Regulatory Challenges in Asset Tokenization
Europe’s regulatory framework was designed for assets that can be traded, yet a significant class of assets, including non-listed shares and custom revenue-sharing agreements, are intentionally non-transferable. The definitions established by the Markets in Crypto-Assets (MiCA) regulation imply that assets must be transferable, while MiFID II focuses on securities that can be traded, which leaves a gap for “digital but non-transferable” representations of these assets. This situation creates a regulatory oversight that needs to be addressed.
Potential Solutions Through the EU Blockchain Sandbox
The EU Blockchain Sandbox presents a potential resolution by acknowledging that a precise “digital twin” can maintain the legal characteristics of the original non-transferable asset, instead of automatically being classified as a new, transferable security token. There is ongoing debate regarding whether allowing non-transferable tokens could lead to regulatory loopholes; however, the assertion that any token on a public blockchain is inherently tradeable is also flawed. The report clarifies that if legal, technical, and contractual frameworks are properly aligned, the digital representation retains its original legal classification.
Tokenization Versus Regulatory Frameworks
A security recorded on a blockchain remains a security under the law. This means that a bond retains its status as a bond, and a share remains a share, regardless of whether it exists in traditional or tokenized formats. Conversely, if a non-transferable asset’s digital twin is created, simply placing it on the blockchain does not automatically classify it as a security token or a crypto asset governed by MiCA.
A Structured Approach to Token Classification
A logical approach that emerged from the EU Blockchain Sandbox process emphasizes a structured analysis. The first step is to determine if the token qualifies as a MiFID II financial instrument; if not, the next step is to evaluate whether it falls under the MiCA framework. If it does not fit either category, the Alternative Investment Fund Managers Directive (AIFMD) should be considered for collective investment vehicles, otherwise, national laws apply. This order is crucial as it prevents the design features of the token from dictating its legal classification. MiCA’s focus on transferability is critical: a token that is non-transferable does not qualify as a MiCA crypto asset, and the categories of utility tokens, asset-referenced tokens, or electronic money tokens do not pertain.
Transferability and Legal Classification
When a true digital twin is created, it should maintain its original legal classification. However, if developers attempt to add transferability features to a non-transferable asset for liquidity purposes, they may inadvertently create a new instrument that is subject to MiCA or MiFID II. The legal designation relies on both the technical and contractual aspects of the token, rather than solely on the documentation associated with it.
Insights from the EU Blockchain Sandbox Experience
For participants in the second cohort, discussions with regulators have refined the understanding of what constitutes the “digital twin” test. If a token is an exact digital replica of its original asset, its legal classification remains intact. However, if the tokenization process introduces new features such as transferability that were not present in the underlying asset, the legal classification may change. This perspective also aligns with current evaluations of when tokens are classified as financial instruments under MiFID II.
The Importance of Clear Regulatory Guidance
Regulatory bodies do not necessarily require new legislation to address risks linked with innovation. Instead, they need concise, practical guidelines that encapsulate the sandbox’s sequence and “twin” test: (1) start with MiFID II; (2) if it doesn’t fit, examine any relevant MiCA asset categories; (3) if neither applies, verify if it is a digital twin of an asset recognized by national law, such as private company shares.
The sandbox experience has underscored the significant benefits of organized dialogue between regulators and the industry, emphasizing the necessity of addressing existing legal ambiguities. This involves clarifying how current frameworks like MiFID II, MiCA, and AIFMD interact with tokenization while identifying uncertainties and finding practical solutions. Key concepts such as digital twins, transferability, and fungibility are vital as they directly influence legal classifications.
The Future of Tokenization in Europe
The next steps will likely involve observing how national sandboxes implement their respective laws in line with these principles and whether this fosters greater consistency among member states, thereby enhancing legal certainty across the European market. Clear guidance would facilitate compliant digitization of Europe’s extensive private company and contractual rights market while preventing unintended reclassification that could hinder issuance. By distinctly defining digital twins and engineered transferability, the EU can support the onshore tokenization of real-world assets (RWA), preventing developers from seeking alternatives outside the EU.
Conclusion on Tokenization’s Role
Tokenization is neither a straightforward advantage nor an inherent risk. The EU Blockchain Sandbox has paved the way for clearer regulations. Now, it is crucial for regulators to solidify these insights, providing developers with clear boundaries and investors with an understanding of what they are purchasing. This approach is essential for maintaining and advancing market integrity in Europe.
