by Yanina Petrovskaya, Alexander Yudovich, and Philipp Lennert, Rechtsanwälte Lennert Partners.
After over 80% of unregulated initial coin offerings (ICOs) turned out to be scams, regulated security token offerings (STOs) became more popular. It turned out that almost every asset can be linked with token as entry in a decentralised register which leads to the appearance of security token, tokenised or digital security.
Security tokens, together with cryptocurrencies, are a fairly new topic in financial market reality and law. The potential of the security tokens or assets tokenisation markets is claimed to be worth billions. In 2018-19 we have seen the rise of security token offering both as a method of fundraising and an attempt to make some illiquid assets such as real estate more liquid. Global STO research with statistics was provided by a swiss tokenisation platform Blockstate, which can be used as illustration for the above statements.
Switzerland and Liechtenstein, as countries with reputable financial markets, recognised the potential of asset tokenisation for their financial market early in its development, and have done much work to provide relevant legal frameworks. In 2018-2019 around fifteen STOs were conducted in Switzerland and around seven in Liechtenstein. The Principality of Liechtenstein as possible jurisdiction for initial coin offerings (ICO) and blockchain projects in general got on the radars together with Switzerland as it published ICO fact sheet in 2017.
One of the first prospectuses on security token issue in Europe was approved by regulators starting from August 2018, ie, prospectus of the NEON Exchange by Financial Market Authority (FMA) Liechtenstein.
Also the “Alpine Malta” attracted attention of the international and especially European crypto-community, when it announced to be one of the first countries in the world to adopt a special legislation on blockchain namely the Token and TT Service Provider Act (Token and Trustworthy Technology Service Provider Act, TVTG, Blockchain Act), also called the Liechtenstein Blockchain Act, which has been enforced from the beginning of 2020, creating one of the world’s first safe and regulated environment for token related services.
This forward-thinking act creates legal security and trust for blockchain service providers as well as protects investors from fraud. The Liechtenstein Blockchain Act serves as an optimal environment for established companies as well as start-ups and investors to take their businesses to the next level by creating an excellent, innovation-friendly and technology-neutral framework.
Unique Civil Law for Tokens
The Liechtenstein Blockchain Act seems to be quite a unique regulation giving first the civil law definition for token, blockchain and blockchain transactions.
The law uses the term "Trustworthy Technology" (or TT) for blockchain and possible future technologies. These are technologies through which the integrity of tokens, the clear assignment of tokens to TT Identifiers and the disposal of tokens is ensured. A TT identifier allows for the clear assignment of Tokens ("public key"), whereas a TT key allows for disposal of Tokens ("private key").
A token container model was developed alongside the Blockchain Act, meaning a token can represent rights to all possible assets.
A “token” is a piece of information on a TT System which can represent claims or rights of memberships against a person, rights to property, or other absolute or relative rights, and is assigned to one or more TT Identifiers.
Key points for effective transfer of tokenised assets are:
- the holder of the private keys has right of disposal (Verfügungsgewalt) over the token;
- they are presumed to be the authorised person with “proprietor’s rights” (Verfügungsberechtigte) over the token; and
- the disposal over the token effects the disposal over the right represented by the token.
Security Tokens from a Legal Perspective
Though when introducing token container model the government wanted specifically not to provide any classifications of tokens, the classical swiss classification from FINMA ICO Guidelines should be mentioned.
FINMA introduced ICO guidelines with major simplified classification of tokens based on its content for the sole purpose of financial market law:
- utility tokens;
- security or asset tokens; and
- payment tokens.
Utility token's give access to services or infrastructure also used for crowdfunding, as donations more known as initial coin offering (ICO) (ie, Bluenote, Smart Valor, Tezos, Ubex etc). Security or asset tokens represent shares in a company, claim or financial instrument (Mt Pelerin, Healthbank, Nexo, HYGH, BlockState, Swiss Alps Mining, eLocations, BlueShare etc). Payment tokens function as a means of payment (Bitcoin, Ether, Ducascopy etc).
A more detailed classification is to be found in the Conceptual Framework for Legal and Risk Assessment of Crypto Tokens ("BCP Framework").
Intense discussions took place in Liechtenstein and Switzerland regarding the legal nature of security tokens. In conclusion, the Liechtenstein government proposed to include uncertified security (or book-entry security) with all the functions of a traditional security of public faith with new articles in Final Part of the Persons and Company’s law (PGR).
The basis of a genuine book-entry security is an electronic register in which both the issue and the transfer of book-entry securities must be recorded. At the same time, Section 81a, Final Part PGR, creates a new interface between the TVTG and securities law. Because the value right register can also be kept on the basis of a blockchain or TT system, such systems are particularly suitable for this purpose because they enable a clear and seamless assignment of legal title to each book-entry security and cannot be manipulated.
Consequently, the issuing of securities and the clearing and settlement of securities transactions on TT Systems are considered to be one of the key potential applications for TT technologies.
Behind the security token could be various types of traditional securities, such as registered shares, participation certificates or profit participation certificates (Swiss and Liechtenstein equivalents of non-voting shares), bonds, collective investment scheme shares and also new uncertificated securities which could be created using tokenisation, ie, derivatives as rights to future income, rights to future commissions (Neon/Nash exchange), derivative security with features of a structured bond (Crowdli project about real estate investments), etc.
Asset tokenisation models for real estate as well as for other illiquid and quite expensive assets such as collectable cars, art objects, precious metals and stones can look as follows:
- Tokenisation of bonds;
- Tokenisation of company equity;
- Tokenisation of collective investment scheme shares;
- Tokenisation of co-ownership in a specific object;
- Tokenisation of future revenue streams etc.
Liechtenstein has paved the way for blockchain with the ICO fact sheet, the first security token prospectus registered in Europe and with numerous drafts of the Blockchain Act, which has now been in force since the beginning of 2020. It is a unique legislation for tokens, asset tokenisation and security tokens, and provides legal certainty for international projects looking for fundraising or more liquidity for existing assets and their investors. Part two of this article focuses on the security token offering requirements in Liechtenstein.
Risks related to application of blockchain technology are mostly in relation to the technology itself, the lack of security tokens trading platforms and the globally fragmented regulations.
Though potential risks of technological and economic nature exist, the potential of tokenisation to transform the assets world is quite large. For now, the market remains in its early stages, with the lack of secondary market holding back the development. Overall, only the application of the new regulations in the real world will provide proof of the success of the regulators approach.
Rechtsanwälte Lennert Partners (RLP Lawyers) provide legal support for distributed ledger technology (DLT)/blockchain projects in Liechtenstein and beyond. RLP Lawyers are regularly retained by domestic and global technology companies to advise on their major transactions in Liechtenstein. Services include company incorporation in Liechtenstein and Switzerland, STO advisory services, tokenised investment fund and crypto exchanges registration, opening of bank accounts, tax compliance services as well as company maintenance in Switzerland and Liechtenstein. The firm has a powerful, flexible, small team of 4 partners and 2 associates and a high-profile international network with a focus on DACH LI, USA, Russia and the CIS countries. The firm is a member of the STO Working Group of the Crypto Valley Association and the Global Legal Blockchain Consortium (GLBC), an organisation of legal and technology industry stakeholders.
Yanina Petrovskaya is an experienced adviser to blockchain projects with over eight years of international legal consulting experience. Coming from an international consultancy background, Yanina used to work as head of compliance in a fund management company before joining RLP Lawyers as of counsel. Yanina is a speaker at international blockchain events such as Blockchain Leadership Summit, Blockchain and Bitcoin Conference, Axess Think Tank, St. Moritz Institutional Investors Summit, etc, as well as partner and lecturer of the supplementary education program Blockchain Lawyers (BCL).
Alexander Yudovich has a field of activity that includes advising private individuals and international companies on all aspects of Russian and international tax law. With over ten years of consulting experience with international law firms in Germany and Russia, he is particularly appreciated by his clients for his cross-border competence in Russia and the CIS issues. As head of tax of a large German law firm in Moscow, he has supported several international business projects from a tax perspective. Alexander sees himself as a problem solver and an international legal intermediary for the goals of his clients.
Philipp Lennert counsels entrepreneurs in questions of international asset succession planning, tax optimisation and asset protection. As a qualified trustee expert, he advises non-profit foundations and their beneficiaries in DACH LI. The focus is on the planning and implementation of structural measures in coordination with the responsible supervisory authorities and the financial administration in Liechtenstein and abroad. As a member of the Board of Trustees, Philipp works on a pro bono basis for various charitable projects.