Blockchain and the Tokenisation of Assets – Overview and Regulation in Mexico

Introduction

In the last few years, blockchain technology has proven itself to be one of the most disruptive new technologies in the world due to the variety of possibilities and applications it has in any field where the secure certification or validation of transactions using computational systems is necessary.

Since its inception, as a technology designed to enable peer-to-peer transactions without the need for third-party intermediaries, the use of blockchain-based systems has evolved to encompass such diverse fields as smart contracts, healthcare, voting systems and elections, intellectual property, supply chain management, and many others.

Most recently, blockchain technology has been used to link real-world assets to digital tokens issued within a blockchain network, where they can be registered or traded. Asset tokenisation has become increasingly common around the world, and currently there are endless projects aiming to tokenise real estate, artworks, debt, securities, and other sophisticated financial products.

As has been the case with rapidly advancing technology, regulators are one step behind in creating an efficient legal framework that regulates the tokenisation of assets. In Mexico, businesses and customers wishing to make use of blockchain technology and to venture into this novel way of conducting business are obligated to apply an anachronistic regulatory framework that was not created for these types of modern business models. If not applied properly, the existing regulation can result in the imposition of fines and penalties, or even in the possibility of being unable to carry out business in the country.

Blockchain Technology and Tokenisation of Assets

Blockchain technology

In 2008, the anonymous author Satoshi Nakamoto published Bitcoin: A Peer-to-Peer Electronic Cash System in which he proposed the creation of a new payment system that would allow users to carry out electronic transactions without the need for a third-party intermediary, such as a bank.

Since its inception, blockchain technology has proposed the creation of a distributed transaction ledger, shared across a network of independent parties. This enables users to process transactions without the need for an intermediary or trusted third party to certify the validity of the information contained in the transactions being conducted, since users themselves, having access to the transaction records, can verify their authenticity and make the corresponding entry in the blockchain. This also makes blockchain systems significantly difficult to compromise, since they lack a single point of failure, which in turn increases the security of the system.

Originally, blockchain technology aimed to create an electronic payment system that would enable direct commerce between individuals without the involvement of any centralised financial institution. This system was designed to operate independently from external agents to the extent that it uses its own cryptographic currency (Bitcoin) as a medium of exchange.

However, due to the way in which blockchain technology provides secure means to electronically store and transfer information, the use of blockchain has evolved beyond the scope of the financial field and has recently been used to tokenise real-world assets, creating a completely new form of doing business.

Tokenisation of assets through the blockchain

Tokenisation of assets refers to the possibility of representing real-world assets on a blockchain, which could be private or public. Public blockchains are distributed networks which operate through a native cryptocurrency, and they are open for anyone to participate in the validation of transactions; while in private blockchains, only those authorised to participate can validate transactions and have access to the information stored in them.

When tokenising an asset, a “digital token” is issued and registered in the blockchain. These digital tokens are used to represent a right that the holder has in relation to the tokenised asset. There are different classifications of digital tokens; however, for the purposes of this analysis, two important types of tokens are worth mentioning:

• security tokens, which are digital assets that represent the entitlement or the ownership of an underlying right or asset; and
• utility tokens, which are digital assets that grant the right to obtain services, products or other benefits from organisations or projects.

Thus, holding a security token may entail, for example:

• the ownership of the company share capital;
• the whole or part of a real estate property;
• the right to obtain any benefit that these assets may produce; and
• others.

Since the token is used to represent the asset, the transfer of a token to another user also entails the transfer of the right related to the tokenised underlying asset.

In the same sense, a utility token may represent a wide variety of things, such as:

• the right to obtain products from a store;
• special access to unique promotions and benefits;
• the right to receive certain services such as access to exclusive events organised for token holders;
• hotel nights at a resort; and
• others.

In this regard, tokens are digital representations of assets on a blockchain. They could be created and managed through smart contracts, which are typically built on blockchain platforms like Ethereum, although other blockchain networks also support smart contract functionality. The code of a smart contract defines the rules and conditions of an agreement, as well as the actions that will be executed automatically when those conditions are met. For example, a smart contract may be programmed so that when a token is sold to another user and payment has been received, the token is automatically registered under the name of the buyer in the blockchain.

Notable examples and advantages of tokenisation

An important use of blockchain technology has been the tokenisation of securities. This consists of the representation of financial assets (such as stocks or bonds) as digital tokens on a blockchain. These digital tokens are issued and then transferred to entities or individuals who can then exercise, using smart contracts, all the rights belonging to the owner of a stock or a bond.

Tokenisation has been used by start-ups to facilitate investments and raise capital. Instead of relying on traditional financing, these entities issue security tokens representing fractional ownership of the business, and provide investors with potential access to dividends and other rights, in the same way as though they were issuing stocks.

Additionally, tokenisation has been used to represent debt (bonds and other debt financial assets). Tokenisation allows for the division of a bond into fractions, allowing for easier transferability and increasing the market share of the issuer of the debt.

Another notable example is the tokenisation of real-world assets, which involves dividing ownership of property into digital tokens on a blockchain. Each token represents a fraction of the property’s value and ownership rights. These tokens are then sold to entities or individuals wishing to invest in the underlying asset.

By using this technology, business models that involve the tokenisation of high-value assets such as artworks or real estate have been successfully implemented around the world, allowing entities and individuals to participate as investors in a manner that they were not able to before.

Today, tokenisation of assets has become increasingly popular due to the advantages it provides against traditional business models. An important advantage of tokenisation is the democratisation of certain markets by allowing for fractional ownership of assets.

There are numerous examples of certain high-value assets that have been sold to the general public through tokenisation, which previously only individuals or entities with considerable resources could afford. Such is the case with real estate, artworks and high-performing shares worth hundreds of dollars, which have been sold fractionally by using tokenisation. An individual may own a small part of a painting by a famous artist, which they can then sell for a profit if the value of the painting increases, or they may own the rights of a fraction of the rents produced by a building.

Tokenisation also has the advantage of providing global market access for businesses. Since tokenised assets can be traded through the web, anyone in the world with internet access can participate. This means that businesses can have access to a consumer base that is not limited by borders, and greatly increase their transactions and profits.

Additionally, tokenisation of assets has the advantage of providing transparency and security to the users since blockchain technology allows a secure and immutable recording of all transactions, which reduces fraud and increases trust for all the participants.

In Mexico, tokenisation projects such as those previously described have begun to take place. However, it is important to consider that legislation regulating these types of operations has not been issued in Mexico. Thus, businesses and entrepreneurs must be very careful when conducting operations in the country to ensure that they are not subject to fines or other penalties.

Mexican Regulation

Regulatory framework

In Mexico, any operation involving securities must comply with the Mexican Securities Market Law. A security is defined by the Law as any stock, obligation, bond, option, certificate, promissory note, and other debt instrument issued en masse that represents the capital stock of a legal entity, an aliquot part of a good or the participation in a collective credit or any individual right in terms of national or foreign provisions.

Pursuant to the above definition, tokens would be legally classified as securities to the extent that they are used to represent any of the previously mentioned concepts; in that case, the corresponding operation could be subject to the provisions set forth in the Mexican Securities Market Law.

For instance, according to this Law, entities can carry out public offerings of securities only if they are registered in the National Securities Registry or are subject to being registered in such Registry.

A public offering is legally defined as any offering in Mexican territory, with or without price, through mass media and to undetermined individuals, to underwrite, acquire, sell or transfer securities.

Additionally, the Mexican Securities Market Law establishes that offerings made abroad (of securities issued in Mexico or by Mexican entities) must be notified to the Mexican Banking and Securities Commission, describing their main characteristics.

It should be noted that private offers of securities not registered in the National Securities Registry may be carried out if:

• the offer is made to qualified or institutional investors;
• the securities represent the capital stock of a company and are offered to less than 100 people;
• the offer is based on an employee plan; or
• the offer is made to partners or shareholders of entities that carry out their corporate purpose exclusively with the securities.

In consequence, each transaction involving the tokenisation of any right or asset must be carefully analysed to determine whether it may qualify as an investment contract or as a public offering, according to the Mexican legal provisions, since the nature of the transaction would determine the applicable law.

When analysing the issuance and sale of tokenised securities and real-world assets to the general public, it is necessary to consider the regulatory framework established by the Mexican Securities Market Law, which limits the entities that carry out activities in the country from issuing and trading such digital assets en masse.

Also, any unauthorised public offering of securities is considered to be a felony by Mexican legal provisions. Thus, entities or individuals carrying out these operations must operate with caution, making sure that they are in full compliance with the law.

It should be noted that there is no specific tax regulation regarding analysis of any transaction involving asset tokenisation. As such, determining the tributary effects in light of the current anachronistic law could present some challenges and distortions.

Practical and legal challenges

Mexican regulations are highly formalistic when dealing with an operation involving tokenised assets. For certain operations to be considered legally valid, it is necessary to comply with the formalities and requirements set forth by the applicable law.

Even though a business may function using smart contracts which ensure that any operations involving tokenised assets are automatically registered in the blockchain, the requirements set forth in the Mexican legislation that may be applicable for such operations must be considered. Such is the case when ensuring that the necessary recordings are made in the Public Registry of Commerce or in the shareholders’ registry when dealing with tokens representing shares of a legal entity.

Regarding the tokenisation of certain real-world assets, such as real estate, Mexican regulation may require that the sale be certified by a public notary, so that such operation has effect before third parties, and be recorded before the Public Registry of Property. This is especially relevant for tax purposes, since Mexican tax authorities do not recognise operations that are not notarised by the parties involved.

Thus, even though the transfer of a token representing a real estate property, for example, may automatically execute itself through a smart contract and register the new owner in the blockchain, the holder of the token will not be legally recognised as a factual owner of the underlying asset unless the operation is certified by a public notary and recorder before the Public Registry of Property.

Conclusion

The tokenisation of assets has several advantages because it allows for an easier transfer of goods and services as well as for the democratisation of certain markets that were previously unavailable to some.

However, currently in Mexico and in most countries, no specific regulation has been issued to regulate transactions involving the tokenisation of assets, which has forced individuals and authorities to apply anachronistic legal provisions to such operations, even though their application may result in legal distortions.

It is thus necessary for the Mexican authorities to issue regulation that specifically regulates the tokenisation of assets, to provide certainty to parties involved in such transactions.

For now, when dealing with tokenisation operations in Mexico, it is important to conduct a professional legal and tax analysis of each transaction to determine the applicable law and the correct manner in which such transactions could be carried out in the country.