Disclaimer: This material is intended for general information purposes only and does not constitute legal advice.

The Tokenization: Introducing How Real Estate Can be Tokenized

Generally, the process of tokenization may be compared with securitization. Both convert low-liquidity real world assets into high-liquidity financial instruments, with the key difference being the method of conversion and medium of operation.

Tokenization turns low-liquidity assets into highly-liquid digital tokens enabling fractionalization, trading and compliance by design powered by the functionalities of Distributed Ledger Technology (DLT) and Decentralized Finance(DeFi) ecosystem.

In practice, real estate tokenization refers to the process of securitizing the real estate assets in a Special Purpose Vehicle (SPV) and tokenizing an instrument issued by the SPV (e.g. shares, bonds, derivatives, etc.) in the form of digital tokens which are offered to investor in a Security Token Offering (STO).

The Jurisdiction

The choice of jurisdiction for the tokenization vehicle and conduct of the offering is a crucial piece of the puzzle as it determines the applicable law and regulatory constraints. The ability to tokenize certain financial instruments (e.g. shares, bonds, derivatives, etc.) is determined by the applicable corporate and securities laws, therefore, the chosen jurisdiction must allow to compliantly represent these instruments with digital tokens.

In many jurisdictions, the main obstacles for tokenization of these instruments are typically archaic processes and outdated requirements, such as the requirement for notarization to effectuate transfer of rights, non-recognition of digital shareholder registers, and legal uncertainty with respect to enforceability of smart contracts.

The following is a (non-exhaustive) list of suitable jurisdictions that avoid these pitfalls either through introduction of dedicated digital asset legislation or targeted removal of obstacles to tokenization:

• United States (Delaware, Wyoming, California)
• EU/EEA (Germany, France, Spain, Denmark, Luxembourg, Liechtenstein, Estonia, Malta, Portugal)
• Switzerland
• UAE (Dubai, Abu Dhabi)
• Asia (Hong Kong, Singapore, Malaysia)
• Africa (Nigeria, South Africa, Mauritious)
• Offshore (BVI, Bermuda, Cayman Islands, etc.)

The Structuring

Structure your tokenization according to your goals

The design of the legal structure will depend on the specific goals of the offering and legal constrains of the chosen jurisdiction. If real estate assets are located in another jurisdiction from the tokenization vehicle, then such assets must be securitized in a separate local special purpose vehicle (SPV) which is wholly owned by the tokenization vehicle. This is necessary due to complexities of direct ownership of foreign real estate and for liability purposes.

The following is a (simplified) illustration of the typical structure

The structure of the tokens itself depends on the business model of the issuer, but most commonly real estate is tokenized either through digital equity shares or bonds issued by the SPV.

The legal process for linking the tokens with shares or bonds varies from jurisdiction to jurisdiction, however, it typically involves an amendment of the articles of association (bylaws) of the company, issuance of board resolution, and preparation of investor agreements.

Technology integration should also be conducted in parallel with the legal process by onboarding a tokenization platform.

The Listing

A short definition of primary and secondary investment offering

In a primary investment offering, investors are purchasing shares (stocks) directly from the issuer. However, in a secondary investment offering, investors are purchasing shares (stocks) from sources other than the issuer (employees, former employees, or investors).

Listing on an exchange for primary or secondary offering

Pending on your tokenized asset, you might benefit from listing on an exchange such as RealEstate.Exchange (RE.X). In order for listing tokenized securities an issuer would need to complete the following steps:

1. Structuring and securitisation of real estate assets in an Special Purpose Vehicle SPV
2. Tokenisation of equity or bonds issued by the SPV
3. Go through a KYB verification and technical onboarding process
4. Comply with financial promotion legislation depending on the type and scope of the offer

The last point warrants additional attention, if an offering is directed towards retail investors it would generally require a prospectus approved by a relevant financial authority of an EU member state. However, for certain issuers and types of offerings, a full prospectus would be inappropriate because of the time, cost and complexity involved in the approval process. An alternative is to relay on one of the following exceptions:

• The total size of the offer in the Union is below EUR 8 million (applicable in Germany and includes retail investors)
• Offer is directed solely to qualified investors
• Minimum investment/ticket size is EUR 100,000

In case of the offer under EUR 8 million on RE.X, the issuer would need to comply with the requirements set out by the German Federal Financial Supervisory Authority (BaFin).

In particular, such issue would need to prepare a short 3 page Securities Information Sheet (WIB) and file it with BaFin, more information can be found here.

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I’ve been working as a journalist, educator and filmmaker for years, and then I fell down the rabbit hole. I will happily engage in any tokenization, blockchain or real estate discussion. I am also interested in productivity, AI-creation tools for art and culture.

This article outlines the legal aspects of tokenizing assets on a blockchain using real estate as an example. It is created by Volodymyr Havrylyuk-Yensen, Legal Counsel at DigiShares | Digital Securities & STO, and Emil Holtemann, Marketing Manager at RealEstate.Exchange.