Archive for category: Banks

-Subhojit Shome (subhojit@vinodkothari.com)

Introduction

The tokenisation of real-world assets (RWA) using cryptographic technology is rapidly emerging as a transformative innovation in the financial ecosystem. Note here that the term RWA refers to all traditional assets including both real assets as well as traditional financial assets that exist in the physical world. By leveraging blockchain technology, tokenisation enables the representation of tangible assets, such as real estate, commodities, and artwork, or intangible assets like intellectual property, as digital tokens on a distributed ledger. This development is reshaping the way assets are managed, traded, and accessed, creating new opportunities and challenges.

RWA tokenisation has garnered attention due to several converging factors. Blockchain technology offers a streamlined alternative to traditional systems by reducing intermediaries, lowering transaction costs, and ensuring faster settlement times. Fractional ownership of high-value assets makes them accessible to a broader range of investors, enhancing market liquidity. Blockchain’s immutable nature provides a transparent record of transactions and ownership, reducing fraud and enhancing trust. Additionally, tokenised assets are borderless, enabling seamless cross-border trading and investment opportunities.

According to market reports, the capital locked in tokenised RWA is expected to touch $50 billion by the end of 2025 surpassing all previous records. In 2024, the ecosystem had achieved a 32% annual growth rate.

In this article, we look at the impetus behind this technology, its status of adoption in India and critical issues that act as roadblocks in its development. 

Development

The tokenisation market has witnessed significant advancements in a number of areas. Real estate tokenisation has enabled properties to be tokenised for fractional ownership, reducing entry barriers for smaller investors. Similarly, commodities like gold and other precious metals have been tokenised, providing an efficient means of trading and ownership. High-value artworks and collectibles are being tokenised to allow multiple investors to own shares in masterpieces. Tokenisation has also extended into private equity and debt markets, enabling innovative funding mechanisms and the development of secondary market opportunities. Moreover, the emergence of regulated tokenisation platforms in certain developed economies (e.g. the UK) underscores the growing maturity of this market.

Figure 1: Benefits of Tokenisation of Real-World Assets using Blockchain

Fractional ownership creates liquidity in traditionally illiquid assets. It also democratises investment by enabling wider participation through reduced minimum investment thresholds. Here the emphasis is not on reduction of any regulatory investment threshold but rather, being represented in the digital world, RWA tokenisation allows infinitesimally fractional parts of an asset to be bought and sold. Cost efficiency is achieved by reducing reliance on intermediaries, which lowers transaction and administrative costs. Blockchain’s transparency increases trust and reduces fraud risks. Furthermore, smart contracts enable automation of compliance, dividend distribution, and other processes.

Process

The process of RWA tokenisation broadly involves the following steps –

Figure 2: Process of RWA tokenisation

In the tokenisation process one may note that the custody of the underlying asset is separated from the ownership of the asset. While the ownership is represented by use of tokens, the underlying asset may need to be held with a custodian ‘off-chain’ (i.e. in the physical world). 

Issues

However, tokenisation is not without challenges. Regulatory uncertainty remains a significant hurdle due to inconsistent global regulatory frameworks. Technology risks, such as cybersecurity concerns and vulnerabilities in smart contracts, could undermine trust. Market volatility is another concern, as tokens may experience higher price fluctuations compared to their underlying assets. Some tokenised assets may face illiquidity risks if the secondary markets lack sufficient depth. Additionally, legal ambiguity regarding ownership rights and the enforceability of tokenised claims persists in many jurisdictions.

Several key regulatory considerations must be addressed. Asset classification is crucial for defining whether tokenised assets are securities, commodities, payment instruments or another category altogether.

In India, regulatory uncertainty remains the key issue in the implementation of RWA tokenisation. Say, for instance, there is tokenisation of real estate in which the management of the property is overseen by the issuer or by a manager appointed by such issuer and fractional ownership units are offered for sale to retail investors. Such a transaction starts to take on the colour of a collective investment scheme and SEBI may intervene and mandate the issuer to register as such with the regulator. In the case of real estate these schemes can also be viewed as having a structure akin to a REIT especially SM REIT. 

The SEBI is yet to notify any regulatory prescription specifically for the purposes of regulating crypto-assets and or token offerings to the retail public and it has been reported in the press¹ that the securities market regulator has informed the Parliamentary Standing Committee on Finance that regulation of crypto-assets would be difficult given the nature of technology that sustains them. In the matter of, An RTI enquiry, as referenced in the matter of Appeal No. 4532 of 2021 filed by Rohith Methayil Rajagopal, was raised with the SEBI’s CPIO as to the stand of Regulator with regard to “digital trading and possession of Cryptocurrencies by the Indian Citizens” and if SEBI had any “legal document and its date that permits digital trading of Bitcoin / Cryptocurrencies in India”. The response of the CPIO, as affirmed by the appellate authority, was that it did not have the knowledge of either matter. Based on this one can conclude that the Regulator has not, yet, formalised its stance over dealings in crypto assets. Recently, however, the Regulator has expressed an openness to a multi-regulator based oversight framework for crypto-assets.²

There have been interest shown by mutual fund houses to invest in ETFs or indices on blockchain-based projects and crypto-assets and draft scheme information documents were filed with the Regulator. SEBI, however, has expressed its reservations³ on approving such funds/ fund of funds. Highlighting high degree of regulatory uncertainty when it comes to crypto-assets which is not an ideal situation either for business houses looking to raise funds using crypto-assets or for investors who have invested in such assets.

Another major inhibitor is the tax treatment of such tokenised assets. This is because given the construct of such token it will get classified as virtual digital asset  under section 2(47A)⁴ of the Income Tax Act, 1961. The implication of this is that income on sale of such assets will get taxed at a flat rate of 30%. Other than the cost of acquisition, any other expenses incurred with respect to such assets are not allowed to be deducted while computing the income. Further, any loss from the transfer of such assets are also not allowed to be set-off against such income or under income computed under any provision of the act. Accordingly, such losses are also not allowed to be carried forward to any succeeding assessment years.

GIFT City

Recently, however, there has been some headway in asset tokenisation in Gujarat International Finance Tec-City (GIFT City) which may be poised to host India’s inaugural regulated platform for the tokenization of real estate and infrastructure assets. This initiative aims to democratize investment opportunities by enabling fractional ownership through digital tokens, leveraging blockchain technology to enhance liquidity and transparency in the sector. To this extent the IFSCA has constituted an ‘Expert Committee on Asset Tokenization’; the terms of reference of this committee are as follows –

• Develop regulations and policy guidelines for tokenization of real and physical assets
• Examine the legal validity of Smart Contracts
• Develop a risk management framework for digital tokens
• Examine the role of Digital Custodians in the asset tokenization model and develop operational policy measures

Conclusion

Tokenisation is a transformative technology that has the capability to change the very nature of real world assets in the way they are managed and traded. The flow of capital into this sector is an indication of the potential of this sector in contributing to the economic growth of a country. In the formation of the working group on crypto-assets to reform US digit asset regulations, the US has taken stock of this development in the market and the need to make such technologies mainstream. It is encouraging to see India’s intention to move ahead with such innovation in the GIFT City. It is now time to wait and watch whether tokenisation will find acceptance in the economic mainstream and for this to happen a clear regulatory architecture has to emerge in India.

1. Why has the market watchdog said it is difficult to regulate such currencies? What is the status of the bill? – Article in The Hindu, June 12, 2022 ↩︎
2. SEBI considers regulatory role in crypto trading, diverging from RBI’s approach. Here’s what experts think – Article in the Economic Times, May 17, 2024 ↩︎
3.  Sebi says no to mutual funds for cryptos. What are your alternatives? – Article in the Economic Times, December 30, 2021 ↩︎
4. Virtual crypto-assets as defined under Section 2(47A) of the Act means—
    any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically; a non-fungible token or any other token of similar nature, by whatever name called;
   any other crypto-asset, as the Central Government may, by notification in the Official Gazette specify. 
   However, the Central Government is empowered to exclude any crypto-asset from the definition of virtual crypto-asset by a notification in the official gazette on this behalf.
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