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Technical Break Down of the Markets in Crypto Assets Regulation

Technical Break Down of the Markets in Crypto Assets Regulation
The Markets in Crypto-Assets Regulation (MiCAR) is a landmark legislation that aims to create a harmonised and comprehensive framework for the regulation of crypto-assets and related services in the European Union (EU). MiCAR was adopted by the European Parliament and the Council of the EU in June 2023 and entered into force on 29 June 2023. It will apply from 30 December 2024, except for some provisions that will apply from 30 June 2024.

MiCAR is anticipated to bring about a substantial influence on the crypto-asset market, introducing legal certainty, consumer protection, market integrity, and financial stability. Moreover, it is poised to encourage innovation and competition by facilitating cross-border activities and providing passporting rights for crypto-asset service providers (CASPs) operating within the EU. Nevertheless, MiCAR presents certain challenges and responsibilities for crypto-asset issuers and CASPs, along with additional obligations for other financial institutions and investors engaged in transactions involving crypto-assets. In this article, I will provide a technical breakdown of the main aspects of MiCAR.

The definition and classification of crypto-assets under MiCAR

MiCAR characterizes crypto-assets as “a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.” This definition is expansive and impartial to specific technologies, encompassing various crypto-assets like cryptocurrencies, tokens, stablecoins, and non-fungible tokens (NFTs).

However, it’s essential to note that it excludes crypto-assets qualifying as financial instruments, deposits, structured deposits, electronic money, securitisation positions, insurance products, or pension products under existing EU financial services legislation. These excluded crypto-assets remain subject to the pertinent sectoral rules and regulations.

MiCAR distinguishes between three main categories of crypto-assets that fall within its scope:

  • E-money tokens (EMTs): These are crypto-assets that purport to maintain a stable value by referencing the value of one official currency that is legal tender. EMTs are similar to electronic money under the Electronic Money Directive 2009/110/EC (EMD2), but they use distributed ledger technology or similar technology to issue, store and transfer value. Examples of EMTs are Tether (USDT) and USD Coin (USDC), which are pegged to the US dollar.
  • Asset-referenced tokens (ARTs): These are crypto-assets that are not EMTs and that purport to maintain a stable value by referencing another value or right or a combination thereof, including one or more official currencies, commodities, crypto-assets or a basket of such assets. ARTs are a type of stablecoins that are backed by a pool of assets, such as fiat currencies, gold or other crypto-assets.
  • Other tokens: These are crypto-assets that are neither EMTs nor ARTs and that have various purposes and characteristics. This category includes utility tokens, which provide access to a good or a service supplied by the issuer, such as decentralized applications (DApps) or platforms. It also includes payment tokens, which are used as a means of exchange, such as Bitcoin or Ether. Furthermore, it includes hybrid tokens, which combine features of different types of tokens, such as governance tokens, which grant voting rights or other benefits to the holders.

They bring forth the concept of significant tokens for EMTs (Electronic Money Tokens) and ARTs (Asset-Reference Tokens). These tokens are subjected to additional requirements owing to their potential impact on financial stability or monetary policy. The task of identifying and monitoring significant tokens falls under the purview of the European Banking Authority (EBA). The EBA employs criteria such as the number of users, transaction values, interconnectedness with the financial system, substitutability with existing payment instruments, and the innovation or complexity of the token to determine significance. The EBA will publish and update a list of significant tokens on its website.

The authorisation and supervision requirements for crypto-asset issuers and CASPs

MiCAR also imposes different authorisation and supervision requirements for crypto-asset issuers and CASPs, depending on the type and significance of the crypto-asset involved.

Crypto-asset issuers

Crypto-asset issuers are natural or legal persons who offer crypto-assets to the public or seek the admission of crypto-assets to trading on a trading platform for crypto-assets. MiCAR requires crypto-asset issuers to comply with the following obligations:

  • White paper: Crypto-asset issuers must prepare and publish a white paper that discloses essential information about the crypto-asset project, such as the features, rights and obligations of the crypto-asset, the project’s objectives and intended use of funds, the risks and costs involved, the governance and technical arrangements, and the identity and contact details of the issuer. The white paper must be notified to the competent authority of the issuer’s home member state at least 20 working days before its publication and must be made available on the issuer’s website and the website of any CASP involved in the offer or admission to trading of the crypto-asset. The white paper must also be updated whenever there is a material change that affects the information disclosed.
  • Authorisation: Crypto-asset issuers of EMTs and ARTs must obtain an authorisation from the competent authority of their home member state before offering such tokens to the public or seeking their admission to trading on a trading platform for crypto-assets. The authorisation process involves submitting an application that includes information such as the identity and contact details of the issuer, the white paper, the governance and technical arrangements, the risk management and internal control mechanisms, the complaints handling procedures, and the arrangements for the protection of the reserve assets backing the EMTs or ARTs. The competent authority must assess the application and grant or refuse the authorisation within three months of receiving a complete application. The authorisation is valid in all member states and allows the issuer to passport its activities across the EU. Crypto-asset issuers of other tokens do not need an authorisation, but they must comply with the white paper requirement and other general obligations under MiCAR.
  • Supervision: Crypto-asset issuers of EMTs and ARTs are subject to ongoing supervision by the competent authority of their home member state, which may impose administrative sanctions or remedial measures in case of non-compliance with MiCAR. The competent authority may also withdraw the authorisation of the issuer if certain conditions are met, such as the issuer no longer meets the authorisation requirements, the issuer has obtained the authorisation by false statements or any other irregular means, the issuer has not made use of the authorisation within 12 months of its granting, or the issuer has ceased to offer or admit to trading the EMTs or ARTs for more than six months. Crypto-asset issuers of other tokens are not subject to ongoing supervision, but they must cooperate with the competent authorities and provide any information requested by them.

Crypto-asset service providers

Crypto-asset service providers are natural or legal persons who provide or perform one or more of the following services or activities on a professional basis:

  • Custody and administration of crypto-assets on behalf of clients
  • Operation of a trading platform for crypto-assets
  • Exchange of crypto-assets for fiat currency or other crypto-assets
  • Execution of orders for crypto-assets on behalf of clients
  • Placing of crypto-assets
  • Reception and transmission of orders for crypto-assets on behalf of clients
  • Providing advice on crypto-assets
  • Providing portfolio management on crypto-assets
  • Providing transfer services for crypto-assets on behalf of clients

MiCAR requires CASPs to comply with the following obligations:

  • Authorisation: CASPs must obtain an authorisation from the competent authority of their home member state before providing any of the above services or activities. The authorisation process involves submitting an application that includes information such as the identity and contact details of the CASP, the programme of operations, the governance and technical arrangements, the risk management and internal control mechanisms, the complaints handling procedures, the arrangements for the safeguarding of clients’ funds and crypto-assets, and the policies and procedures for the prevention of money laundering and terrorist financing. The competent authority must assess the application and grant or refuse the authorisation within three months of receiving a complete application. The authorisation is valid in all member states and allows the CASP to passport its activities across the EU.
  • Supervision: CASPs are subject to ongoing supervision by the competent authority of their home member state, which may impose administrative sanctions or remedial measures in case of non-compliance with MiCAR. The competent authority may also withdraw the authorisation of the CASP if certain conditions are met, such as the CASP no longer meets the authorisation requirements, the CASP has obtained the authorisation by false statements or any other irregular means, the CASP has not made use of the authorisation within 12 months of its granting, or the CASP has ceased to provide or perform the crypto-asset services or activities for more than six months.
  • Prudential requirements: CASPs must comply with prudential requirements, such as holding a minimum amount of own funds, maintaining adequate capital adequacy ratios, applying sound accounting and auditing standards, and ensuring the continuity and regularity of their operations. The prudential requirements vary depending on the class of the CASP, which is determined by the type and scope of the crypto-asset services or activities provided
  • Conduct of business rules: CASPs must comply with conduct of business rules, such as providing clear and accurate information to clients, acting honestly and fairly, avoiding conflicts of interest, ensuring the suitability and appropriateness of their services or activities, executing orders promptly and efficiently, and disclosing any fees or charges. The conduct of business rules vary depending on the type of client, which may be retail, professional or eligible counterparty.
  • Safeguarding requirements: CASPs must comply with safeguarding requirements, such as segregating clients’ funds and crypto-assets from their own assets, keeping accurate records and accounts, ensuring the availability and accessibility of clients’ funds and crypto-assets, and protecting clients’ funds and crypto-assets from insolvency, fraud, theft or cyberattacks. The safeguarding requirements vary depending on the type of crypto-asset service or activity provided or performed and the type of crypto-asset involved.
  • Anti-money laundering and counter-terrorism financing (AML/CTF) obligations: CASPs must comply with AML/CTF obligations, such as applying customer due diligence measures, monitoring transactions, reporting suspicious activities, keeping records, and cooperating with the competent authorities. The AML/CTF obligations are aligned with the Fifth Anti-Money Laundering Directive 2018/843/EU (AMLD5) and the Sixth Anti-Money Laundering Directive 2018/1673/EU (AMLD6), which apply to other obliged entities in the financial sector.

The transitionary provisions and exemptions under MiCAR

  • MiCAR provides for some transitionary provisions and exemptions for crypto-asset issuers and CASPs that are already operating in the EU before the application date of MiCAR.
  • Grandfathering clause: Crypto-asset issuers and CASPs that are authorised or registered under national regimes in one or more member states before the application date of MiCAR may continue to provide or perform their services or activities in those member states until 30 June 2025, without obtaining an authorisation under MiCAR. However, they must comply with the relevant national rules and regulations and notify the competent authorities of their intention to continue their operations. They must also apply for an authorisation under MiCAR by 30 June 2024, if they wish to provide or perform their services or activities in the EU after 30 June 2025.
  • Pilot regime for distributed ledger technology (DLT) market infrastructures: MiCAR establishes a pilot regime for DLT market infrastructures, which are a new type of market participants that use DLT to provide both trading and settlement services for crypto-assets that qualify as financial instruments. The pilot regime aims to test the use of DLT in the trading and post-trading of crypto-assets, while ensuring a high level of investor protection and market integrity. The pilot regime will apply for five years from the application date of MiCAR, with a possibility of extension. DLT market infrastructures must obtain an authorisation from the competent authority of their home member state and comply with specific requirements under MiCAR. They are also subject to the supervision and cooperation of the European Securities and Markets Authority (ESMA) and the EBA. The pilot regime will allow DLT market infrastructures to operate in a sandbox environment, where they can benefit from certain exemptions and derogations from existing EU financial services legislation, such as the Markets in Financial Instruments Directive 2014/65/EU (MiFID II), the Central Securities Depositories Regulation 909/2014/EU (CSDR) and the Settlement Finality Directive 98/26/EC (SFD).
  • Exemptions for central banks and public authorities: MiCAR does not apply to crypto-assets that are issued or guaranteed by central banks, member states, third countries or public international organisations. It also does not apply to crypto-asset services or activities that are provided or performed by central banks or other public authorities in the performance of their public tasks or functions. These exemptions aim to preserve the monetary sovereignty and policy of the EU and its member states, as well as to facilitate the development of central bank digital currencies (CBDCs) and other public initiatives in the crypto-asset space.

The implications of MiCAR for investment firms and the travel rule

MiCAR also has some implications for investment firms and the travel rule, which are relevant for the crypto-asset market.

  • Investment firms: Investment firms are natural or legal persons who provide or perform investment services or activities on a professional basis, such as reception and transmission of orders, execution of orders, portfolio management, investment advice, underwriting or placing of financial instruments. Investment firms are subject to the MiFID II framework, which regulates their authorisation, conduct of business, organisational and prudential requirements, and supervision. MiCAR allows investment firms that are authorised under MiFID II to provide or perform crypto-asset services or activities in relation to crypto-assets that qualify as financial instruments, without obtaining an additional authorisation under MiCAR. However, they must comply with the relevant MiFID II rules and regulations, as well as some specific requirements under MiCAR, such as the safeguarding and AML/CTF obligations. Investment firms that wish to provide or perform crypto-asset services or activities in relation to crypto-assets that do not qualify as financial instruments must obtain an authorisation under MiCAR and comply with its rules and regulations.
  • Travel rule: The travel rule is a requirement that obliges financial institutions to exchange certain information about the originator and the beneficiary of a funds transfer, such as their names, addresses, account numbers and transaction amounts. The travel rule aims to prevent money laundering and terrorist financing, as well as to facilitate the traceability and transparency of funds transfers. The travel rule applies to crypto-asset transfers under MiCAR, which are defined as any transaction that results in the change of ownership of one or more crypto-assets from one person to another person. MiCAR requires CASPs that are involved in crypto-asset transfers to exchange the following information with other CASPs:
    • The name and account number of the originator
    • The name and account number of the beneficiary
    • The originator’s address, official personal document number, customer identification number or date and place of birth
    • The beneficiary’s address, official personal document number, customer identification number or date and place of birth
    • The amount and type of crypto-asset transferred
    • The date and time of the crypto-asset transfer
    • Any other information required by the competent authorities

The CASPs must ensure that the information is accurate and complete, and that it is transmitted securely and confidentially. They must also keep records of the information for at least five years. They must implement the travel rule by 30 June 2024, which is the same date as the application of the Financial Action Task Force (FATF) standards on virtual assets and virtual asset service providers.

The leading EU jurisdictions for MiCAR compliance and regulatory arbitrage

MiCAR’s objective is to establish an equitable environment and a unified market for crypto-assets and associated services within the EU. This is to be achieved by standardizing and simplifying the current national regulatory frameworks, thereby eradicating regulatory fragmentation and uncertainty. Nonetheless, MiCAR acknowledges the need for a degree of regulatory flexibility and discretion at the national level, which opens the door to regulatory arbitrage and competition among EU member states in specific areas.Some of the areas where MiCAR grants national discretion and flexibility are:

  • The definition and treatment of crypto-assets that qualify as financial instruments, deposits, structured deposits, electronic money, securitisation positions, insurance products or pension products under existing EU financial services legislation. MiCAR does not provide a clear and uniform definition of these crypto-assets, nor does it harmonise their classification and regulation across the EU. Therefore, the member states may adopt different approaches and interpretations, which may affect the scope and applicability of MiCAR.
  • The authorisation and supervision of crypto-asset issuers and CASPs. MiCAR establishes a home member state principle, which means that the crypto-asset issuers and CASPs are authorised and supervised by the competent authority of the member state where they have their registered office or head office. The authorisation is valid in all member states and allows the crypto-asset issuers and CASPs to passport their activities across the EU. However, the member states may have different procedures and criteria for granting or refusing the authorisation, as well as different supervisory practices and enforcement actions, which may create regulatory divergence and inconsistency.
  • The fees and charges for the authorisation and supervision of crypto-asset issuers and CASPs. MiCAR allows the competent authorities of the member states to charge fees or charges for the authorisation and supervision of crypto-asset issuers and CASPs, in order to cover their costs and expenses. However, MiCAR does not specify the amount or the calculation method of the fees or charges, nor does it impose any limits or caps. Therefore, the member states may set different levels and structures of fees or charges, which may affect the competitiveness and attractiveness of their crypto-asset markets.

Given these areas of national discretion and flexibility, some of the leading EU jurisdictions for MiCAR compliance and regulatory arbitrage are:

  • France: France is one of the first and most proactive EU member states to adopt a national regime for crypto-assets and related services, under the PACTE law of 2019. The PACTE law provides an optional registration and an optional licence for CASPs, as well as a mandatory approval for initial coin offerings (ICOs). The PACTE law also recognises crypto-assets as intangible property and grants them legal and tax certainty. France has a supportive and innovative regulator, the Autorité des Marchés Financiers (AMF), which has issued several guidance and recommendations on crypto-assets and related services. France is also a founding member and a key player of the European Blockchain Partnership (EBP), which aims to develop a European Blockchain Services Infrastructure (EBSI) that supports the delivery of cross-border digital public services. France is likely to maintain and enhance its leading position in the crypto-asset market under MiCAR, as it has a solid and flexible national regime, a favourable and stable legal and tax environment, and a strong and cooperative regulator.
  • Germany: Germany is another pioneer and leader in the crypto-asset market, as it has a comprehensive and advanced national regime for crypto-assets and related services, under the Banking Act of 1961 and the Securities Trading Act of 1998. The Banking Act defines crypto-assets as financial instruments and subjects them to the MiFID II framework, while the Securities Trading Act regulates the issuance and trading of crypto-assets that qualify as securities. The Banking Act also requires CASPs to obtain a licence from the Federal Financial Supervisory Authority (BaFin), which is a competent and experienced regulator that has issued several guidance and circulars on crypto-assets and related services. Germany has a robust and diversified crypto-asset ecosystem, with several established and emerging players, such as Bitwala, Bison, Bitbond, Nuri and Neufund. Germany is expected to retain and strengthen its leading role in the crypto-asset market under MiCAR, as it has a clear and consistent national regime, a reliable and efficient legal and tax framework, and a reputable and supportive regulator.
  • Malta: Malta is a small but ambitious EU member state that has positioned itself as a global hub for crypto-assets and related services, under the Virtual Financial Assets Act of 2018. The Virtual Financial Assets Act provides a comprehensive and bespoke regime for crypto-assets and related services, which covers the issuance, offering and admission to trading of crypto-assets, as well as the licensing and supervision of CASPs. The Virtual Financial Assets Act also introduces the concept of a virtual financial asset (VFA) agent, which is a person who acts as an intermediary between the crypto-asset issuers or CASPs and the regulator, the Malta Financial Services Authority (MFSA). The MFSA is a proactive and forward-looking regulator that has issued several rules and guidance on crypto-assets and related services, as well as a VFA framework that sets out the principles and best practices for the crypto-asset industry. Malta has attracted and hosted several prominent and innovative players in the crypto-asset market, such as Binance, OKEx, BitBay and ZBX. Malta is likely to continue and expand its leading role in the crypto-asset market under MiCAR, as it has a comprehensive and bespoke national regime, a favourable and attractive legal and tax framework, and a proactive and forward-looking regulator.

Conclusion

MiCAR is a landmark legislation that aims to create a harmonised and comprehensive framework for the regulation of crypto-assets and related services in the EU.

They will introduce legal certainty, consumer protection, market integrity and financial stability, as well as foster innovation and competition, by enabling cross-border activities and passporting rights for crypto-asset issuers and CASPs within the EU. However, MiCAR also poses some challenges and obligations for crypto-asset issuers and CASPs, as well as for other financial institutions and investors that interact with crypto-assets.

I look forward to see the development of this framework.

 

Source: https://www.securities.io/technical-break-down-of-the-markets-in-crypto-assets-regulation/

Anndy Lian is an early blockchain adopter and experienced serial entrepreneur who is known for his work in the government sector. He is a best selling book author- “NFT: From Zero to Hero” and “Blockchain Revolution 2030”.

Currently, he is appointed as the Chief Digital Advisor at Mongolia Productivity Organization, championing national digitization. Prior to his current appointments, he was the Chairman of BigONE Exchange, a global top 30 ranked crypto spot exchange and was also the Advisory Board Member for Hyundai DAC, the blockchain arm of South Korea’s largest car manufacturer Hyundai Motor Group. Lian played a pivotal role as the Blockchain Advisor for Asian Productivity Organisation (APO), an intergovernmental organization committed to improving productivity in the Asia-Pacific region.

An avid supporter of incubating start-ups, Anndy has also been a private investor for the past eight years. With a growth investment mindset, Anndy strategically demonstrates this in the companies he chooses to be involved with. He believes that what he is doing through blockchain technology currently will revolutionise and redefine traditional businesses. He also believes that the blockchain industry has to be “redecentralised”.

www.anndy.com
j j j

Public Market- Where are the biggest institutional opportunities?- Digital Assets: Realised – Hong Kong

Public Market- Where are the biggest institutional opportunities?- Digital Assets: Realised – Hong Kong

Public Markets – Where are the Biggest Institutional Opportunities? ETF, Mutual Funds, Stocks, Bonds

– Moderator: Julien Bahurel, Partner, Deep Blue/Definer Fund
– Anndy Lian, Senior Advisor, Peach Income Fund
– Tony Wong, Managing Director, CSOP Asset Management
– Nicholas Studholme Wilson, Chief Operating Officer – Asia, GFO-X

At the panel discussion, industry experts gathered to explore the transformative potential of tokenization in asset classes and the future of financial markets. The conversation, moderated by Julian, delved into the implications of digitizing assets and the infrastructure required to support this evolution.

Julian opened the panel by highlighting the significance of functional markets, which are valued at approximately 4 trillion dollars. The focus then shifted to the opportunities presented by liquid markets through tokenization or digitization.

Tony discussed the enormous opportunities within the crypto space, particularly in Asia, where a significant portion of crypto trading activity originates. He emphasized the institutional interest in crypto markets, especially following price openings, and the inquiries from traditional managers and private bankers about accessing these new asset classes with appropriate risk levels. He pointed out that mutual funds might be the first asset class to adopt tokenization, revolutionizing the distribution landscape. He envisioned mutual funds being traded on exchanges like any other asset, within regulatory frameworks, making them accessible 24/7.

Anndy concurred with Tony’s views on mutual funds. He described tokenizing them as a “piece of cake” and predicted a substantial uptake, particularly in Hong Kong, which could become a significant player in the Asian market. Anndy also touched upon the role of exchanges like NASDAQ in a blockchain-dominated world, speculating that traditional exchanges might adapt to offer 24/7 services using blockchain technology.

Nicholas shared his perspective on achieving the end goal of a fully tokenized state on multiple chains. He stressed the importance of starting with existing infrastructure to generate revenue before transitioning to more advanced systems. Nicholas also discussed the challenges of latency and privacy considerations, suggesting that permissioned chains might be a necessary starting point before moving to public chains.

The panelists debated the coexistence of traditional liquid markets with tokenized markets, agreeing that while they may initially coexist, the superior efficiency of tokenized systems would eventually lead to a transition.

The conversation also touched on the regulatory implications of tokenization. While the technology offers exciting possibilities, it also presents challenges for regulators who must adapt to a rapidly evolving landscape.

As the discussion concluded, the panelists expressed optimism about the future of tokenized markets. They envisioned a world where traditional and tokenized markets coexist and eventually converge, thanks to improved infrastructure and broader acceptance of blockchain technology.

The panel’s insights suggest that while the journey toward widespread tokenization is still in its early stages, the destination promises a more inclusive and efficient market for all participants. As the technology matures and regulatory frameworks evolve, we may witness a significant shift in how assets are traded and managed globally.

Digital Assets: Realised held in Hong Kong on 7 March 2024. The event brought traditional funding, listing players, and new digital exchange and platform opportunities.

 

Source: https://blockcast.cc/videos/public-market-where-are-the-biggest-institutional-opportunities-digital-assets-realised/

Anndy Lian is an early blockchain adopter and experienced serial entrepreneur who is known for his work in the government sector. He is a best selling book author- “NFT: From Zero to Hero” and “Blockchain Revolution 2030”.

Currently, he is appointed as the Chief Digital Advisor at Mongolia Productivity Organization, championing national digitization. Prior to his current appointments, he was the Chairman of BigONE Exchange, a global top 30 ranked crypto spot exchange and was also the Advisory Board Member for Hyundai DAC, the blockchain arm of South Korea’s largest car manufacturer Hyundai Motor Group. Lian played a pivotal role as the Blockchain Advisor for Asian Productivity Organisation (APO), an intergovernmental organization committed to improving productivity in the Asia-Pacific region.

An avid supporter of incubating start-ups, Anndy has also been a private investor for the past eight years. With a growth investment mindset, Anndy strategically demonstrates this in the companies he chooses to be involved with. He believes that what he is doing through blockchain technology currently will revolutionise and redefine traditional businesses. He also believes that the blockchain industry has to be “redecentralised”.

www.anndy.com
j j j

ERC3643 Unveiled: Enhancing Compliance and Control in Tokenizing Real-World Assets

ERC3643 Unveiled: Enhancing Compliance and Control in Tokenizing Real-World Assets

ERC3643 is an Ethereum standard for permissioned tokens, also known as security tokens. It is an open-source suite of smart contracts that enables the issuance, management, and transfer of tokens that represent real-world assets, such as equity, debt, real estate, or art. It is designed to work with an on-chain identity system that allows for the validation of the identities and credentials of investors and issuers through signed attestations issued by trusted claim issuers. It aims to provide a comprehensive framework for managing the lifecycle of security tokens, from issuance to transfers between eligible investors, while enforcing compliance rules at every stage. Also, supports additional features such as token pausing and freezing, which can be used to manage the token in response to regulatory requirements or changes in the status of the token or its holders. In this article, I will provide a personal perspective on the current state of ERC3643, provide statistics and data to support an opinion on its benefits and challenges, and offer research to support an argument for or against its adoption.

ERC3643 was first proposed in July 2021 by a group of developers from Tokeny Solutions, a platform for tokenizing securities. The proposal was based on the previous T-REX protocol, which had been used by Tokeny and its partners to tokenize over €28 billion worth of assets across 180 jurisdictions. The proposal was reviewed and accepted by the Ethereum community as an official standard in 2021, becoming the first standard for permissioned tokens on Ethereum. Since then, ERC3643 has been adopted by several projects and platforms in the security token space, such as Securitize, Polymath, and Tokensoft.

One of the main benefits is that it enables the tokenization of real-world assets in a compliant and efficient way. Tokenization is the process of converting the ownership rights of an asset into a digital token that can be stored and transferred on a blockchain. This process can bring several advantages, such as:

  • Increased liquidity: Tokenization can lower the barriers to entry and exit for investors, allowing them to trade fractional ownership of assets in a global and 24/7 market. This can increase the demand and supply of assets, resulting in higher liquidity and lower costs.
  • Reduced intermediaries: Tokenization can eliminate or reduce the need for intermediaries, such as brokers, custodians, and lawyers, who often charge high fees and introduce delays and risks in the transaction process. By using smart contracts and blockchain technology, tokenization can automate and streamline the issuance and transfer of tokens, reducing costs and increasing efficiency.
  • Enhanced transparency: Tokenization can provide a higher level of transparency and trust for investors and issuers, as the tokens and their underlying assets are recorded and verified on a public and immutable ledger. This can improve the quality and availability of information, as well as the accountability and governance of the token issuers.
  • Improved accessibility: Tokenization can democratize access to assets that are traditionally illiquid, expensive, or exclusive, such as real estate, art, or private equity. By creating fractional and digital ownership of assets, tokenization can enable more investors to participate in the market, diversify their portfolio, and benefit from the returns of the assets.

However, tokenization also faces several challenges, especially when it comes to security tokens, which are subject to complex and varying regulations across different jurisdictions. Security tokens must comply with the laws and rules that govern the issuance and transfer of securities, such as KYC (Know Your Customer), AML (Anti-Money Laundering), and CFT (Combating the Financing of Terrorism). These regulations are meant to protect investors and issuers from fraud, manipulation, and other risks, but they also impose restrictions and requirements that can limit the potential of tokenization. For instance, security tokens may have to comply with:

  • Eligibility criteria: Security tokens may only be issued and transferred to investors who meet certain criteria, such as accreditation, residency, or income. These criteria may vary depending on the type and jurisdiction of the token and the investor, and they may require the verification of the identity and credentials of the investors.
  • Transfer restrictions: Security tokens may have to follow certain rules and limitations when they are transferred between investors, such as lock-up periods, holding periods, volume limits, or whitelists. These rules may depend on the status and jurisdiction of the token and the investor, and they may require the approval of the issuer or a third party.
  • Disclosure obligations: Security tokens may have to provide certain information and reports to the investors and regulators, such as prospectuses, financial statements, or audits. These information and reports may vary depending on the nature and jurisdiction of the token and the issuer, and they may require the involvement of professionals and authorities.

These challenges pose significant technical and legal difficulties for the tokenization of real-world assets, as they require the integration and coordination of multiple systems and parties, such as blockchain platforms, identity providers, claim issuers, regulators, and intermediaries. Moreover, these challenges may also affect the attractiveness and feasibility of tokenization, as they may reduce the liquidity, efficiency, transparency, and accessibility of the tokens.

This is where ERC3643 comes in. It is designed to address these challenges by providing a standard and flexible framework for the creation and management of permissioned tokens on Ethereum. Leverages the power and versatility of smart contracts and blockchain technology to encode and enforce the compliance and control rules of the tokens, while also integrating with an on-chain identity system to validate and verify the identities and credentials of the investors and issuers. It defines several interfaces that are described below:

  • Token interface: This interface defines the basic functions and events of the token, such as minting, burning, transferring, pausing, and freezing. It also defines the functions and events related to the token lifecycle, such as issuing, redeeming, and updating. It also inherits from the ERC-20 interface, which is the standard for fungible tokens on Ethereum.
  • Identity Registry interface: Defines the functions and events related to the identity registry, which is a smart contract that stores and manages the on-chain identities of the investors and issuers. The identity registry allows the registration and removal of identities, as well as the addition and revocation of attestations. An attestation is a signed statement issued by a trusted claim issuer that attests to a certain attribute or credential of an identity, such as accreditation, residency, or income. The identity registry also allows the verification of the eligibility of an identity to hold or receive a token, based on the attestations and the token rules.
  • Identity Registry Storage interface: Defines the functions and events related to the identity registry storage, which is a smart contract that stores the data of the identity registry, such as the identities, the attestations, and the token rules. The identity registry storage is separated from the identity registry to allow for the upgradeability and modularity of the identity registry.
  • Compliance interface: Defines the functions and events related to the compliance, which is a smart contract that implements the logic and rules for the compliant transfer of tokens. The compliance contract checks the eligibility of the sender and the receiver of a token transfer, as well as the validity and availability of the token. The compliance contract also allows the issuer or an agent to update the token rules, such as the eligibility criteria or the transfer restrictions, as well as to force or block a token transfer in case of emergency or dispute.
  • Trusted Issuers Registry interface: Defines the functions and events related to the trusted issuers registry, which is a smart contract that stores and manages the list of trusted claim issuers that can issue attestations for the identities. The trusted issuers registry allows the issuer or an agent to add or remove claim issuers, as well as to specify the claim topics that each claim issuer can attest to. A claim topic is a numerical identifier that represents a certain attribute or credential of an identity, such as accreditation, residency, or income.
  • Claim Topics Registry interface: Defines the functions and events related to the claim topics registry, which is a smart contract that stores and manages the list of claim topics that can be used for the attestations. The claim topics registry allows the issuer or an agent to add or remove claim topics, as well as to specify the description and the verification method of each claim topic.

By using these interfaces, ERC3643 provides a standard and flexible framework for the tokenization of real-world assets on Ethereum, while ensuring the compliance and control of the tokens. It allows the issuer or an agent to customize and update the token rules and the identity system according to the specific needs and requirements of the token and its jurisdiction. Also allows the investor to register and verify their identity and credentials on-chain, as well as to transfer and receive tokens in a compliant and efficient way.

In my opinion, ERC3643 is a valuable and innovative standard that can facilitate and accelerate the adoption of security tokens on Ethereum. It can enable the tokenization of a wide range of asset classes and industries, such as real estate, private equity, funds, and debt, which can unlock new opportunities and benefits for investors and issuers. It can also enhance the liquidity, efficiency, transparency, and accessibility of security tokens, while ensuring the compliance and control of the tokens. It can also foster the interoperability and compatibility of security tokens with other Ethereum protocols and applications, such as decentralized exchanges, lending platforms, and wallets.

However, ERC3643 is not without its challenges and limitations. It still faces the complexity and diversity of the regulatory landscape, which may differ from country to country, or even from state to state. This means that they may have to adapt and comply with different and changing regulations, which may pose technical and legal challenges for the issuer and the investor. For instance, ERC3643 may have to deal with the issue of cross-border transfers, which may involve different jurisdictions and regulations, as well as the issue of regulatory updates, which may require the modification or migration of the token and the identity system.

Another challenge is the scalability and security of the Ethereum network, which is the underlying platform that supports ERC3643. Ethereum is a public and decentralized blockchain that allows anyone to create and execute smart contracts and applications. However, Ethereum also suffers from some limitations, such as:

  • Low throughput: Ethereum can only process a limited number of transactions per second, which is currently around 15-20. This means that ERC3643 may face congestion and delays when there is a high demand for token transfers or identity operations, which may affect the user experience and the performance of the token.
  • High fees: Ethereum charges a fee for every transaction that is executed on the network, which is called gas. The gas fee depends on the complexity and the demand of the transaction, and it can fluctuate significantly depending on the network conditions. This means that ERC3643 may incur high and variable costs for the issuer and the investor, which may reduce the profitability and the feasibility of the token.
  • Security risks: Ethereum is a public and open network that is secured by a consensus mechanism called proof-of-work, which relies on the computational power of the network participants, also known as miners. However, proof-of-work also exposes Ethereum to some security risks, such as 51% attacks, which occur when a malicious actor gains control of more than half of the network’s computing power and can manipulate or disrupt the network. This means that ERC3643 may face the risk of losing or compromising the tokens or the identities, which may result in financial or reputational losses for the issuer and the investor.

These limitations are not inherent to ERC3643, but rather to the Ethereum network, which is still evolving and improving. Ethereum is currently undergoing upragdes, which relies on the stake of the network participants, also known as validators. Proof-of-stake is expected to increase the throughput, reduce the fees, and enhance the security of the network, which may benefit ERC3643 and other Ethereum protocols and applications.

In conclusion, ERC3643 is a promising and innovative standard that can enable the tokenization of real-world assets on Ethereum, while ensuring the compliance and control of the tokens. It can bring several benefits, such as increased liquidity, reduced intermediaries, enhanced transparency, and improved accessibility, for both investors and issuers. It can also foster the interoperability and compatibility of security tokens with other Ethereum protocols and applications. However, it also faces some challenges and limitations, such as the complexity and diversity of the regulatory landscape, and the scalability and security of the Ethereum network. ERC3643 is still a relatively new and evolving standard, which may require further development and testing before it can achieve its full potential and adoption. Therefore, I believe that ERC3643 is a valuable and innovative standard that deserves our attention and support, but also our caution and scrutiny.

 

 

 

Source: https://www.securities.io/erc3643-unveiled-enhancing-compliance-and-control-in-tokenizing-real-world-assets/

Anndy Lian is an early blockchain adopter and experienced serial entrepreneur who is known for his work in the government sector. He is a best selling book author- “NFT: From Zero to Hero” and “Blockchain Revolution 2030”.

Currently, he is appointed as the Chief Digital Advisor at Mongolia Productivity Organization, championing national digitization. Prior to his current appointments, he was the Chairman of BigONE Exchange, a global top 30 ranked crypto spot exchange and was also the Advisory Board Member for Hyundai DAC, the blockchain arm of South Korea’s largest car manufacturer Hyundai Motor Group. Lian played a pivotal role as the Blockchain Advisor for Asian Productivity Organisation (APO), an intergovernmental organization committed to improving productivity in the Asia-Pacific region.

An avid supporter of incubating start-ups, Anndy has also been a private investor for the past eight years. With a growth investment mindset, Anndy strategically demonstrates this in the companies he chooses to be involved with. He believes that what he is doing through blockchain technology currently will revolutionise and redefine traditional businesses. He also believes that the blockchain industry has to be “redecentralised”.

www.anndy.com
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