Legal Insights
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There are over 10,000 tokens currently listed on CoinMarketCap, each presenting unique claims about their function and utility. Remarkably, some tokens transparently admit to having no utility at all.
All these tokens vary widely in their purposes, ranging from facilitating transactions to representing assets and granting access to exclusive services. In this article, we will delve into the major categories of tokens and their specific use cases, offering a clearer view of this dynamic ecosystem.
Security Tokens
Security tokens are a class of tokens that represent ownership in a real-world asset, such as a company, property, or revenue stream. They are subject to national securities regulations; they can offer certain investor protections that are not available with other types of tokens.
Examples of security tokens include:
- Private Equity Tokens: These tokens represent shares in private companies or special purpose vehicles (SPVs). They allow investors to own a stake in ventures that are not publicly traded.
- Project Debt Tokens: These are tokens backed by real estate or other forms of debt. Investors receive interest payments from the underlying asset.
- Profit Sharing Tokens: Holders of these tokens receive a share of the profits generated by a project or company.
- Mortgage Debt Tokens: These tokens are backed by mortgage debt, providing a way for investors to earn returns from the real estate market.
- Structured Product Tokens: These tokens are tied to structured financial products, offering exposure to a variety of assets or financial strategies.
Legal and Regulatory Regime
The criteria used to define a security differ across jurisdictions. Consequently, a specific token may be classified as a security token in one jurisdiction but not in another.
The regulatory framework for the issuance and offering of security tokens varies significantly on a national level. The process for issuing security tokens closely resembles a primary public or private offering of equities or other traditional securities. This involves a regulated process with substantial documentation requirements, often facilitated through a chain of intermediaries. In most cases, issuers of security tokens will need to adhere to securities laws such as preparing a prospectus, registering investment documents with the regulator, and obtaining regulatory approval for the issuance of security tokens.
Additionally, security tokens can only be listed on licensed securities trading platforms, adding another layer of complexity for issuers as the company must meet platform requirements before the token can be offered to the public.
In the UAE, according to the Federal financial regulator, the Securities and Commodities Authority (the ‘SCA’), the issuance, offering, and trading of tokens that have features of security tokens will fall under SCA supervision.
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Utility Tokens
Utility tokens are designed to provide access to a product or service within a particular blockchain ecosystem. They are not intended as investments but rather as keys to access certain features or benefits.
Examples include:
- Service Access Tokens: These tokens grant users the ability to access a particular service or platform.
- Experience Tokens: These tokens provide access to exclusive experiences or events.
- Food Stamps on the Blockchain: These tokens can be used to purchase food or other necessities, functioning similarly to traditional food stamps, but are based on a blockchain.
- Governance Tokens: These tokens allow holders to vote on decisions affecting the blockchain protocol or platform.
- Reward Tokens: Typically issued as incentives for participation or engagement, these tokens can be earned through various activities within a network.
- Utility NFTs: Unique tokens that provide specific access or benefits within a digital ecosystem.
Legal and Regulatory Regime
Utility tokens are generally not considered securities if they are used solely to access a service or product. However, if they are marketed as an investment or have profit potential, they might be classified as securities.
Compliance Required
Issuers must ensure that their tokens genuinely function as utilities. They should avoid making investment promises and focus on the functionality of the tokens within their ecosystem.
Tax Considerations
Utility tokens may be subject to VAT or sales tax when used to purchase goods or services. Income earned from the sale of utility tokens may also be taxable. Therefore, careful consideration must be given to the issuance of utility tokens to minimize tax exposure.
Payment Tokens
Payment tokens are intended to function as a means of payment, similar to traditional currencies but on a blockchain. They facilitate transactions and can be used to purchase goods and services.
Examples include:
- Stablecoins: These tokens are pegged to a stable asset, such as a fiat currency, to reduce volatility. They are widely used for transactions and as a store of value.
- Transaction Tokens: These tokens are used specifically for processing transactions within a blockchain network.
- Rent Payment Tokens: These are used to make rental payments within a blockchain ecosystem.
- Purchase Tokens: These can be used to buy goods or services, often with added benefits such as discounts or rewards.
United Arab Emirates
The Central Bank of the UAE (the ‘CBUAE’) has recently announced the development of stablecoin regulation and licensing rules. As per the CBUAE statement, payment tokens can only be backed by the national currency, the UAE dirham, and cannot be associated with other currencies, virtual assets, or algorithms. It has been specified that merchants and service providers may exclusively accept dirham-backed payment tokens, and no other virtual assets will be recognized as a valid form of payment.
European Union
The EU Uniform MiCAR does not specifically define the term “stablecoin”, but it introduces the concepts of Asset-referenced tokens (ARTs) and E-money tokens (EMTs) as two potential forms of a stablecoin. Asset-referenced tokens are pegged to multiple fiat currencies or other assets, with the goal of maintaining a stable value. On the other hand, Electronic Money Tokens are pegged to a single fiat currency, meant to serve as e-money and can be used for payments or transfers.
In comparison with previous regulations, MiCAR imposes stricter requirements on issuers and service providers, including licensing, reserve funds, information disclosure, and governance structure. For example, stablecoin issuers must establish a physical presence in the EU, have at least one director residing in the EU, and secure EU authorization as a credit institution or electronic money institution, adhering to standards on capital requirements, governance, risk management, and more.
Hong Kong
Hong Kong is developing its stablecoin regulations and recently launched the stablecoin issuer sandbox arrangement. The aim is to communicate supervisory expectations to parties interested in issuing fiat-referenced stablecoins and obtain feedback from participants on the proposed regulatory requirements. According to the proposed framework, issuers of fiat-referenced stablecoins (the ‘FRS’) must obtain a license from the Hong Kong Monetary Authority and comply with comprehensive licensing conditions and requirements relating to, among other things, the issuer, its financial and other resources, the FRS it issues, and the reserve assets and stabilization mechanism supporting the FRS.
Only certain regulated entities and platforms will be allowed to offer FRS in Hong Kong or actively market them to the public. Furthermore, only FRS issued by HKMA-licensed issuers can be offered to retail investors, and other FRS can only be offered to professional investors.
Other Types of Tokens
In addition to the primary categories, there are several other types of tokens that serve unique purposes within the blockchain ecosystem.
These include:
- Non-Fungible Tokens (NFTs): Unique tokens that represent ownership of a specific item or piece of content, such as digital art, collectibles, or real estate.
- Membership Tokens: These provide exclusive access to clubs, services, or platforms.
- Asset-Backed Tokens: These tokens are backed by physical assets, such as gold or real estate, providing a digital representation of the asset.
- Participation Tokens: Often used in community-driven projects, these tokens grant holders the ability to participate in various activities or governance.
- Experience NFTs: Unique tokens that grant access to special experiences or events.
- Badge Participation Tokens: These tokens can signify membership, achievement, or participation in certain events or communities.
Legal and Regulatory Regime
The classification and regulation of these tokens can vary widely depending on their specific use case and jurisdiction.
Conclusion
Understanding the different types of tokens is essential for navigating the complex world of Web3 and cryptocurrency. Security tokens offer investment opportunities with regulatory oversight, utility tokens unlock access to services and experiences, and payment tokens facilitate transactions. Meanwhile, other specialized tokens, such as NFTs and RWA tokens, open up new realms of possibilities for digital ownership and participation.
If you plan to issue a token for your project and need guidance on the legal implications, don’t hesitate to reach out to us. With experience supporting over 230 Web3 and crypto projects, we are fully equipped to provide you with expert advice and comprehensive support tailored to your needs.
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