Asset Tokenisation: IFSC signals plan to move forward, set regulations

The IFSCA formed a committee to develop regulations for the tokenisation of real and physical assets and examine the legal validity of smart contracts.

In the week following the G20 summit, the International Financial Services Centres Authority (IFSCA) became the first Indian regulator to officially announce its intention to come up with regulations and policy guidelines governing a blockchain-based product. The IFSCA formed a committee to develop regulations for the tokenisation of real and physical assets and examine the legal validity of smart contracts. The regulator’s move signifies a renewed proactive approach by India towards regulating emerging technologies and shall enhance India’s recognition on the global stage as a forward-thinking player in the blockchain space. It seems to be a well-timed move as tokenization is expected to have a huge impact on the world economy, even more than cryptocurrency.

Few assets have been tokenized to date with the exception of cash in the form of fully reserved “stablecoins” and tokenized bank deposits. As per Binance, the largest crypto exchange, fiat-backed stablecoins made up more than 90 percent of the total stablecoin market cap. However, a report by the Citi Group released in March 2023 predicts that the cumulative size of tokenized assets globally could reach up to $5 trillion in value by 2030. Later in April, Franklin Templeton launched the first US-registered mutual fund that is run on Ethereum via Polygon, an Indian blockchain-as-a-service (BaaS) provider.

Digital Representation Of Assets

Put simply, tokenization through blockchain refers to the digital representation of real-world assets (RWAs), both tangible and intangible. These tokens carry immutable records of all transactions with respect to the RWA represented. This makes the investments more secure and promotes ease of transaction and liquidity. Tokenization can streamline operationally intensive manual processes, thus, reducing transactional costs. These cumulatively make it feasible for smaller investors to deal in assets otherwise associated with high transaction costs. Thus, democratizing the participation in financial markets. Taking the example of real estate, the transfer of tokenized assets could possibly take place without visiting a government office, registering a sale deed and mutation of land records. Smart contracts could be coded in a way to achieve the same effect as provided by these intermediaries.

Apart from tokenization, fractional ownership of assets is yet another way in which blockchains can further contribute to the process of democratization by enabling more investors to participate in the markets. For example, investment in a company necessitates the ability of the investor to at least buy a share in the company. However, fractional ownership would enable an investor to buy a fraction of the share. A share in MRF (tyre manufacturer) for instance is worth around Rs 1,00,000. Fractional ownership, however, would allow 100 individuals having Rs 1,000 each to invest in the company. Fractional ownership is already permitted in foreign stocks listed in GIFT City through deposit receipts.

Additionally, SEBI’s proposal for the regulation of entities facilitating fractional ownership of real estate is another step in that direction. hBits and RealX are the major players in the Indian real estate market that facilitate fractional ownership. They use blockchain technology for the same. This is like REITs and InvITs except it allows for direct ownership of a fraction of the asset, unlike REITs and InvITs.

Considering that the idea of fractional ownership exists independent of blockchain, what difference does blockchain make? Transparency is key to ensuring that the large-scale influx of new investors facilitated through fractional ownership continues to be safe. Transparency in this context does not mean that all the data related to a transaction will be available to everyone but rather that the technology would eliminate the need to verify personal details in a trustless system enabled by blockchains. Going back to the real estate example, smart contracts can be used to efficiently manage ownership rights and distribute profits to investors based on their fractional ownership without necessitating an intermediary.

Need New Regulatory Framework

The prospects for tokenization are however not without concerns. Tokenization often involves the creation of digital securities, which may not fit neatly into existing securities laws in India. Regulators must create a new framework to accommodate the new form of ownership facilitated by blockchain.

The challenges, however, are associated with the present state of the technology as well. Having multiple blockchains in different jurisdictions can lead to interoperability problems. They may arise while interacting with centralized backend systems outside blockchain ecosystems and across new architectures built on different chains. An additional challenge is that of a lack of experienced virtual digital asset service providers (VASPs) such as those with expertise in the safe-keeping of tokens.

Despite these concerns, the move by IFSCA is a big step towards India’s embrace of blockchain technology. As we await more comprehensive regulations, the government must also consider encouraging the existing and prospective VASPs to devise innovative solutions to facilitate faster adoption of blockchain technology. Industry consultations by the government in policy formulation can be very useful in this endeavour.

—Aditya Rathore, Consultant, Cyril Amarchand Mangaldas contributed to this article.

Arjun Goswami is Director - Public Policy, Cyril Amarchand Mangaldas. Views are personal, and do not represent the stand of this publication.