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Tokenization Regulations 2023: A Comprehensive Guide 

Karolina

13 Jun 2023
Tokenization Regulations 2023: A Comprehensive Guide 

Tokenization has become a prominent trend in the finance sector, with conventional funds and asset managers progressively examining alternative assets' tokenization potential. Utilizing blockchain technology, artificial intelligence, and cryptocurrencies, tokenization provides numerous advantages. For example heightened liquidity, superior transparency, increased operational efficiency, and streamlined processes. Nevertheless, understanding tokenization regulations and navigating the intricate regulatory environment can be daunting. This all-inclusive guide will thoroughly explore regulatory advancements in connection to tokenization across major jurisdictions. We will focus on the United Kingdom, European Union, and the United Arab Emirates (UAE). This guide offers invaluable knowledge for individuals and businesses within this swiftly advancing realm.

Table of Contents

Key Terms

To fully understand the regulatory landscape of tokenization, it is essential to familiarize ourselves with key industry terms. Here are some important terms related to tokenization:

  • Token: A token refers to a tradeable piece of code that digitally represents a traditional asset on a distributed ledger. It serves as a digital representation of an underlying asset.
  • Tokenized Fund: A tokenized fund is a type of fund that issues digital tokens on a distributed ledger. These tokens represent interests in the fund and can be traded and recorded on the distributed ledger. Tokenized funds provide increased accessibility and liquidity for investors.
  • Distributed Ledger: A distributed ledger is a decentralized database of transactions that is managed across a shared network. It enables investors to view real-time holdings, as the ledger updates with each transaction occurring on the network.

Understanding these key terms will lay the foundation for comprehending the regulatory developments in tokenization. In the following sections, we will explore the regulatory landscape in the UK, EU, and UAE. We highlight the initiatives and frameworks put forth by regulatory authorities to govern tokenization activities.

Tokenization Regulations in the United Kingdom

With a strong interest in fostering innovation within the blockchain and cryptoasset industries, the United Kingdom has set its sights on becoming a global hub for technology and investment in this area. In 2022, the UK government made a commitment to develop a supportive regulatory environment for businesses involved in this sector.

Government's Call for Evidence

To understand the potential impact of tokenization on traditional securities and capital raising methods, the UK government initiated a request for evidence. It was focused on tokenization and distributed ledger technology in 2021. This effort sought to gather valuable input from industry experts to better comprehend the opportunities and challenges presented by tokenization. Also to determine if further guidance or legislation is necessary.

FCA Discussion Paper

In February 2023, the Financial Conduct Authority (FCA), the UK's primary financial regulator, issued a discussion paper addressing enhancements to the country's asset management system. A portion of this paper specifically dealt with fund tokenization, as the FCA aimed to evaluate the benefits of such units for authorized funds and identify required regulatory modifications for issuing these tokenized units. The feedback received will inform any potential rule changes pursued by the FCA.

The Role of the UK Jurisdiction Taskforce

Supporting both government and industry efforts, the UK Jurisdiction Taskforce acknowledges cryptoassets (including tokens) as a form of property and validates smart contracts embedded within tokens as legally enforceable under English law. This creates a firm legal foundation for tokenization activities, although challenges remain regarding smart contract validity, possible legal solutions in case of errors, and interpretation by judicial systems.

Collaborative Approach

The UK government is dedicated to working collaboratively with key stakeholders such as the Bank of England, FCA, and other industry representatives to create an environment conducive to tokenization advancement. Their joint efforts will identify necessary adjustments and potential legal actions needed to support growth in this area.

As the FCA anticipates releasing a feedback statement later in 2023, based on the input received, further developments in the UK's regulatory landscape are expected. Following the outcomes, the FCA will evaluate rule modifications and provide guidance for those involved in tokenization activities. These tokenization regulations display the UK's commitment to becoming a frontrunner in the development and application of tokenization and blockchain technologies.

Tokenization Regulations in the European Union

In the pursuit of establishing a comprehensive legal framework for cryptoassets and tokenization, the European Union (EU) has been actively engaged. Although a uniform legal framework for crypto services is currently lacking across the EU, numerous member states have adopted their own national crypto laws. Nonetheless, the forthcoming Markets in Crypto-Assets Regulation (MiCA) aims to harmonize a European legal framework for cryptoassets and crypto services.

About Markets in Crypto-Assets Regulation (MiCA)

The goal of MiCA is to implement a technology-neutral regulatory framework in the EU. It is to oversee and regulate cryptoassets and their service providers. The regulation will address various token types, such as utility tokens, currency tokens, and stablecoins, while excluding security tokens (falling under Markets in Financial Instruments Directive II - MiFID II) and non-fungible tokens (NFTs).

MiCA's Range

The regulation will tackle several critical aspects of crypto services, including:

  • The custody of cryptoassets with defined parameters and standards under Crypto Custody Services.
  • Establishment of proper operation and management rules for platforms that facilitate crypto trading under Operation of Crypto Trading Platforms.
  • Regulation of the exchange between cryptoassets and traditional fiat currencies. Along with associated requirements under Exchange of Cryptoassets into Fiat Currency.
  • Oversight of brokerage activities related to cryptoassets under Brokerage of Crypto Assets.
  • Provision of advice protocols on cryptoassets under Advisory Services.
  • Implementation of rules regarding the issuance and offering of cryptoassets under Offering of Cryptoassets.

License Requirements and Passporting

MiCA will require home member state licensing for crypto service providers. These licenses will entail specific criteria concerning managerial reliability and qualifications, organizational obligations, risk handling, IT security, and capital. Crucially, licensed entities can passport the MiCA license throughout the entire EU, allowing them to operate across member states.

Mandatory White Paper

A White Paper is required for the cryptoassets managed by crypto service providers, akin to securities prospectus under EU Prospectus Regulation. This is aimed at enhancing transparency and shielding investors.

It is anticipated that MiCA will be effective around the end of 2024. Until then, national crypto laws may continue to be enforced by member states. Keeping abreast of evolving regulations and ensuring compliance at the EU and national level are essential for businesses operating within the EU.

The European Union's DLT Pilot Regime and ESMA Guidelines

The European Union (EU) has taken significant steps to explore and promote the adoption of transformative technologies in the financial sector, including the adoption of Distributed Ledger Technology (DLT). The EU's Regulation (EU) 2022/858, also known as the DLT Pilot Regime, came into force on March 23, 2023. This regime allows market infrastructures to apply for authorization to trade tokenized financial instruments on DLT platforms, subject to the provisions of the DLT Pilot Regime.

Objectives of the DLT Pilot Regime:

The DLT Pilot Regime aims to enable the development of financial cryptoassets and DLTs while ensuring investor protection, market integrity, and financial stability. It provides a temporary exemption for certain market infrastructures from specific financial legislation requirements, allowing them to create solutions for trading and settling transactions involving a limited number of financial instruments, such as shares or bonds.

Tokenization of Financial Instruments:

The DLT Pilot Regime defines "tokenization of financial instruments" as the process of converting traditional financial asset classes into digital tokens. Tokenization is expected to revolutionize the financial sector by improving efficiency in trading and post-trading processes.

Scope of the DLT Pilot Regime

The DLT Pilot Regime covers market infrastructures that function as specialized market infrastructure based on distributed ledger technology, known as DLT TSS (DLT Trading and Settlement System). It merges the functions of multilateral trading facilities and securities settlement systems.

ESMA Guidelines

The European Securities and Markets Authority (ESMA) has issued guidelines regarding the applications for authorization to manage a market infrastructure based on DLT. These guidelines provide further clarity and guidance to market participants seeking to operate within the DLT Pilot Regime.

Access and Parameters

Each EU member state may establish different access regimes and parameters for participation in the DLT Pilot Regime. This may result in uneven access across member states.

Considerations for Natural Persons

The DLT Pilot Regime allows natural persons to participate in executing transactions within DLT market infrastructures. However, there are considerations regarding the reporting of transactions executed by natural persons and the assessment of their technical skills and reputation.

It is important for market participants and stakeholders to stay informed about the evolving regulatory landscape in the European Union, including any updates or amendments to the DLT Pilot Regime and guidelines issued by ESMA. Consulting official sources, such as the EU legislation and guidance from regulatory authorities, is crucial to ensure compliance with the applicable regulations and requirements.

Read more

Tokenization Regulations in the United Arab Emirates

In the United Arab Emirates (UAE), a strong commitment to digital innovation has been demonstrated, leading to the establishment of a nurturing environment for the growth of crypto and other digital assets, products, and businesses. The regulatory landscape for digital assets in the UAE is multifaceted and constantly changing, with regulations existing at the federal level, emirate level, and within financial free zones as the country pursues digitalization.

Digital National Economy Strategy

Aiming to foster digitalization and the digital economy, the UAE's Digital National Economy strategy has led to a variety of initiatives across the Emirates. They support digital innovation and draw in businesses operating within crypto and digital assets.

Regulatory Authorities

Several regulatory authorities oversee the regulation of digital assets in the UAE, each implementing their own regulations and jurisdiction. The primary regulatory authorities involved in managing tokenization regulations for digital assets comprise:

  • Securities and Commodities Authority (SCA): Overseeing onshore UAE's regulation of digital assets, excluding Dubai.
  • Virtual Assets Regulatory Authority (VARA): Responsible for regulating digital assets in Dubai, excluding the Dubai International Financial Centre (DIFC).
  • Dubai Financial Services Authority (DFSA): Serving as the regulator for DIFC's financial free zone.
  • Financial Services Regulatory Authority (FSRA): Regulating digital assets within Abu Dhabi Global Market's financial free zone.

Complex Regulatory Landscape

The complexity of the tokenization regulations landscape within the UAE arises from differing regulatory levels. Federal-level regulations, those specific to each emirate, and those found within financial free zones. Businesses operating in this region need to carefully navigate these regulations based on their jurisdictions, ensuring compliance.

Openness to Dialogue

The UAE's regulatory authorities are open to discussing with market stakeholders. They aim to boost understanding, address concerns, and increase the chances of developing successful regulatory frameworks.

It is crucial to remain aware that digital asset regulations in the UAE are in a constant state of flux. Staying informed on the latest developments requires regular reference to official sources like the aforementioned regulatory authorities, government announcements, and consultation with legal professionals who specialize in UAE digital asset regulations.

Conclusion

In conclusion, the tokenization of assets and the regulatory landscape surrounding it are rapidly evolving. The United Kingdom, European Union and United Arab Emirates have recognized the potential of tokenization and are taking steps to establish regulatory frameworks that support its growth. The UK government is actively considering changes to facilitate tokenization, while the EU is introducing the DLT Pilot Regime to enable the trading of tokenized financial instruments. The UAE is embracing digital innovation and creating an environment conducive to tokenization. As these jurisdictions continue to refine their regulations, it is crucial for businesses and investors to stay informed. Also to navigate the regulatory landscape effectively. By understanding the regulatory developments and complying with the requirements, stakeholders can seize the opportunities presented by tokenization.

Thinking about tokenization? Be sure to contact us!

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Token Engineering Process

Kajetan Olas

13 Apr 2024
Token Engineering Process

Token Engineering is an emerging field that addresses the systematic design and engineering of blockchain-based tokens. It applies rigorous mathematical methods from the Complex Systems Engineering discipline to tokenomics design.

In this article, we will walk through the Token Engineering Process and break it down into three key stages. Discovery Phase, Design Phase, and Deployment Phase.

Table of Contents

Discovery Phase of Token Engineering Process

The first stage of the token engineering process is the Discovery Phase. It focuses on constructing high-level business plans, defining objectives, and identifying problems to be solved. That phase is also the time when token engineers first define key stakeholders in the project.

Defining the Problem

This may seem counterintuitive. Why would we start with the problem when designing tokenomics? Shouldn’t we start with more down-to-earth matters like token supply? The answer is No. Tokens are a medium for creating and exchanging value within a project’s ecosystem. Since crypto projects draw their value from solving problems that can’t be solved through TradFi mechanisms, their tokenomics should reflect that. 

The industry standard, developed by McKinsey & Co. and adapted to token engineering purposes by Outlier Ventures, is structuring the problem through a logic tree, following MECE.
MECE stands for Mutually Exclusive, Collectively Exhaustive. Mutually Exclusive means that problems in the tree should not overlap. Collectively Exhaustive means that the tree should cover all issues.

In practice, the “Problem” should be replaced by a whole problem statement worksheet. The same will hold for some of the boxes.
A commonly used tool for designing these kinds of diagrams is the Miro whiteboard.

Identifying Stakeholders and Value Flows in Token Engineering

This part is about identifying all relevant actors in the ecosystem and how value flows between them. To illustrate what we mean let’s consider an example of NFT marketplace. In its case, relevant actors might be sellers, buyers, NFT creators, and a marketplace owner. Possible value flow when conducting a transaction might be: buyer gets rid of his tokens, seller gets some of them, marketplace owner gets some of them as fees, and NFT creators get some of them as royalties.

Incentive Mechanisms Canvas

The last part of what we consider to be in the Discovery Phase is filling the Incentive Mechanisms Canvas. After successfully identifying value flows in the previous stage, token engineers search for frictions to desired behaviors and point out the undesired behaviors. For example, friction to activity on an NFT marketplace might be respecting royalty fees by marketplace owners since it reduces value flowing to the seller.

source: https://www.canva.com/design/DAFDTNKsIJs/8Ky9EoJJI7p98qKLIu2XNw/view#7

Design Phase of Token Engineering Process

The second stage of the Token Engineering Process is the Design Phase in which you make use of high-level descriptions from the previous step to come up with a specific design of the project. This will include everything that can be usually found in crypto whitepapers (e.g. governance mechanisms, incentive mechanisms, token supply, etc). After finishing the design, token engineers should represent the whole value flow and transactional logic on detailed visual diagrams. These diagrams will be a basis for creating mathematical models in the Deployment Phase. 

Token Engineering Artonomous Design Diagram
Artonomous design diagram, source: Artonomous GitHub

Objective Function

Every crypto project has some objective. The objective can consist of many goals, such as decentralization or token price. The objective function is a mathematical function assigning weights to different factors that influence the main objective in the order of their importance. This function will be a reference for machine learning algorithms in the next steps. They will try to find quantitative parameters (e.g. network fees) that maximize the output of this function.
Modified Metcalfe’s Law can serve as an inspiration during that step. It’s a framework for valuing crypto projects, but we believe that after adjustments it can also be used in this context.

Deployment Phase of Token Engineering Process

The Deployment Phase is final, but also the most demanding step in the process. It involves the implementation of machine learning algorithms that test our assumptions and optimize quantitative parameters. Token Engineering draws from Nassim Taleb’s concept of Antifragility and extensively uses feedback loops to make a system that gains from arising shocks.

Agent-based Modelling 

In agent-based modeling, we describe a set of behaviors and goals displayed by each agent participating in the system (this is why previous steps focused so much on describing stakeholders). Each agent is controlled by an autonomous AI and continuously optimizes his strategy. He learns from his experience and can mimic the behavior of other agents if he finds it effective (Reinforced Learning). This approach allows for mimicking real users, who adapt their strategies with time. An example adaptive agent would be a cryptocurrency trader, who changes his trading strategy in response to experiencing a loss of money.

Monte Carlo Simulations

Token Engineers use the Monte Carlo method to simulate the consequences of various possible interactions while taking into account the probability of their occurrence. By running a large number of simulations it’s possible to stress-test the project in multiple scenarios and identify emergent risks.

Testnet Deployment

If possible, it's highly beneficial for projects to extend the testing phase even further by letting real users use the network. Idea is the same as in agent-based testing - continuous optimization based on provided metrics. Furthermore, in case the project considers airdropping its tokens, giving them to early users is a great strategy. Even though part of the activity will be disingenuine and airdrop-oriented, such strategy still works better than most.

Time Duration

Token engineering process may take from as little as 2 weeks to as much as 5 months. It depends on the project category (Layer 1 protocol will require more time, than a simple DApp), and security requirements. For example, a bank issuing its digital token will have a very low risk tolerance.

Required Skills for Token Engineering

Token engineering is a multidisciplinary field and requires a great amount of specialized knowledge. Key knowledge areas are:

  • Systems Engineering
  • Machine Learning
  • Market Research
  • Capital Markets
  • Current trends in Web3
  • Blockchain Engineering
  • Statistics

Summary

The token engineering process consists of 3 steps: Discovery Phase, Design Phase, and Deployment Phase. It’s utilized mostly by established blockchain projects, and financial institutions like the International Monetary Fund. Even though it’s a very resource-consuming process, we believe it’s worth it. Projects that went through scrupulous design and testing before launch are much more likely to receive VC funding and be in the 10% of crypto projects that survive the bear market. Going through that process also has a symbolic meaning - it shows that the project is long-term oriented.

If you're looking to create a robust tokenomics model and go through institutional-grade testing please reach out to contact@nextrope.com. Our team is ready to help you with the token engineering process and ensure your project’s resilience in the long term.

FAQ

What does token engineering process look like?

  • Token engineering process is conducted in a 3-step methodical fashion. This includes Discovery Phase, Design Phase, and Deployment Phase. Each of these stages should be tailored to the specific needs of a project.

Is token engineering meant only for big projects?

  • We recommend that even small projects go through a simplified design and optimization process. This increases community's trust and makes sure that the tokenomics doesn't have any obvious flaws.

How long does the token engineering process take?

  • It depends on the project and may range from 2 weeks to 5 months.

Tagi

What is Berachain? 🐻 ⛓️ + Proof-of-Liquidity Explained

Karolina

18 Mar 2024
What is Berachain? 🐻 ⛓️ + Proof-of-Liquidity Explained

Enter Berachain: a high-performance, EVM-compatible blockchain that is set to redefine the landscape of decentralized applications (dApps) and blockchain services. Built on the innovative Proof-of-Liquidity consensus and leveraging the robust Polaris framework alongside the CometBFT consensus engine, Berachain is poised to offer an unprecedented blend of efficiency, security, and user-centric benefits. Let's dive into what makes it a groundbreaking development in the blockchain ecosystem.

Table of Contents

What is Berachain?

Overview

Berachain is an EVM-compatible Layer 1 (L1) blockchain that stands out through its adoption of the Proof-of-Liquidity (PoL) consensus mechanism. Designed to address the critical challenges faced by decentralized networks. It introduces a cutting-edge approach to blockchain governance and operations.

Key Features

  • High-performance Capabilities. Berachain is engineered for speed and scalability, catering to the growing demand for efficient blockchain solutions.
  • EVM Compatibility. It supports all Ethereum tooling, operations, and smart contract languages, making it a seamless transition for developers and projects from the Ethereum ecosystem.
  • Proof-of-Liquidity.This novel consensus mechanism focuses on building liquidity, decentralizing stake, and aligning the interests of validators and protocol developers.

MUST READ: Docs

EVM-Compatible vs EVM-Equivalent

EVM-Compatible

EVM compatibility means a blockchain can interact with Ethereum's ecosystem to some extent. It can interact supporting its smart contracts and tools but not replicating the entire EVM environment.

EVM-Equivalent

An EVM-equivalent blockchain, on the other hand, aims to fully replicate Ethereum's environment. It ensures complete compatibility and a smooth transition for developers and users alike.

Berachain's Position

Berachain can be considered an "EVM-equivalent-plus" blockchain. It supports all Ethereum operations, tooling, and additional functionalities that optimize for its unique Proof-of-Liquidity and abstracted use cases.

Berachain Modular First Approach

At the heart of Berachain's development philosophy is the Polaris EVM framework. It's a testament to the blockchain's commitment to modularity and flexibility. This approach allows for the easy separation of the EVM runtime layer, ensuring that Berachain can adapt and evolve without compromising on performance or security.

Proof Of Liquidity Overview

High-Level Model Objectives

  • Systemically Build Liquidity. By enhancing trading efficiency, price stability, and network growth, Berachain aims to foster a thriving ecosystem of decentralized applications.
  • Solve Stake Centralization. The PoL consensus works to distribute stake more evenly across the network, preventing monopolization and ensuring a decentralized, secure blockchain.
  • Align Protocols and Validators. Berachain encourages a symbiotic relationship between validators and the broader protocol ecosystem.

Proof-of-Liquidity vs Proof-of-Stake

Unlike traditional Proof of Stake (PoS), which often leads to stake centralization and reduced liquidity, Proof of Liquidity (PoL) introduces mechanisms to incentivize liquidity provision and ensure a fairer, more decentralized network. Berachain separates the governance token (BGT) from the chain's gas token (BERA) and incentives liquidity through BEX pools. Berachain's PoL aims to overcome the limitations of PoS, fostering a more secure and user-centric blockchain.

Berachain EVM and Modular Approach

Polaris EVM

Polaris EVM is the cornerstone of Berachain's EVM compatibility, offering developers an enhanced environment for smart contract execution that includes stateful precompiles and custom modules. This framework ensures that Berachain not only meets but exceeds the capabilities of the traditional Ethereum Virtual Machine.

CometBFT

The CometBFT consensus engine underpins Berachain's network, providing a secure and efficient mechanism for transaction verification and block production. By leveraging the principles of Byzantine fault tolerance (BFT), CometBFT ensures the integrity and resilience of the Berachain blockchain.

Conclusion

Berachain represents a significant leap forward in blockchain technology, combining the best of Ethereum's ecosystem with innovative consensus mechanisms and a modular development approach. As the blockchain landscape continues to evolve, Berachain stands out as a promising platform for developers, users, and validators alike, offering a scalable, efficient, and inclusive environment for decentralized applications and services.

Resources

For those interested in exploring further, a wealth of resources is available, including the Berachain documentation, GitHub repository, and community forums. It offers a compelling vision for the future of blockchain technology, marked by efficiency, security, and community-driven innovation.

FAQ

How is Berachain different?

  • It integrates Proof-of-Liquidity to address stake centralization and enhance liquidity, setting it apart from other blockchains.

Is Berachain EVM-compatible?

  • Yes, it supports Ethereum's tooling and smart contract languages, facilitating easy migration of dApps.

Can it handle high transaction volumes?

  • Yes, thanks to the Polaris framework and CometBFT consensus engine, it's built for scalability and high throughput.

Tagi