Gunnar Jaerv is COO of First Digital Trust, a Hong Kong-based financial institution developing of tokenized asset custody solutions.
In the last couple of years, traditional financial institutions and regulators have started to embrace digital assets. Asset tokenization – declaring ownership rights to an asset in digital form – is opening up new market opportunities, channels of investments and consequently, new streams of capital for global businesses and markets.
Some estimates show that more than $544 trillion worth of assets could become tokenized in the future, and nations with progressive regulators will be the first to access its potential. There’s been a recent uptick of financial regulators and institutions developing digital asset adoption infrastructure further indicating the advancement of this new way of managing funds. In May 2020, the Swiss Financial Market Supervisory Authority (FINMA) declared customers can now legally carry out digital asset transactions, for example.
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French banking giant Societe Generale is testing tokenized bonds that are settled in digital euros by the central bank of France. In Asia, Hong Kong’s Inland Revenue Department has begun providing guidance for taxpayers on how to correctly invest in these new forms of digital assets.
Institutional adoption of tokenized assets in 2020 is inevitable, but, like other newly introduced assets, they need clear taxation processes, security protocols and regulatory frameworks across the board for investors to make the most of them legally, and safely.
Tokenization of assets is starting
From precious metals to real estate and art, tokenization is revolutionizing a wide range of industries.
One of the most popular forms of tokenization is precious metals, in particular gold. Gold has long been a trusted store of value for investors, especially when fiat currencies experience volatility. By tokenizing assets like gold on the blockchain, you are guaranteed the digital rights to your investment.
Tokenized gold has a myriad of benefits when it exists on the blockchain. Firstly, when investors buy-in, they are purchasing the rights to real physical gold stored in secure vaults. This eliminates issues of storage and transport and eradicates unnecessary bureaucracy and untrusted third parties, as the asset is immutable and instantly accessible on a distributed ledger.
It can be traded, collateralized or static, and can be cheaper too. Traditional gold purchases have added premiums up to 30% when sold through retailers. When you buy tokenized gold, you’re able to access it closest to its spot market price. And if you were looking to break up a traditional gold bar, it immediately drops in value and you can no longer sell it in bulk to certain institutions.
In the real estate industry, you can now enjoy the luxury of investing in property by purchasing fractional ownership, which dramatically opens up opportunities for wealth. In 2018, Hong Kong was the most expensive city for property, with the average price for a home costing $1.24 million. For the majority of the population, entering the house market is a near impossible task. Digitized real estate is not a radical idea either as it already exists in the form of digital titles in various countries around the world.
Some countries are still using outdated forms of record-keeping via paper, but many are already keeping digital records. The next step is adding this asset to the blockchain and drafting smart contracts that declare the rights.
Having real estate titles on a decentralized ledger can boost investor confidence and foreign direct investment too. Some countries are plagued with inefficient record-keeping and corruption concerns. With a title registry on the blockchain, these transactions are transparent and secure, enabling investors to rest assured record titles are honored by government bodies.
In sport, we see Spencer Dinwiddie, a famous NBA player, becoming the first athlete to tokenize his own contract and introduce a new asset class to a fanbase of more than 2 billion. In the art world, we see enthusiasts purchasing digital tokens to own a portion of rare anime artwork.
There’s a few things to consider when deciding to invest in tokenized assets. It’s simply not enough just to purchase a token – you need to understand the tax requirements of your investment and the regulations of your own jurisdiction.
Digital tokens often fall under strict regulations that can vary significantly from jurisdiction to jurisdiction. Therefore you should only trade on exchanges that are compliant. If jurisdictions prevent the free and international exchange of tokens, then your opportunities will be limited. But, luckily, international regulatory alignment is increasing.
Some regions of the world have environments of free token trade, allowing the industry to flourish. Hong Kong, where First Digital Trust is located, has a unique position. The growth of Ethereum has led to many private and public companies moving to the city to make the most of its position in business, technology and law.
On top of that, assets like gold are taxable in the hands of individuals or corporations in most places around the world. But in Hong Kong, gold tokens can be designed so that U.S. taxes can be deferred. This has made Hong Kong an ideal location for tokenized trade.
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The Basic Law of Hong Kong enshrines multiple free market principles that have always made it an enticing financial hub and place of trade. Despite COVID-19 causing economic challenges, and the recent turn of events, Hong Kong’s free market principles have not been affected. The financial centre has remained resilient, and global trade continues to flow throughout the city.
In 2019, the “Statement on Security Token Offerings” was announced, highlighting a strong interest in the new asset class of virtual assets, acknowledging the advantages of cryptocurrencies, crypto-assets and digital tokens.
The benefits for institutional investors are undeniable, but what’s holding them back is a lack of clarity. Digital assets are not just shiny cryptocurrencies. They are securities and commodities in various forms. Investors aren’t clear on what can be tokenized, and they are not confident in the regulations and processes surrounding them.
For this industry to thrive, we need greater involvement from key players. We need more than token issuers running the project – we need taxation, accounting, ownership titles, custodians, legal teams, auditors and regulators. We need a global collaborative effort and the regulatory infrastructure to optimize on these opportunities.
Real-world custodial solutions
With new asset opportunities, there also comes new risks. For example, if a token issuer is also holding onto the underlying assets, what’s stopping them from selling it or borrowing against it? How do you protect the claim to the underlying asset and be protected by law?
As with any new digital asset advancement, the correct technology and infrastructure must be able to protect it. This is where custody services are critical, and why they are on the rise. Qualified independent custodians and trustees hold the title and safekeep the real-world asset that is backing the digital token.
Furthermore, digital assets can be fraught with risk if they are not settled correctly. Custodians eliminate the risk of counterparties failing to fulfil a transaction, and investors are better protected when using regulated custodians. The solutions for digital asset security must be as robust as traditional asset security.
Tokenized assets are the future, and regional regulators, custody providers and investors all have a part to play. There is immense potential in opening the doors to tokenizing assets, but a global standard is required. Legislative and regulatory frameworks differ from one jurisdiction to the next, limiting the spread of adoption.
Without supportive regulatory measures, increased engagement from relevant parties and stronger levels of protection, the whole industry is at risk. A lack of scrutiny and protection could shatter the entire token economy, scaring off investors from digital asset potential. But if we do it right, the opportunities are endless.
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