NFT’S TOKENISATION OF PROPERTY – DOS AND DON’T’S

NFT Real Estate

Property Companies Leveraging Technology

You’ve decided that you want to help more people benefit from the relatively safe risk-adjusted returns provided by the property sector and you see the tokenisation of property as a golden opportunity.

Companies worldwide that are programming digital assets to represent virtual property holdings in the form of non-fungible tokens are increasing daily but that does not mean it is being done with the right structure for success.

The concept of property tokenisation is a relatively simple one. Each token represents a fraction of the property written in a smart contract. 

 So, for a single property, you can create one token, ten tokens, hundred tokens, and so on. 

 If you decide to create just one token for a specific property when the buyer purchases that token, they will acquire the rights of ownership of the whole property.

 Suppose you create one hundred tokens for one specific property (fractional) when the buyer purchases ten or twenty tokens, they will acquire the ownership rights of that fractional part of the property.

 If the buyer purchases one hundred tokens, they will acquire the ownership rights in the whole property.

 Although the above concept is straightforward in theory its implementation is far more complex in practice and needs careful thought before launching the business.

 Understanding the many legal and regulatory pitfalls that can hinder or bring your project to a grinding halt will greatly enhance your chances of success.

 Below, we’ve got the dos and don’ts to help.

Blockchain lawyer

Do

 Where to incorporate?

•  Consider whether there is a real need to incorporate the business in so-called offshore jurisdictions including Cyprus, the British Virgin Islands or Curacao. There may be tax advantages but there are good reasons for incorporating in the UK for example such as contributing to the UK economy. You will also be working with the Financial Conduct Authority (FCA) and other competent institutions that can give clear guidance in engaging with businesses on the blockchain. Choosing a jurisdiction like the UK will provide investor confidence.

Real property or the bundle of rights that attach to the property

• There is a critical difference between tokenising the physical property itself or the bundle of rights that attach to the real property. Alternatively, you could choose to tokenise the real property and the rights attached to that property. Examples of the type of rights that may attach to the property include: Easements – (the right to use part of another’s property even though you do not own it); Leases and Licences – right to lease and license property collecting rental income; Mortgages and Security – right to borrow money in return for a charge over the property; Covenants – right to impose restrictions over the property; Planning Permission – right to an interest in the planning permission granted by the local authority attached to the property; Profit a Prendre – a right to take something from another person’s land. You need to consider who is responsible for the burdens that come with ownership of a fraction of the property.

Utility or Security Token

•  Do consider whether you are issuing a utility or security token. The difference is of crucial importance as utility tokens might fall outside the regulated perimeter. However, security tokens are regulated. To clarify, the utility token might fall outside the regulated perimeter if the NFT offers the holder the rights to a specific service, including building access, the use of meeting rooms, and cloud storage. The property token may also be classified as a hybrid token. For more information on hybrid tokens please contact us for a consultation.

•  The classification of an unauthorised NFT as a utility token is critical because partners such as custodial wallets will not support security tokens unless they are authorised. Custodial wallets are important because the private keys are held by the service provider. They help to facilitate the safe storage and trading of crypto assets. The NFT holder can have confidence that their crypto assets are safe which increases confidence in the NFT issuer particularly if the NFT issuer is relatively new in the crypto asset space.

  Well-known custodial wallet providers include: Trustology; 5ire; WireX; Copper; Fireblocks; Digiwallet.

Collective Investment Scheme or Special Purpose Vehicle

Do consider the most regulatory advantageous structure for the project.

•  a.     Special Purpose Vehicle (SPV) (a legal entity created for a limited purpose. SPVs are used for a number of purposes including the acquisition and/or financing of a project, or the set up of securitisation or a structured investment vehicle. They are usually used because they are free from any pre-existing obligations and debts, and are separate to the parties that set them up for accountancy, tax and insolvency purposes);

•  b.     Collective Investment Scheme (S.235 of the Financial Services and Markets Act 2000). Under section 235 (1) FSMA, a collective investment scheme is any arrangement with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.

 Which you choose will depend on the ultimate purpose of the business. If the purpose of the business is to provide investors with the ability to buy, sell and trade tokenised fractions of real estate for profit then it is best to structure it as a CIS which is regulated. Typically, property token offerings are structured as an SPV if there is no yield. SPVs are unregulated and should be used for tokens that solely unlock services and benefits for the user.

 You can also structure the business as an SPV which is a CIS.

Don’t

• Do not start issuing tokens without first considering the above dos. If you do and you needed authorisation you are breaking the law. It is better to find the right structure for the project first. You may not need authorisation for the first phase, but you need to consider the structure of the token carefully.

• Do not just assume that a token can only be issued in return for security investment. You can also issue an NFT in return for a loan. The buyer is deemed party to a loan agreement. An unsecured debt.

• Consider getting expert advice first by way of an initial assessment of your white paper before offering tokens.

The writer is a specialist in blockchain-related digital assets including NFTs and Cryptocurrency. For an initial consultation please contact: peter@pailsolicitors.co.uk or +44(0)207 305-7491. Charge rates will apply at the prevailing hourly rate and may vary.