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Real Estate Tokenization
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OVERVIEW WHITE PAPER
The tokenization of assets refers to the process of issuing a security token that is the digital representation of a real asset and secured through the implementation of blockchain technology. These security tokens, generated through a security token oﬀering (STO) to distinguish it from other types of ICOs, can produce diﬀerent tokens such as equity, utility, or payment tokens. An STO creates a digital representation—a security token—of an asset, meaning that it can represent a share in a company, ownership of a piece of real estate, or participation in an investment fund and traded on a secondary market or exchange.
A new “token economy” oﬀers the significant potential for greater eﬃciency by reducing the friction involved in the creation, buying, and selling of various securities. We see four key advantages this provides for both investors and sellers:
- Greater liquidity
Tokenizing of assets—especially private securities or traditional illiquid assets such as ﬁne art—generates trade opportunities on a secondary market of the issuer’s choice. This access to a broader base of traders increases potential liquidity, beneﬁting investors and granting more opportunity to sellers because the tokens beneﬁt from the “liquidity premium,” thereby representing a higher value percentage of the underlying asset.
- Faster and cheaper transactions
Because the token operations occur within smart contracts (software algorithms integrated into a blockchain with trigger actions based on pre-deﬁned parameters), most parts of the exchange process are now automated. This automation reduces the administrative burden involved in buying and selling, with fewer intermediaries needed, leading to not only faster deal execution, but also lower transaction fees and increased security.
- Increased fiscal transparency
A security token can have the token-holder’s rights and legal responsibilities embedded within the token itself, including an immutable record of ownership. These characteristics promise to add transparency to transactions, allowing anyone to know with whom you are dealing, the express right granted, and who owned any particular asset.
- Greater Accessibility
Tokenization opens investment in assets to a much wider audience due to reduced investment requirements and accessibility periods. Tokens are divisible by design, meaning investors can create fractional tokens that represent smaller percentages of the underlying assets. If each order is cheaper and easier to process, it will open the way for a signiﬁcant reduction of required investment amounts. Moreover, the higher liquidity of security tokens also reduce required investment periods as investors can exchange their tokens on secondary markets, which are globally active 24/7 (subject to regulatory limits).
These advantages most apply to asset classes that are considered illiquid and can beneﬁt from improved transparency, eﬃciencies, and lower minimum investments. Two areas are particularly interesting when considering the possibilities of tokenization: real estate and ﬁne art. Rather than requiring very large investments, or tying up your money for extended periods with your investment split across several other assets in the fund, tokenization could permit you to invest €50 in the piece of art or speciﬁc building in which you are interested, and then easily sell the token at your discretion. This ability to freely choose where you invest will open a new era of much greater personalization and customization in investment—an area that is increasingly relevant as investors now look beyond just returns and pay much closer attention to where their investments are made.
Historical Context: Digital Certainty and Scarcity
On October 31st, 2008, some anonymous person/persons under the alias Satoshi Nakamoto released a white paper, “Bitcoin: A Peer-to-Peer Electronic Cash System” on a cryptography mailing list. The paper outlined a financial system that did not rely on trusted third parties but rather cryptographic mechanisms to eliminate the double-spending problem and the centralization of vulnerabilities (Nakamoto 2008). The Bitcoin network went live January 2009. The Nakamoto protocol implemented clever cryptography to create a novel financial application, a medium of exchange without masters. This alien fintech drew upon decades of research in the areas of public-key cryptography and digital cash systems, succeeding where those attempts failed by eliminating the variable of the vulnerable, centralized server and instead introducing the data structure that became known as the blockchain, a distributed, cryptographically verifiable database underlying the Bitcoin currency.
The real magic of Satoshi’s opus, however, was found in the redefinition of the digital object. Before Satoshi’s white paper, the identity of a digital object was defined mostly within the context of its presumed greatest ability: infinite duplication and malleability. While these are essential elements that were the groundbreaking tools that led our foray into the digital realm, they also led to unintended consequences as they evolved. Most of the industry uses developed to take advantage of new digital technologies focused upon and leveraged these two qualities.
Satoshi revealed, however, that a more powerful side of the digital object exists. One where all digital objects are defined by their certainty and scarcity. The evidence of the impact of these factors is found in the qualities of the infinite digital object as well. Because it is defined by its lack of scarcity, there is a noted lack of certainty in any transaction involving an infinite digital object. The ultimate nature and power of digital objects is enforced and maximized through the leveraging of its own elemental certainty. True or False. 1 or 0.
Once this certainty can be utilized, the digital object becomes resilient, sometimes “antifragile,” and can organize itself into the specific, defined quantities of serialized inventory. Even at a million defined elements, a digital object with a defined inventory of known objects, is inversely made more certain and scarcer than the infinite digital object.
Obviously, many companies have leveraged infinite digital objects to great advantage, and continue to do so, but their success was always dependent upon the centralization of resources and data protection. It is the centralized systems that provided the (artificial) certainty and scarcity needed. This is declared as “artificial” because the elements of certainty and scarcity are not innate qualities of infinite digital objects. They are instead created by the forced centralization of access, payment, and verification.
The success and growth of Bitcoin in the light of challenging the world’s legal, economical, and even political notions regarding the use of digital objects, has done little more than legitimize the philosophy behind Satoshi’s work.
Technology Context: Programmable Blockchains and Smart Contracts
Bitcoin was designed for the singular purpose of its financial application as an alternative currency to challenge the existing establishment. While there were non-financial applications such as “proof of existence,” a method of timestamping and hashing a unique digital document, the Bitcoin protocol lacked versatility due to its lack of extensive scripting capabilities—programmability—necessary to develop a wider range of applications. This limitation prompted Vitalik Buterin to propose a new blockchain platform that allowed developers to write and deploy smart contracts—programs that execute on a blockchain—thereby allowing the development of a wide range of decentralized applications (Dapps). Ethereum is a decentralized “world computer” which requires Ether, the protocol currency, to run computations (Buterin 2014).
The notion of the smart contract was originally proposed by Nick Szabo in 1994 before there were any systems capable of actualizing it. The essential thesis: since contracts are “imbedded in the world,” in the many facets of our personal and business relationships, it is possible that programmable contracts could facilitate all manner of peer-to-peer interactions and transactions, thus opening many economic opportunities previously unavailable (“Smart Contracts” 1996).
Currently, there are many projects tackling different areas of commerce and finance using blockchain-based architecture, or even building new protocols upon which to build these applications. Whether or not these efforts result in mass adoption of blockchain, cryptocurrency, and decentralization depends on the developers and entrepreneurs in the space keeping the end users of these systems at heart.
Pieces Form a Whole
What we have here is the scaffolding for a new architecture of decentralized systems, simultaneously antifragile and inclusive. The efforts of cryptographers such as David Chaum, Hal Finney, Ian Grigg, Nick Szabo, Satoshi Nakamoto, et al are coalescing into form and purpose as technologists and entrepreneurs challenge the status quo and the powerful monopolies of the world, creating sustainable tools of commerce fit for the overwhelming pace of society.
A lot of the frictions of the world are due to uncertainty: of purpose, of intent. Blockchain and the general notion of triple entry accounting allow a neutral source of certainty in an increasingly digital world, thus making possible to maintain security, pseudonymity, and confidence in one’s business and financial endeavors.
The Funder One-Capital Constitution: Codifying Intent
The blockchain is a shared ledger of discrete events constituted in a cryptographically secure data structure. If the transactions are verified and validated in the consensus protocol, the functioning narrative will persist indefinitely. The design and structure of the Funder One-Capital Platform is inherently human-centric, for real, active users are necessary for any dynamic and prosperous network to perform optimally. Since the human element is inseparable from the abstract data in the context of any digital participation, these types of systems require self-governance.
Governance within decentralized networks presents a challenge as the total lack thereof can produce toxicity amongst the human nodes or cause instability or obsolescence within the software itself. A notable example of this is the forking of blockchain software. Such events arise when there is lack of social consensus or clarity of intent behind the community. Politics amongst miners, developers, or others with vested interests can inhibit the growth of a network relying on a blockchain accounting system. The people who rely on these systems indirectly through applications or businesses running the software should not have to experience the stagnation or volatility that arises when there is lack of a fair governance structure from the beginning.
Most blockchain environments operate under the axiom “code is law,” which places the data structure and its processes and functionality above the human element. Most of these networks rely solely on crypto-economic schemas which are often defined and implemented in such a way as to inhibit the purpose (if present) of the network with the emergence of influencers, cartels, and other entities basking in the “might is right” ecosystem. When the goal is to maximize human potential, putting the machinery on a pedestal seems outright ludicrous.
The Funder One-Capital Platform will use a constitution as the foundation of its governance. This is inspired by Dan Larimer’s research on governance models for the EOS blockchain operating system (Larimer 2016). The Funder One-Capital Constitution will codify and detail the general rules and associated roles within the environment, define the areas of accountability, set methodology of dispute resolution, and cement the core values of the network to be accepted by all participants.
Intentionality is a crucial element to the platform. As contractual relationships are one of the main components of commerce between collaborating Entities, the constitution takes this model and applies it throughout the entire network as a system-wide, generalized contract. From the user perspective, this is not unlike a terms and conditions clause. What makes this document different from the average terms and conditions agreement is that it is possible to define and enforce the values of the network rather than focusing entirely on the rules. Constraints are fine and necessary to define any operating structure, but if they are too many and too granular it will inhibit the growth of the network.
Who is affected by the constitution? The simplest answer would be the user, but since the Funder One-Capital Platform could be the operating system on which real estate projects run their accounting system and business processes, are the users of those applications and services in turn affected by the constitution? Where does privity of contract end in this chain? A lot of this is contextual as some projects launched on Funder One-Capital may choose to default to the original constitution or draft and implement their own. The exact minutiae of this framework are still being defined. Ideally, this document should be static, changing only with the overwhelming indication and approval of the community. A governing document revised over time with accumulating edge cases loses its simplicity and clarity, particularly when used in parallel with a myriad of local and global jurisdictions and regulations.
In practice, the constitution will be presented to the User upon entrance into the network like a terms and conditions clause. The process of verifying one’s unique User ID and creating the first pseudonymous Entities for interacting and transacting on the platform requires a cryptographic signature of the constitution by the new user. The hash of this document will be included in every subsequent transaction throughout the network, showing that the user behind the pseudonymous Entity has agreed to the same parameters as the rest of the network. This satisfies privity of contract, where only the parties to the contract can contest the contract and initiate a dispute.
Blockchains can allow distributed accountability amongst all network participants and do so in a manner that does not compromise the User’s privacy or self-sovereignty. However, the processes involved are facilitated through software, so the users as well as the developers of the platform are beholden to the constitution. No exceptions. The goal is to create mechanisms and frameworks that allow intentional interactions and transactions in specified, unambiguous contexts with consent of all parties involved.
Next, the conceptual thorn that has challenged philosophers and computer scientists alike: identity.
“Who are You?” The Problem of Identity
To untangle the difficult notion of identity, we once again fall back to the dichotomy of physical vs. digital. In physical space, we often define identity as an indicator of a unique flesh-and-blood human being with a singular, persistent personality. Actual experience would indicate that the domain of one’s identity is not singular, but plural. If someone, due to disease or trauma, loses all memory and semblance of who they are or were, identity extends from that individual to their network of peers, their social graph. There is also the actual experience of identity wherein we behave differently in different contexts. We are multifaceted. We contain multitudes.
Identity is not singular. It is correlative.
In digital space, identity presents an even bigger challenge because we lack the face to face interaction that creates trusted relationships. Networks are subject to Sybil attacks, in which one bad actor can create a multitude of identities to overtake or hinder the network. Sybil-resistance is a key requirement for any decentralized system.
As stated above, one of the important elements in establishing a presence in this platform is pseudonymity that does not sacrifice accountability or privacy.
The Value of Pseudonymity
It seems that the use of pseudonyms is quite natural in two areas of activity relevant to this project: digital and online environments.
The world is full of entities who choose other legal identifiers: corporations, stage names, pen names, alter egos, etc. Sometimes this is part of a performance, a conscious attempt to create an aura of mystique and intrigue, an aesthetic, that the artist and audience alike can tune into. Some writers, such as Stephen King and J.K. Rowling, have at some point chosen not to leverage their fame for certain works, so they use pen names (until their real identity is discovered, which is common in such cases.)
The rise of the internet brought a flourish of new identities. People could communicate with one another in relatively private channels. The constraints and social mores of physical interactions no longer applied. The Cypherpunks of the nineties valued pseudonymity and anonymity as fundamental rights of people within the developing surveillance state, so many of these computer scientists and cryptographers set out to develop more secure methods of encryption to protect the public.
As technologist David Birch writes in Identity is the New Money, “All of the identities we exchange are virtual, and while the virtual identities are of course linked to our mundane identities, they should not be confused. None of them is ‘real’…all identities are pseudonyms” (Birch, 2014).
The Funder One-Capital Platform allows digital entrepreneurs and their customer base to generate pseudonymous “economic avatars” (Lanier, 2013) through which they can interact and transact with one another in digital commerce. We call these Entities.
In keeping with the spirit of digital and digital personae, digital entrepreneurs can generate multiple identities for a variety of contexts; however, this is not without some necessary limitations.
Entry into the platform is invitation-only. This not only allows the network to grow organically as Owners invite their friends and frequent collaborators into the fold, but also helps establish a network built with human nodes, where the connections and points of convergence are key. Ian Grigg’s notion of identity as an “edge protocol” (Grigg, 2017) rather than a nodal one resonates here, since we are emphasizing in our design the social graph of individuals and connections therein rather than static features as mundane as name, date of birth, or Social Security number (or some equally extraneous variable implemented outside the US) supplied by a central authority.
The crypto-asset, Funder One-Capitals, are utilized to create unique seat licenses which are required to enter the ecosystem. The first step is to generate a User ID, a human-unique identifier. This is the root ID in the system that establishes presence, the mundane identity of the Owner or Collaborator. This is important if we want to crystallize that individual’s presence in the network and verify that he or she is not duplicitous. User IDs, however, are not visible Entities on the network but rather a necessary root to combat Sybil attacks and provide the appropriate bedrock for dispute resolution, arbitration, and generally interfacing with the real world (as the platform evolves to incorporate more advanced use cases, real property assets, etc.) Once a User ID is created, a Funder One-Capital is locked to that ID and taken out of circulation.
The specific process of the digital identity creation is designed to provide a personally encrypted and managed data chain of information that allows the user to share as much, or as little information about themselves that they wish. An individual, secure, and immutable record of personal identity. Your on-chain identity is as important as your off-chain identity and in time, will grow to become more so as social networks and e-commerce become increasingly ubiquitous.
Privacy is not about hiding, it is having the ability to reveal yourself on your own terms. That is why all User information that is collected is stored by each User upon their own data chain, and they can choose to provide access to the information to any requester.
Ultimately, tools such as Driver’s Licenses, Social Security numbers, passports and more are arbitrary pieces of identification in which a third party (the government most of the time) vouches for the validity of the information that is provided. Ironically, the information on these forms is generally used to verify the User so that they may gain access to their own information, money, or property. When personally identifiable information is centralized under one authority, that authority will no doubt become the target of massive data breaches, like the case of the Equifax hack, in which the information of 145.5 million Americans was compromised.
Instead, these digital identities, and the secure ownership of them, is utilized in tandem with our analog, physical identities to create a bridge between the digital record chain we create and physical ownership of any asset in question.
Funder One-Capital Entities
There are three discreet Entities on the Funder One-Capital platform: Owners, Collaborators, and Projects. Each new User will initially start off by creating the first three, as this is necessary to interact and transact on the platform.
Owners start Projects and begin the process of drafting a Project Compact which defines the assets that are created, developed, and offered for distribution within the network.
Collaborators are the various Entities who work within a Compact to help use, maintain, or develop any Project. These entities can be business partners, architects, designers, developers, or even contractors.
Projects are Composite Entities that consist of autonomous Entities bound by the common purpose outlined with the Project Compact.
Finding the Others
Yet again, we find ourselves at the intersection of analog and digital. As mentioned earlier, the Funder One-Capital Platform is an invitation-only environment. Naturally, Owners who have a Project in mind can bring friends and acquaintances, nodes, into the network. This is ideal for Users who want to leverage their existing analog and digital networks (social graph) and bring them onto Funder One-Capital to pursue their endeavors.
For a digital commerce platform to really accommodate the needs of its users, there needs to be a social component that allows connections to occur between Owners and Collaborators. These points of convergence are the moments that contribute to the network’s growth. An Entity’s record of past collaborations can be made transparent to other Entities, allowing the opportunity for networking and enduring professional relationships.
Contracts for Digital Assets
Contracts are imbedded throughout all areas of our society. Politics. Finance. Business. In all industries, the common goal is that all parties of a contract simply want to ensure that agreements are met, usually agreements pertaining to ownership and compensation. Are my real property rights being protected? Am I getting paid according to the agreed expectations and parameters?
Traditional legally-binding contracts are often written in a byzantine prose that few individuals can fully understand much less those affected by the contract. The drafting and deciphering of these contracts have been the domain of lawyers who have spent years learning the codes and intricacies of their field. The user experience of the parties subject to these contracts is unwieldy and inefficient considering existing technical capabilities. In a digital commerce platform that intends to eliminate such frictions, relying on contracts with obscure legalese prose can lead to unnecessary ambiguity of responsibility and intent.
Smart contracts are code that execute on the blockchain, directing the movement of value (or assets) in the network. Software that runs on decentralized networks holds a lot of potential in automating a wide range of business logic. Being the operable and programmable side of blockchains, smart contracts will play an important role in applications and platforms built on blockchain infrastructure.
The Project Compact: Codifying Intent
The Project Compact is a living document of objectives, settings, and automated agreements (smart contracts). It utilizes Ricardian elements with a simple prose document coupled to it with parameters matching the code, so there is no ambiguity as to the intended purpose of the smart contracts (Grigg, 2015). This helps codify the intent behind a contract. By eliminating the semantic richness and ambiguity of legalese prose, we can maximize the clarity amongst all the parties to the contracts and the courts of the land. The Compact is essentially a nexus of the programmatic agreements around a common endeavor, detailing ownership and compensation as well as detailing the project’s goals.
The Compact is not only a tool to reduce friction between different collaborating pseudonymous personas and the resulting distribution of value, it also provides potential Collaborators the means to scope out the prospect of the project as it is being developed.
Since the end user has no reason to interact with raw code, the parameterization of the smart contract can allow one to change very specific variables within the code using templates. There will be a variety of contract templates catered to certain spheres of digital activity. Over time, owners will have access to a library of contracts each designed to implement a specific type of project defined by its intent and number of participants.
Compacts: the combination of operable software and an easily parsable prose contract (intent clause). “What You See Is What You Sign.” (WYSIWYS)
By refuting the axiom, “code is law,” we can protect the users from possible errors in the underlying software. While smart contracts are deterministic—a given set of inputs will generate a certain output—for security and resiliency of the economic activity taking place we must assume that bugs or errors will occur either within the software or with the participants actions or assumptions themselves (“wetware”). Having the intent clause is a key piece in any meeting of minds. This also builds a nice foundation for arbitration mechanisms for streamlined dispute resolution without resorting to costly and time-consuming litigation. Most courts throughout the land acknowledge arbitration as a valid form of dispute resolution.
The Compact is a stable manifestation of intent that is the machinery of the economic activity around a common endeavor that issues a very specific shape and size of transaction to the blockchain upon an agreed upon set of conditions defined within it. This creates a channel that can assume consensus because all members agree upon all the explicit terms that define that individual channel’s means of creating a valid transaction to the blockchain.
Channels of Consensus
The Project Compact provides a critical element within its environment: defining the consensus of its operation within the network in agreement with the Constitution. In completely open blockchain environments, consensus is maintained with the clever combination of cryptography and economic incentives (crypto-economics). This is necessary to maintain the integrity of the network, and guarantee accuracy of the ledger. Now, that’s more of an infrastructural element to blockchains which need to combat adversaries seeking to change the narrative. If the narrative can only be changed upon certain parameters with consensus between certain designated Entities, then you can set up “channels of consensus.” The Compact’s design does not allow subterfuge because none of the Collaborators can interact with the raw code of the Compact, only certain parameters that define constitutional attributes to the code. Changes can only be made with transparency and the positive vote of all Entities within the Project. This ensures that all participants are incentivized to work in a beneficial manner on a Project, since the only way it can generate value for the Owners and Collaborators is through that Project’s ongoing participation and verification within the network.
You can eliminate the bottlenecks of a distributed network if the Entities within certain consensus channels agree on the settings of the machine (the Compact). Is the machine working? Yes. Okay, moving on. The mechanics of implementation of the Project Compact are defined by the smart contract’s protocol, which in turn is defined and enforced by the Funder One-Capital Platform’s Constitution that defines the specific parameters by which any contract is considered acceptable by the blockchain and rendered by its ability to transact within it.
Projects as Composite Entities
When Entities work on a Project, there is a “shape” that is formed when these nodes connect. Obviously, if there is an ongoing collaboration between the same Entities, they should be able to reassemble for more Projects. Therefore, Compacts also double as Composite Entities.
This also extrapolates outward in interesting ways considering how partnerships work. A retail development corporation teaming up with multiple construction contractors for a project is an example of two Composite Entities working together for a Project with its own Compact. As value flows into this new Compact, it will then be redirected automatically to the Compacts of each Entity automatically as defined by the Project Compact. This creates fractal business structures without increasing contractual complexity.
Tokenizing Real Property
What happens upon a Project’s completion when the asset is now ready for the open market? The efforts need to crystallize into some “thing.” In our goal in bridging the best of both worlds—physical and digital—we have determined that utilizing digital bearer certificates in the form of crypto-asset tokens provides the cryptographic certainty and scarcity that can be the pillars of a sustainable digital economy.
By using a scarce object architecture often constrained to the physical realm, we can bring the familiarity of physical possessions into a digital context in a manner that is understood by both the user and the issuer alike (Szabo, 2004), thus allowing many use cases that are made possible at that compromise.
These are not tokenized securities such as Bowie Bonds (Espiner, 2016) that offer future revenue share in exchange for investment, but simply product keys that grant access to specific revenue generated by that project.
An economy of scarce objects is not always the ideal model to achieve sustainability, but in the digital economy this design can create value for all participants in the network if implemented appropriately.
Distribution and Market Entry
There are two methods of distribution which roughly correlate to consumer and wholesale, but the dynamics are a bit different in the context of digital objects.
One method is to provide digital assets at a consumer price. When the Customer purchases the product (a transaction that takes place between them and the Compact, not any one Entity within it), a token is “minted” and put into circulation in the ecosystem. The owner of this newly minted asset can then use it for the defined purpose—rent, lease, share, etc.—and later choose to sell or trade it on the open market to a new owner.
The other method presents a wide variety of options and is made possibly only with scarce digital assets: rail distribution.
This approach could be compared to the practice of token “airdrops” on other blockchains, except the utility and purpose of the token is explicitly defined and available immediately upon reception, not a priori.
The Compact, using the imbedded Funder One-Capital application, has granular control over asset distribution by designating a rail token and applying certain parameters, such as proportioned rates, by which the new asset will be distributed into the ecosystem to all collaborators. This allows a wide range of market strategies. Mutual benefits. Another method is to set rails within one’s own asset, increasing demand. There are many ways Owners can use this to their advantage and increase interest in Projects with potential collaborators.
Naturally, the rail system is free for those who receive the assets. So how does this generate value?
A Sustainable Secondary Marketplace Model
The secondary marketplace currently acts like an event horizon in the digital industries. The tenuous connection between an Owner and their Project is comparable to a black hole absorbing light around an approaching object. Always diminishing, never retaining its brightness and color. This problem is persistent in both the digital and physical markets. After examining the advantages of each, we have reconstituted a new model designed to incentivize users to participate in the distribution of digital assets without eliminating the fractional owners from the equation.
As Users of the Platform accumulate digital assets through consumer sale or rail distribution, they will end up with a sizeable portfolio. Some of these assets they may not want or desire to convert its value into another Project. The solution here is to turn that excess or unwanted asset into value for the Collaborators and the Owners of the assets.
The User can set a basket of assets to sell on the open market. A manual approach to this would result in “mental transaction costs” too high for a good user experience. By employing an autonomous agent, an algorithmic trading bot, a user can sell these extra/unwanted assets on an open market to those who didn’t partake in the rail distribution or to those who joined the network afterwards. As of now, many algorithmic trading systems utilize a decentralized AI trading bot for crypto-assets that allows for customization of trading strategies.
Such a “nanomarket” system, complete with scarce objects and autonomous trading, has already been hypothesized in a pre-blockchain context by Nick Szabo (2007). Blockchain simply helped make this vision possible with transactional certainty and digital scarcity.
For the Users of the platform, this can result in a consistent passive income without having to expend much time, energy, or attention.
In order to maximize the value Owners receive from their Projects, the Compact can designate a secondary market transaction fee, denominated in Funder One-Capitals. Whenever the asset moves from one Entity to another, a small “gas” price must be paid. This creates an ongoing stream of revenue that feeds into the Compact and its constituents. In perpetuity.
This model of distributed fractional ownership provides an effective framework for all participants of the platform to tap into various networks of value created by the Projects.
All these economic models do not amount to much if Owners’ real property are at risk. As mentioned earlier, the Compact has prose elements that can enforce jurisdictional legal ownership as well as compensation. Ownership is a more benign element compared to compensations since the latter is more operable.
The platform will also utilize a novel form of digital management to secure a connection between Owners and their real assets. Instead of the past applications setting artificial limitations such as physical presence and other various nonsense, the model we are keen to utilize is inspired by Benji Rogers’s notion of “digital rights expression,” in which metadata pertaining to a certain digital asset such as ownership is hardcoded into the file itself (Rogers, 2017). This would allow the settings of the Compact to be honored outside of the Funder One-Capital ecosystem. This can create many different ways to define and provide previously unachievable value to any asset: streaming, time locks, interactive media, virtual reality experiences, etc.
Some obstacles need to be overcome, however, if tokenization and the broader token economy are to take oﬀ. A big problem revolves around regulatory alignment, especially since blockchain-based platforms are de facto decentralized. Security regulations are typically technology agnostic, meaning that security tokens, depending on their exact features, can fall under the full scope of relevant security regulations, which can vary signiﬁcantly from jurisdiction to jurisdiction. This is true not just for the creation and initial sale of the tokens, but also for trading them on secondary markets. Consequently, many of the advantages of tokenization are undermined if regulations prevent the free and international exchange of security tokens.
What is needed are compliant methods of creating and exchanging tokens in a domestic and, ideally, international scope. International regulatory alignment is an unlikely milestone soon, but adding clarity to the regulatory environment for security tokens and facilitating compliant involvement in the token economy is a possible and necessary path forward if the opportunities are to be realized.
Additionally, regulations speciﬁc to tokens or, at the minimum, clear guidance from regulators would be welcome, since there is often uncertainty as to how a security token should be considered within the law. While it may seem counterintuitive to encourage regulation of a technology with decentralization and independence as some of its core characteristics, it is important to consider the risks of not providing a legal and safe framework in which the technology can thrive. A lack of scrutiny can allow scams and open the door to hacking—something particularly relevant for a relatively nascent technology. Scams and hacks not only harm investors and the broader economy, but enough of them could discourage investors and cripple the token economy completely.
There has been a considerably uneven approach so far to regulating and accepting tokenization, but there are signs that the traditional market infrastructure is adapting to the token economy. For example, both the US SEC and EU’s ESMA have made comments, albeit generic, in this area. Meanwhile, Malta and Switzerland have made more progressive plans to accommodate new marketplaces for tokenized securities1. Having a clear regulatory framework is of vital importance for the safe development of the token economy. In the meantime, a set of common good practices and rules would be a good foundation.
Beyond regulations, as with any new technology or solution, some questions need addressing. How tokens will remain linked to the real asset that they represent is a point of concern. For example, imagine if you own tokens representing a small fraction of 100 gold bars at a bank, and ﬁve bars are stolen. What happens to your token and to the other token owners is crucially important, since the value of tokens becomes greatly undermined if they cannot be proven to be linked to real-world assets. Another point of consideration is the issue of governance. If ownership of an asset, such as a building, is split among thousands of people, there is little incentive for owners to bear the costs associated with that asset, such as maintenance and ensuring rent is collected. There are also concerns related to risks of hacking that any digital or online products have, as well as stability concerns with a hyper-liquid market. These are problems that will likely be overcome or minimized, but they require thought and possibly intermediaries of some sort.
Once those critical issues about the functioning of the token economy can be answered, and there is progress on the regulatory front, tokenization might become increasingly present across the ﬁnancial industry.
This movement will involve actors from all levels (governments, central banks, private companies, and even local communities), and will depend on their communal eﬀort to move tokenization forward. If the abovementioned issues are addressed, as adoption increases and overhype—which undermines the true value of the token economy—dies down, the token economy might take oﬀ rapidly, with ripple eﬀects throughout the ﬁnancial services industry and broader economy.
The token economy represents a remarkable power shift from large, centralized trust agents to the individual. Cryptology replaces third-party intermediaries as the keeper of trust, with blockchain participants running complex algorithms to certify the integrity of the ledger of transactions. Financial institutions must determine how they are going to adapt to the token economy. We see major areas that ﬁnancial institutions must consider if they wish to remain relevant in the token economy:
Financial institutions will have to choose where to play in the value chain. For example, they might choose to advise issuers on how to structure their token or could act as safe keeper of the tokenized asset (art, real estate property, luxury vintage car, etc.). They could also leverage their expertise as custodian banks or paying agents to create life cycle event transactions on the distributed ledger or, in a more advanced model, implement life cycle processing in smart contracts and deploy them on a public blockchain platform. At the other end of the value chain, they could oﬀer services to maintain customer accounts in cryptocurrencies and tokens or prefer to act as central distributors facilitating access for their clients to transact on diverse tokenization platforms or token exchanges.
Depending on the business model they choose to embrace, they will implement diﬀerent operating models. One of the main components of those new operating models being the block chain platform, they will have to choose which platforms they will work or collaborate with. This will depend on the regulation they have to follow, the type of products or services they will oﬀer to their clients, and other factors more related to the platform itself, such as its product strategy, and its potential as regards the type and size of the user community. Institutions need to consider an infrastructure that will provide both technical and economic solutions to their business model while also considering the eﬀect it will have on downstream systems. Added to this, if the new platform cannot integrate with legacy systems, institutions may face a partial re- platforming of their information system.
With digital payments reaching US$721 billion in 2017, and the growing popularity of bitcoin and other cryptocurrencies, tokens are more often targeted by cybercriminals. While the distributed ledgers themselves implement a high degree of cybersecurity measures at their core thanks to cryptology and consensus among multiple nodes, the whole ecosystem does have some possible weak points at its edges that need to be properly secured. One of them lies in the management of the wallets and private keys that control them; it could also be man-in-the-middle attack or advanced social engineering to steal private keys. Not only shall the ﬁnancial institutions consider implementing proper security measures to secure the whole value chain when they run or interact with blockchain platforms, but they might also consider proposing a new kind of service to their customers, for instance, to securely store their wallets and keys. Institutions need to carefully plan for cybersecurity at diﬀerent levels from network and infrastructure, through systems, to applications, and consider the opportunity of diﬀerentiation through advanced cybersecurity prevention.
MiFID, Anti-money laundering (AML), know your customer (KYC), and other regulations are at the center of any ﬁnancial institution’s obligations when it comes to client service. In the token economy in which business interactions are more direct, expeditious and irreversible, operational measures to comply with regulations will have to be adapted, potentially becoming more upstream, factorized, and standardized. Institutions should not reinvent the wheel, but collaborate with new actors such as tech start-ups, KYC utilities, or blockchain analytics software vendors to implement new operational measures and demonstrate to the regulators that they remain compliant while operating in the digital space. We can imagine that, soon, KYC processes would likely be realized once by a specialized KYC utility, encoded in a self-sovereign digital identity, and used by customers each time they enter a relationship with a new ﬁnancial institution. Provided that they have consent from the customer, ﬁnancial institutions will transfer the reference to this identity down the value chain so that other institutions know with whom they are dealing, such as a crypto exchange transferring the identity to a bank. This will speed up the on-boarding process, reduce the overall cost of KYC compliance and, at the same time, enable more direct and rapid interactions that are fundamental to the token economy.
Another area that will be aﬀected is taxation. Financial institutions that are responsible for processing some tax will have to adapt their information systems and processes to compute and deduct certain tax schemes, such as withholding tax. Part of that processing might be encoded in a smart contract and automated, and if the tax authorities do not accept payment of tax in cryptocurrencies, ﬁnancial institutions will remain in the taxation ecosystems.
With legislative and regulatory frameworks diﬀering from jurisdiction to jurisdiction, ﬁnancial institutions must ensure tokens remain compliant both in the issuer’s as well as in the investor’s multiple jurisdictions (e.g., a Canadian seller and Japanese buyer). They should implement measures to prevent investment by customers from jurisdictions with which a token they oﬀer or give access to is not compliant. This is especially true for institutions that have a global scale.
We expect that with the spread of tokenization there will be new actors, new roles, and new services. A decentralized ﬁnancial system does not guarantee one without ﬁnancial institutions, and prepared and forward-thinking institutions will be those that are most able to embrace the token economy. Traditional players will have the opportunity to meet the new demands of a token economy, be it a provision of platforms for storing tokens, or acting as trusted intermediaries for when the blockchain alone is not enough. Those that do not rise to the challenge will struggle in the face of ﬁerce competition for an exciting new, tokenized world.
There are, however, signiﬁcant legal and regulatory challenges. In theory, tokenization sounds great, but in practice, you cannot just disregard existing securities laws, tokenize any property, and start selling shares representing fractional ownership in that asset. Any type of token representing fractional ownership is a security and therefore subject to existing securities laws. This is precisely why existing fractional ownership and real estate crowdfunding products such as REITs (Real Estate Investment Trusts) and eREITs are limited. They would love to cater to retail investors but are typically limited to accredited investors due to existing securities laws. Any future reform that allows for blockchain based REITs, which typically tokenize commercial properties, to accept investments from retail investors would also apply to traditional REITs which is precisely why we don’t see consider these types of projects to be particularly disruptive or exciting.
Commercial property trading is plagued by being an inherently illiquid asset class involving many hidden costs, regulations, middlemen and a lack of transparency.
With the advent of blockchain-based smart contracts, a trend emerges for establishing disintermediated collaboration structures to engage in the formation of P2P transactions.
The state-of-the-art shows that technologically it is possible to create P2P commercial transaction platforms that eliminate cost-creating and time-consuming intermediaries and obsolete stage processes while fulfilling the goals of a unifying Constitution that ensures that the Projects within the network are strictly defined by intent rather than various competing legal entities, and only for the purposes of securing transactions and defining chain of ownership. This paper ﬁlls the gap by answering the question of how to provide a smart-contract/blockchain based commercial property trading and value- chain platform that avoids disintermediated middlemen for enabling P2P trades with low costs and optimized time consumption
This presents the case for the novel blockchain technology-based Funder One-Capital system for a smart-contracts driven trade of real property. We ﬁrst deﬁne the requirement that must be satisﬁed by presenting a unifying Constitution comprising organized sets of reﬁning functional goals of all entities within the Funder One-Capital system. Subsequently, the dynamic behavior of the components ensures all blockchain transactions for definable events that must be immutably stored. This shows with pre-existing industry solutions, the Funder One-Capital system can be quickly deployed. At the same time, we also show that the aspect of creating veriﬁable smart contracts for the Funder One-Capital system is still a topic of ongoing research and legal regulation, so the implementation of a flexible, network-based constitution allows for the appeal to multiple jurisdictions and changing legal environments through the codification of intent securing all Project Compacts.
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- Inside Magazine 19 part 2 – from a core transformation, technology perspective