June 10, 2021 · 6 min read
Should all digital assets be subject to financial regulation? - Introducing a "sensible" token classification system
Novum Insights is pleased to share a "Sensible Token Classification System" presented by Global Blockchain Convergence. Novum Insights is an active participant in the GBC trade body. In this blog post, we summarize main points illustrated by GBC. Click here to read the full document.
Since Bitcoin was launched in 2009, the cryptocurrency world has faced regulatory scrutiny due to an unclear regulatory framework around the emergent technology. Financial regulators and policy makers' initial responses raised concerns that its anonymous nature could be well exploited for illicit activities such as money laundering and funding terrorist activities.
Regulators around the world have responded in varying ways from banning crypto to sandbox style experimentation. They have scrutinised digital asset exchanges on two fronts; firstly, they want to ensure that digital asset exchanges are not facilitating trading in regulated financial products (e.g., tokens which have the characteristics of securities) without holding the appropriate license or authorization and, secondly, they want to understand how exchanges market their services to potential customers and whether such marketing activity itself constitutes some form of regulated financial activity for which a license or authentication and authorisation is required. At the same time, it is clear that not all digital assets should be subject to financial regulation.
A clear gap has been any kind of globally accepted token asset classification system. Today we introduce a “sensible token classification system” led by Lee Schneider of the Global Blockchain Convergence (GBC), an informal global organization dedicated to creating an environment that facilitates the adoption of blockchain and other complementary technologies.
GBC first points out that whether physical or intangible, anything can be tokenized and be represented digitally on distributed ledger technology. Many tokens already fall under well developed legal framework, however, subjecting all tokens to financial regulation may not be appropriate because the mere act of tokenization does not change the essence or inherent characteristics of the underlying asset.
The “sensible token classification system” categorizes different tokens by functionality and/or features. Then it goes back to the often-cited principle of “same asset, same risk, same regulation” or “same activity, same risk, same regulation.” Expanding this principle, GBC notes that “what has been regulated a particular way for the physical world should be regulated the same basic way for the digital world.”
The sensible token classification system thus introduces five categories of tokens - 1. physical asset tokens, 2. services tokens, 3. intangible asset tokens, 4. native DLT tokens, and 5. stablecoins. Below we map out the GBC taxonomy.
Physical Asset Tokens
Physical asset tokens are a digital representation of a real-world (tangible) asset created and maintained on a distributed ledger, including blockchain. These assets fall within well developed regulations, abiding by the principle of “same asset, same risk, same regulations.” The fact that the tokenized versions of physical assets result in greater liquidity should not result in different regulatory treatment. Assets in this category include tokenized gold, tokenized paintings (not digital art, but real-life art), tokenized designer shoes and more.
Services tokens are a digital representation of services to be provided by person(s)/entities to other person(s)/entities. Assets in this category include music files, purely digital art files, cleaning services tokens, concert tokens and more. As these are “services” tokens, applicable terms and conditions may set the parameters and limitations of the services to be provided. For music or digital art files, the associated copyrights, licenses, intellectual property may fall under the “intangible asset tokens” category discussed next, unless they are transferred with the files.
Intangible Asset Tokens
Intangible asset tokens are any traditional intangible asset tokenized on DLT. These assets also fall within well developed regulations like the two above. Assets in this category include security tokens, real estate ownership tokens, intellectual property, government program tokens and more. As these tokens represent intangible assets, it is important to include terms and conditions, limitations and obligations of different parties in the smart contract.
Native DLT Tokens
Native DLT tokens are native to the distributed ledger technology. One might confuse Intangible Asset Tokens and Native DLT Tokens. The latter cannot exist outside of DLT. These tokens are created by a smart contract and the desired functions and features can be programmed within the token. GBC sets out the characteristics of native DLT tokens below. Native DLT tokens serve as / provide at least one of the following:
As these tokens’ features and functions can be built with programming, this category of tokens does not have a pre-specified set of features and functions. GBC therefore proposes to regulate entities that provide services around native DLT tokens, not individuals using such tokens and services.
Stablecoins are tokens designed to maintain stable value against an underlying asset, reference or a basket of assets. Excluding tokens that overlap with the categorizations set out above, there remain tokens designed to be used as a general means of payment and tokens stabilized against fiat currencies.
We are in the formative stage of the crypto markets and Decentralized Finance. The taxonomy presented by Global Blockchain Convergence and other initiatives taken by complementary industries contribute immensely to the smooth transition to the digital world and serve as a valuable material both to regulators and the community as we navigate this rapidly evolving ecosystem.
If you want more detailed information about the sensible token classification system, click here.
More about Global Blockchain Convergence
GBC is an informal global organization whose primary mission is to create organic opportunities for collaboration and self-organizing communities of professionals from diverse segments of the global blockchain ecosystem, dedicated to advocating, writing about and generating proposed approaches to business, market and policy frameworks that facilitate the adoption of blockchain and complementary technologies and that advance entrepreneurship and inclusion. Our membership includes nearly 200 professionals, many with extensive backgrounds in legal, compliance and operations. Members volunteer time and resources in working groups, monthly meetings and projects to help further initiatives and education. This classification system represents one of those collaborations and does not purport to speak for all members of GBC.*
* Primary author: Lee A. Schneider. Contributing authors: Emma Channing, Joey Garcia, John Ho, Jannah Patchay, Emma Pike, Wendy Saunders, Dr. Jane Thomason. The authors would like to thank those who helped us refine the ideas laid out in this sensible system.