportunities for building wealth and economic power through property ownership within the Black community.
The real estate industry has high barriers to entry, in large part, because most real estate deals require large amounts of up-front liquid capital. By facilitating fractionalized ownership, tokenization has the potential to lower the entry-level threshold for real estate investments. This could potentially enable low-income communities to pool money to purchase real estate. Also, the ability to place the tokens on a blockchain-based secondary market where they can be exchanged for other cryptocurrencies, could boost liquidity in these low-income real estate markets.
A token that represents a fractionalized ownership of real property isn’t inherently a security. Rather, a token representing a passive investment would amount to a security under ,the Howie test and the U.S. Securities Act of 1933. Tokenized fractional ownership of real estate generally represents a share in a company that owns a real estate asset. In the case of rental properties, investors could buy security tokens which would confer a right to a share of the Company’s profits generated by rental income in addition to ,other benefits. In return, the token offering would help finance acquiring properties.
While STO issuers have a variety of securities exemptions available, including Regulation D Rule 504, Regulation A+ and Regulation CF, the most popular real estate STOs have been structured through ,Regulation D 506(c). This SEC registration exemption allows the issuer to publicly advertise the offering and raise an unlimited amount of capital but only where wealthy ,accredited investors are the purchasers.
Unfortunately, systematic racism, sanctioned and led by federal and State securities regulations, restricts newer community ownership financial models, such as the neighborhood REIT, community investment trust, and community IPO, to wealthy corporations and individuals (i.e. ,accredited investors).
Without changes to the securities laws, tokenization wouldn’t increase the ability for low-income investors to collectively purchase real estate. But by making investment more attractive through the ability to exchange tokens on a blockchain-based secondary market, tokenization could increase ,investment into affordable housing.
Tokenizing Products and Services
Tokenizing products and services may support the solidarity economy by supporting equitable markets.
For instance, tokenizing peer-to-peer supply chains could facilitate transactions by the unbanked and allow them to purchase goods directly from suppliers in a trustless environment. There wouldn’t be any need for banks or money to be exchanged through a distributor. This would also keep more money in the business, instead of money being shelled out to multiple transaction fees.
Also, tokenization could facilitate the barter economy. Although it doesn’t currently utilize blockchain technology, ,Simbi is a platform that demonstrates a framework for tokenizing the bartering economy. Users can directly barter goods and services, or they can earn simbi tokens which can be exchanged for goods or services at a later time.
The ability to tokenize shares in a company could increase the availability of business financing within the solidarity economy. Tokenized shares may be issued through ,Direct Public Offerings (DPOs).
The most common ,Direct Public Offering (DPO) is Regulation D Rule 504. Known as SCOR (Small Corporate Offering Registration), this exemption gives companies the ability to raise up to $1 million in any 12-month period through the sale of stock, membership interests, debt, or other securities. The Rule 504 exempt offering is opened to both accredited investors and non-accredited investors. To learn more about this exemption, read our article, “,Introduction to Regulation D.”
The ability to tokenize shares would bring liquidity to these otherwise illiquid stocks. Being able to sell the tokens on a blockchain-based exchange, would make them more attractive to investors, thus likely to bring additional investment in DPOs.
In conclusion, blockchain-enabled tokenization has the potential to support the solidarity economy by facilitating peer-to-peer markets, providing liquidity to otherwise illiquid shares, and making real estate investments in low-income communities more attractive. However, SEC regulations currently restrict low-income investors from collectively investing in real estate and benefits of tokenization mostly rest in the hands of wealthy individuals and institutions.
If you’re thinking of raising capital through the tokenization of real estate assets, ,schedule a consultation so that we can help you do so legally.
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Shirah Dedman is a Legal Fellow at Elizabeth L. Carter, Esq., LLC. Her focus is on blockchain, NFT, and cryptocurrency matters.