Blockchain companies flock to Switzerland for its favorable outlook towrad cryptocurrency. Recently, Switzerland’s Crypto Valley Association released a paper providing a framework for asset tokenization under Swiss law. We decided to take a deep dive.
The paper addresses legal and technical questions around the tokenization of assets, providing guidance to entrepreneurs looking to issue digital tokens in the Alpine nation. Crypto Briefing decided to take a deep dive into the paper to assess just how easy it is for startups to launch tokenized assets and securities in Switzerland.
Setting the Context for Asset Tokenization in Switzerland
Amid ongoing regulatory uncertainty in the U.S., many blockchain firms have decided to set up shop in Switzerland. Zug’s Crypto Valley is now home to 800 companies operating in the blockchain or cryptocurrency space, including the Libra Association, the Ethereum Foundation, and Bitmain.
The Swiss Financial Market Supervisory Authority (FINMA) has taken a pragmatic approach of “same functions, same rules” in applying existing financial and securities rules to cryptocurrencies and tokens. At the same time, it’s been steadily issuing guidance in response to ongoing developments in the space.
One of the most significant pieces of guidance came last year when FINMA released a paper outlining its position on ICOs. It provided three categories of tokens: payment, utility, and asset tokens. These categories aren’t mutually exclusive and any token falling into the asset category would likely be classified as a security.
However, since the initial guidance came out, there have been several developments. Asset tokenization has become a broad term, where the asset underlying any given token could be anything from a share in a mutual fund, to a derivative, to a physical object. Furthermore, the Swiss Federal Council passed a proposal to amend several existing laws to accommodate some specific characteristics of blockchain.
Therefore, the Crypto Valley paper aims to provide a comprehensive interpretation of the Swiss position on asset tokenization. So, how easy is it for anyone to create their own asset-backed tokens in Switzerland?
The paper is 52 pages long, so you can rest assured that there are still plenty of legal and regulatory considerations underpinning asset tokenization, even in blockchain-friendly Switzerland. The sections of interest to anyone looking to tokenize a particular asset cover the types of assets and their tokenization, as well as the issuance of tokenized assets onto primary markets.
Types of Asset Tokenization
There are six different types of tokenized assets, according to the paper. These are shares, participation certificates, cooperative membership, bonds, collective investment schemes, derivatives, and titles representative of property.
Tokenized Shares and Participation Certificates
In September of this year, the Seychelles national stock exchange announced its first IPO in tokenized shares — the first of its kind in the world. According to the Crypto Valley paper, Swiss companies wanting to follow suit will need to adhere to the same procedures as companies wanting to issue traditional shares.
A public offering of shares involves filing a prospectus with FINMA and undertaking the necessary anti-money laundering checks on purchasers. The company’s articles of association will also have to be updated with some specific provisions around the tokenized shares, such as what happens in the event of a loss.
Participation certificates convey the same economic benefits as a share, but without any voting rights. Intriguingly, although tokenized participation certificates are treated as securities by FINMA, the paper states that there is no legal requirement for issuers to obtain FINMA approval. This is provided that the company’s Articles of Association allow for the issuance of tokenized participation certificates, that the shareholders consent to the issuance, and that there is a register of the certificates issued.
Therefore, issuing tokenized participation certificates may be a means of tokenizing equity for companies wanting to avoid the regulatory hurdle of gaining prospectus approval. The paper does recommend that any issuance of participation certificates should be on the basis of a memorandum detailing the investment terms, even if a full prospectus isn’t legally required.
Cooperative Membership
A cooperative under Swiss law is defined as “a legal entity which serves the purpose of promoting and safeguarding specific economic interest of the members which form part of it.” However, it cannot necessarily be set up as a DAO because proof of cooperative membership cannot be in the form of a security or asset, meaning this provision is extended to tokenized securities or assets.
While observing the necessary prospectus filing requirements, it is possible to use a utility token as a technical tool to facilitate voting processes among members of a Swiss cooperative.
Essentially, a Swiss cooperative can operate as a DAO, provided that the membership titles don’t offer any financial stake in the cooperative itself, and the voting tokens operate as a pure utility token.
Tokenized Bonds
It is possible to issue tokenized bonds. However, as security tokens, these would fall under the supervision of FINMA.
Assuming bond issuers are prepared to undergo the necessary regulatory checks, the paper outlines many benefits to issuing bonds on the blockchain. For example, smart contracts can be used to automate interest payments and repayment at maturity.
Collective Investment Schemes
Collective investment schemes are better known as funds. The paper discusses the legal basis of a tokenized fund, where a digital token represents investment units in the fund.
Swiss law allows for various types of funds, and each is strictly regulated. As the paper puts it: “FINMA is currently not inclined to deem collective investment schemes issuing their units/shares as Tokens as eligible for approval.”
This is for various practical reasons. One is that the custodian bank for a fund has specific legal responsibilities in issuing and redeeming the fund shares, that cannot simply be replaced by a blockchain. So, for the time being, tokenized funds have no legal basis in Swiss law.
Derivatives
As expected, derivatives of any nature are regulated as securities under Swiss law. Therefore, anyone wanting to issue tokenized derivatives must comply with all the relevant prospectus filings laid down by FINMA, and all dealings in tokenized derivatives are subject to FINMA supervision.
Titles Representative of Property
“Titles representative of property” refers to tokens that confer ownership rights of a physical asset. One of the more intriguing parts of asset tokenization is the potential to “tokenize anything,” such as art, real estate, a sports club, or any other physical assets. The potential for physical asset tokenization means that someone could own a fraction of that asset. This opens up markets to broader pools of investors, bringing new liquidity.
According to the paper, unfortunately, this potential may be some distance in the future, under current Swiss law. It discusses “immovable assets,” such as real estate, as well as “moveable assets,” such as a sports car. The challenges are largely practical and likely to translate into many other jurisdictions. For example, real estate ownership has to be recorded into a land registry, meaning that simply buying and selling fractional ownership tokens doesn’t actually convey any legal ownership rights.
While there’s nothing to stop investors buying shares as tokens, such a sale could be deemed as a collective investment scheme and subject to the necessary licensing requirements for such a scheme.
Regulatory Considerations of Token Issuance
Even though not all instances of asset token issuance may attract the supervision of FINMA, the tokenization paper advises caution. In all cases of issuing security tokens, it recommends clarifying the position with FINMA, even if the project has sought specialist legal advice. FINMA will answer short questions by email. However, for more detailed assessments, projects can expect to pay a fee to the regulator, which will vary according to the time taken.
Summary
The Crypto Valley paper is perhaps the most extensive documentation available that compares the practical reality of asset tokenization with existing legal frameworks. Although it’s almost impossible for asset token issuers to avoid regulatory hurdles, this is inevitably going to be the case in many developed countries as the cryptocurrency space matures.
However, Switzerland remains light years ahead of the U.S. in providing blockchain startups freedom to operate through a transparent set of rules and procedures that they need to follow. Until US lawmakers start to take a similarly pragmatic approach, fintech entrepreneurs are likely to continue their exodus to the land of cheese, chocolate, and chain-based assets.
Please note that this article is merely a summary of the Crypto Valley Asset Tokenization paper, which itself is a summary of the main provisions of Swiss law governing asset tokenization. This article should not be construed as legal advice.
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