Blockchain technology can design digital information units that contain elements of a property right, creating a new type of decentralized blockchain-based assets: Blockchain Crypto Property ("BCP") - or Tokens, which is the term widely used by the blockchain community.
We are very happy to announce "Block 2" of our Conceptual Framework for Legal and Risk Assessment of Crypto Tokens (aka Blockchain Crypto Property | "BCP"): Download Framework (PDF, 1.4 Mb)
The current version includes several amendments to the initial genesis version from September 2017, including a more detailed classification and Token development stages. The Framework can be considered in all jurisdictions, regardless of national legal and regulatory frameworks. Nevertheless, in Annex 1 an Analysis of the Regulatory Qualification in our "Home Juristiction", Switzerland, is included.
The age of tokenized ecosystems has begun, the shift from centralized to decentralized blockchain-based creations and the transfer of assets is ongoing. Our current world is full of different asset classes ranging from money (in a narrow sense) to gold, real estate, securities, intellectual property ("IP") etc., many of which are difficult to physically trade or subdivide. Distributed ledger technology, or more specifically blockchain technology, is increasingly providing solutions to this problem.
Blockchain technology can design digital information units that contain elements of a property right (according to civil law concepts) to which an owner has direct and exclusive access that can be defended against third parties (right in rem). It contains the tools to program a unique set of information that attributes a property right and enables a secure and registered public transfer of the new type of digitally-defined property: Blockchain Crypto Property (“BCP”).
In addition, the introduction of Smart Contract Systems (“SCS”) at the application level of the blockchain has added immutable functions and property terms to BCPs, enabling not only the execution of bilateral and multilateral programs in accordance with contractual terms and conditions, but also the ability to create co-ownership like organizations. A BCP is therefore defined as a digital property that can be registered on the blockchain, in addition, it may carry out coded functions governed by an SCS, following coded or manual input by an agreed party (called an “Oracle”).
In order to consistently assess the legal and tax implications, associated risks and investment suitability of BCPs in the tokenized ecosystem, a reliable classification model and risk assessment criteria are indispensable. By applying an assessment method based on functionality, rather than on a particular country’s legal concepts, the classification and risk assessments can be considered in all jurisdictions, regardless of national legal and regulatory frameworks. Though the BCP classification may ultimately lead to different regulatory treatments in each jurisdiction, it may facilitate the multijurisdictional understanding of existing and new applications in the tokenized ecosystem, as well as identify coins which may not have the essential characteristics of digital property (i.e. not a BCP). The objective of the risk assessment and resulting BCP rating is to increase awareness and serve as a basis for establishing governance and diligence standards for all aspects of creating, offering, transferring and holding tokens.
With the above in mind, a “Conceptual Framework for a Legal and Risk Assessment of Blockchain Crypto Property” was developed. The current "Block 2” version includes several amendments to the initial genesis version from September 2017, including a more detailed classification and Token development stages.
This paper will:
- provide functional classification leading to three different BCP Classes;
- introduce three BCP Development Stages; and
- provide a risk assessment model for BCP, resulting in BCP Risk Categories.
Functional BCP Classification
This framework proposes a classification of Tokens or BCPs based on their function or target use. Key elements that further define the classification include the existence and type of counterparty along with the presence of an underlying asset or value. For example, if the Token includes some form of asset and a counterparty, it will have significant legal and regulatory differences compared to a native “currency-like” Token. All BCPs are transferable property that may carry out certain functions, including the transfer of rights or revenue.
Categorizing tokens based on these criteria aims to clarify a Token holder’s rights, allowing the community to precisely define a Token’s value, mitigate any risks and provide a supporting framework.
Following the above, our BCP Famework distinguishes between three major classes of BCPs and Tokens:
BCP Class 1: Native Utility Tokens
BCP Class 1 Tokens can be transferred on a decentralized ledger from user 1 to user 2, but do not grant any rights towards a counterparty. The owner of a Native Utility Token does not have any relative or absolute right, except for the right relating to the Token itself. The fact that a Token might be used on a specifc blockchain system, for example as “gas”, does not exclude it from being assigned to the BCP Class 1. The relevant criteria for this category is the lack of a relative right against a counterparty, such as the Token generator or a third party.
BCP Class 2: Counterparty Tokens
The second category, BCP Class 2, refers to Tokens which include any form of a relative right against a third-party. The relative right might be a (legal) right to use the Token generator’s services, a right to receive a financial payment, a right to receive an asset or a bundle of shareholder’s right.
BCP Class 3: Ownership Tokens
The third category, BCP Class 3, includes cases in which the Token provides technical, SCS based ownership rights in assets. The purpose of a BCP Class 3 token is to transfer rights of associated assets by transferring the Token. These assets can include IP rights (e.g. copyright) and may also include material objects in certain jurisdictions. In contrast to BCP Class 2, BCP Class 3 Token holders do not have a claim or relative rights against a counterparty. Rather, BCP Class 3 Tokens provide absolute rights (erga omnes) in the form of a right in rem of the associated assets.
BCP Development Stages
Functionality is the basis for the BCP classification introduced above. Therefore, all three BCP Classes refer to functional tokens. However, many Tokens will not be functional from the moment a contribution is made in the context of a Token Generating Event ("TGE"), also known as an Initial Coin Offering ("ICO"). In some cases, early investors may be granted a right to receive a future BCP. In order to provide greater transparency into the rights and obligations generated at various stages of a Token’s creation, distribution or exchange, this analysis adds three development stages to the BCP Framework which defines the various development layers and maturities of the related protocol, application, business or projects associated with a BCP.
The following stages have been identified:
- Pre-BCP:The first development stage refers to situations in which contributions are recorded centrally by a legal entity or decentrally on a blockchain, but do not result in the receipt of a Token. A contribution can be registered within a protocol or any other distributed or centrally managed ledger entry but is not transferable. For example, a project team could save all contributor addresses and future application wallets on the Bitcoin Blockchain or within an Ethereum SCS and undertake to allocate future tokens accordingly. At this stage, a contributor has no transferable assets on a distributed ledger. He can only transfer the wallet data bilaterally and off-chain. Therefore, the ledger entry for a proposed future Token allocation does not fulfil the transferability requirement of our BCP definition. The same applies to constellations in which a contributor receives a passphrase allowing him to access future BCPs.
- Pre-Operational BCP:Tokens which are transferable via a protocol, but cannot yet offer their intended utility on the network are categorized as “pre-operational” Tokens. Such Tokens are often listed and traded on a secondary market exchanges. Within this category, we distinguish between BCP Voucher Tokens, which need to be converted into separate Tokens, and pre-operational Tokens, which requires a completion of the underlying protocol, the infrastructure and/or the application. Pre-operational Tokens fulfil the definition of BCP (i.e. the transferability) but lack the intended target utility.
- Operational BCP: This stage refers to BCPs which operate in accordance with the intended design. Operational BCP can be classified into the BCP classes 1 to 3 and its specific sub-classes.
Relationship between BCP and FINMA Classification
The Swiss Financial Market Supervisory Authority FINMA has published guidelines (“Guidelines”), dated February 16, 2018, setting out how it intends to apply financial market legislations in handling enquiries regarding the applicable regulatory framework for initial coin offerings (“ICO”). The Guidelines complement FINMA’s earlier Guidance 04/2017, published on September 29, 2017.
FINMA remains more or less in line with frameworks discussed by leading practitioners, including the current Blockchain Crypto Property Classification model (“BCP”) at hand, however in a simplified version by grouping all token forms into three categories (i.e. Payment, Utility and Asset Tokens) without any sub-categories. Both the BCP and FINMA models are based on the functionality of specific Tokens. However, FINMA points out that the individual token classifications are not mutually exclusive and hybrid Tokens are possible. The absence of a precise classification leads to some degree of legal uncertainty in practice. Moreover, the qualification of Tokens for decentralized, open-sourced and community-based projects, which do not need a centralized issuer, seems to be out of scope in the FINMA model.
The aim of the Blockchain Crypto Property Classification 2.0, which is based on 3 BCP Classes and 12 BCP Sub-Classes, is to enhance the existing framework for Token classification approach and complement the high-level FINMA model in order to simplify the legal, risk and regulatory evaluation.