Tokenisation and Digital Assets
A Transformative Approach Towards Investments
November 2020 Contents
Executive Summary 3 Foreword: Investments, Then and Now 5 Introduction The Emergence of Tokenisation 10 Definitions and Token Taxonomy 13 Does Tokenisation Work? 15 Potential Implications 17 Industry Applications 21 Case Studies Case 1: Real Estate – BTG Pactual 23 Case 2: Venture Capital – SPiCE VC 25 Case 3: Financial Services – Vanguard 27 Regulatory Landscape 29 UAE Insights 31 Industry Impact 35 Opportunities for the UAE 44 Taking Action to Encourage Digital Assets Development 47 Looking Forward: Next Steps for Digital Assets 49 UAE Initiatives 51 Market Sentiment: Confidence in UAE Ecosystem Development 55 Challenges to Adoption 57 Digital Assets Consideration 66 Conclusion: Future and Recommendations 68 Acknowledgements 73
2 Executive Summary
In the last few decades, the UAE has developed a robust ecosystem of pro-business regulatory frameworks, tax laws, and free zones, established to encourage business start-up and economic growth. These strides have positioned the country as a regional and global hub for commerce and investment.
Furthermore, the UAE continues to advance its national mandate of leveraging emerging technologies to enhance economic growth, social development, and government efficiency. As digital transformation and business restructuring becomes even more important, particularly post COVID-19, it is critical to continuously assess the emerging technology landscape to identify novel opportunities for economic and social advancement.
3 Executive Summary
Tokenisation and digital assets have emerged This report was developed to answer the following as one such opportunity, and the Centre for the key questions: Fourth Industrial Revolution UAE (C4IR UAE), a collaboration between the Dubai Future Foundation • What are tokenisation and digital assets and the World Economic Forum, together with and how are they being utilised? Accelliance, have been actively working at the Emirate and Federal level to evaluate the potential. As an • What are the implications across industries? outcome of these efforts, this report summarises the findings from a combination of research and • What are the opportunities and challenges? analysis, supported by a survey of over 100 industry stakeholders and 25 in-depth interviews. • How could this be applied in a local context, and what actions should the UAE take? Tokenisation and digital assets can be evaluated in two separate settings for two distinct purposes: Ultimately, anything that has the potential to advance the accessibility, security, transparency, Improving Existing Financial Systems: and efficiency of capital markets is a welcome development. While the C4IR UAE found that there Applying the technology to modernise existing are a number of remaining obstacles and prevailing financial market infrastructure, for purposes risks to mainstream adoption, tokenisation may such as advancing the dematerialisation of present an opportunity to enhance the UAE’s securities and streamlining the clearing and existing financial infrastructure. It may also, in settlement of securities transactions. turn, create new opportunities to further position the country as a hub in areas such as capital Creating New Financial Systems: market issuances, secondary markets for digital assets, and digital asset custodial services. Applying the technology where it can address shortcomings in existing capital markets through Furthermore, findings showed that such an providing new platforms, improving access ambitious venture to create a significant tangible to funding and credit facilities, tokenising impact can only be accomplished through assets to unlock liquidity, and creating new concerted efforts, requiring close collaboration opportunities for both issuers and investors. between regulators and regulated entities.
4 Foreword: Investments, Then and Now
5 Foreword: Investments, Then and Now
Over the last few centuries, across several financial hubs, humankind has become more business ventures could pool industrious and productive. This capital from many investors to global jump in productivity was finance their initiatives. We can preceded by the emergence of refer to this as the first wave of capital – the concept of investing accessibility, where illiquid assets in the future. Whereas historically and claims were converted into economies were generally seen as tradeable securities. This wave stable and unchanging, as political ushered in the rapid growth of conflict and economic competition exchanges and market liquidity, were seen to result in a ‘zero-sum paving the way for the rise of early game’ – the current foundations of European financial centres such the global economy are built upon as Amsterdam and London. the continuous expectation of future growth, which has opened Looking back, we have the floodgates for investment. come a long way from early capital markets. Advances in The platforms built to support technology and the digitisation these systems have developed of global markets have led to greatly since the initial emergence unprecedented global accessibility of financial centres – including and liquidity, and markets the formation of joint-stock continue to evolve rapidly. This companies, bond markets, dematerialisation of securities and investment funds. These over the last century, replacing represented the earliest physical certificates with electronic capital markets, where entities records, led to a second wave of issued bonds and shares that accessibility, bringing markets could be divided into smaller into the digital realm from the representations of ownership, stock exchange floor to the with shares accessible to a wide personal computer. This has range of investors. Prior to this, accelerated the development of ambitious business ventures were global liquidity and market access, generally restricted to a limited and it is now commonplace to number of wealthy individuals and diversify one’s investment portfolio institutions. With the emergence across a variety of geographies, of effective investment tools sectors, and asset-classes.
6 Foreword: Investments, Then and Now
Yet, there is still plenty of runway for investing, investors receive left. Financial market infrastructure digital ‘tokens’ representing has aged, with operational costs a stake in an asset, such as a and other challenges persisting. commodity, equity, or debt. For While markets are more example, this approach can be connected than ever, there are used to ‘tokenise’ a right in a fund, still gaps in accessibility of capital a right to an underlying asset, or a and market integration. Many representation of a financial asset. areas remain relatively illiquid, and barriers continue to exist for Many have proposed that this the average investor in accessing could usher in the third wave of various investment opportunities. accessibility, with the potential to Indeed, many opportunities streamline existing infrastructure continue to remain limited only to as well as integrate global markets wealthy investors and investment and investment opportunities, funds, whether by regulation, leading towards truly flat, globally accessibility, or otherwise. interoperable platforms for Simultaneously, there persists a the issuance and exchange of global pool of capital that remains various assets and securities. largely inaccessible to most small businesses, and even to corporates or governments seeking investment.
Enter ‘tokenisation’ – a novel approach of recognising either existing securities or completely new assets on blockchain or distributed ledger technology (DLT) – creating opportunities to modernise existing financial infrastructure and develop new investment platforms and opportunities. New forms of tokens could promise a new take on raising capital, where in return
7 Financial market infra- structure has aged8 9 The Emergence of Tokenisation
Within the context of blockchain and distributed ledger technology, tokenisation is most broadly defined as the representation of a particular asset, such as equity or bonds, through the issuance of tokens representing fractional shares of the underlying asset.
Like a coupon redeemable for an item, a token can represent a share of any tradeable asset, such as equity, debt, real estate, commodities, and more. These tokens are issued on a blockchain or distributed ledger. For simplicity, this report will use these terms interchangeably to refer to the technology layer underpinning tokens, leaving aside architectural differences between the two.
10 The Emergence of Tokenisation
TOKENISATION: ADVANCING INITIAL COIN OFFERINGS: THE SECURITY TOKENS: FINANCIAL MARKET GRASSROOTS PHENOMENA A MIDDLE PATH? INFRASTRUCTURE (FMI) The origins of asset tokenisation Security tokens entered as a Distributed ledger technology with blockchain technology can go-between positioned between (DLT) first appeared in the financial be traced back to the concept the ‘wild west’ of unregulated industry mainstream in 2015, of ‘coloured coins’ in 2013 tokens and the tokenisation and where it quickly gained traction in that marked certain coins to blockchain projects that were financial industry circles as a way represent assets in the real world tackling the lumbering legacy to apply elements of blockchain on the Bitcoin blockchain. infrastructure and intimidating technology to streamline the processes of capital markets. clearing and settlement of In the meantime, a new securities transactions by using trend was surfacing. In 2017, A security token can represent a a shared ledger among market demand skyrocketed for what share of a company, an investment participants. DLT was proposed became known as initial coin fund, a debt instrument, real as a new type of financial offerings (ICOs), a new take on estate, or other assets. As such, infrastructure to reduce operational crowdfunding, sidestepping security tokens generally fall under processes and costs associated traditional venture capital and the classification of a ‘security’ with reconciliation and dispute financing tools. A plethora of and are thus subject to much more resolution. Its approach to asset initiatives emerged, issuing stringent regulatory scrutiny. provenance and mutualised various coins and tokens to financial infrastructure has held raise capital for projects, often great potential appeal for some with little consideration for the industry stakeholders such as application of regulations and the American Depository Trust & securities laws. Many fell in Clearing Corporation (DTCC) and a grey area when it came to Australian Stock Exchange (ASX), compliance, and a number of who have developed distributed scams and frauds began to ledger systems in recent years. emerge. As demand slowed and regulators began to regulate ICO activities, a new concept emerged, the ‘security token’.
11 The Emergence of Tokenisation
At a high level, this has three functions:
Facilitating Access to Capital
Organisations finding existing capital markets options inadequate could raise funds via issuance of security tokens representing a particular asset.
Fractionalisation
Traditionally fixed, illiquid assets such as real estate or fine art could be broken down and represented as tokens, thereby fractionalising the underlying asset and offering new investment opportunities and liquidity.
Facilitating Access to Investments
The accessibility and Fractionalisation of assets through tokens could lower barriers relating to minimum investment requirements and geographies, opening up a global pool of capital.
12 Definitions and Token Taxonomy
Due to the early stage of already exists. Security tokens, these technologies, no unified also known as asset tokens, nomenclature has yet emerged for are meant to represent the various tokens and therefore some underlying asset – both financial definitions are required. For the (eg: equity, debt, funds) and purpose of clarity in this report, the non-financial (eg: real estate, following definitions shall apply: art). This is a new approach to new financial systems with Tokenisation: emerging service providers and secondary exchanges. the general process of representing an asset with a Although this report primarily blockchain-based token. focuses on the impact of security tokens (asset-backed tokens), Tokenised Securities: these tokens are also part of a broader classification of digital existing securities such as assets, also often referred to equities and fixed income that as ‘crypto assets’ and ‘virtual are dematerialised via a DLT- assets’ as a generic term for based system or transferred to tokens. While there is currently such a system. This represents no globally standardised an infrastructure and architectural classification of token types, many departure from the status regulators have been moving quo, but as it is applied within towards establishing categories existing networks of financial and definitions of tokens. institutions, it generally falls within existing regulations. Classifications are highly This is a new approach to dependent on the regulatory existing financial systems. approach – tokens can be evaluated from the perspective Security Tokens: of securities, or from their economic functions. As such, tokens issued in a security token tokens are generally split into offering, often resembling an three categories: security tokens, IPO or bond issuance – rather payment tokens, and utility tokens. than tokenising a security that
13 Definitions and Token Taxonomy
Figure 1 DIGITAL ASSETS Token Taxonomy Overview Security Tokens (Asset / Asset-backed Tokens) The classifications have been derived through These tokens represent the ownership of real economic assets synthesising the various definitions and or securities. Tokens that enable physical assets to be traded on approaches of several authorities and regulators the blockchain fall into this category, along with contracts. Asset across Switzerland, Lichtenstein, the United Tokens can range from the representation of ownership of certain States, Singapore, Malta, and Hong Kong, amount of gold, to a share in future earnings, to the ownership of including organisations such as the European equity in a company. Therefore, in terms of their economic function, Central Bank, International Monetary Fund many asset tokens are considered analogous to securities. (IMF), Financial Action Task Force (FATF), and Financial Stability Board (FSB). Payment Tokens (Exchange / Currency Tokens) Payment tokens (also equivalent to cryptocurrencies) are tokens that are intended to be used as a means of payment or exchange. This includes payment for acquiring goods or services, or as a means of value transfer.
Utility Tokens Utility tokens are tokens that leverage blockchain infrastructure in order to provide access digitally to a product, application, or service.
Hybrid Tokens This definition encompasses tokens that combine features of more than one category. For example, a token could serve as a means of payment, while simultaneously be used as a mechanism to provide access to certain products, services, or applications.
CENTRAL BANK DIGITAL CURRENCY (CBDC)
Wholesale CBDC Wholesale CBDCs are meant to be used as a settlement instrument for domestic and cross-border transactions but cannot be used in retail. These are being explored primarily for the purposes of boosting the resilience of the financial system and enhancing the efficiency of the central bank.
Retail CBDC Retail CBDCs are meant to be made available to the general public, meaning households and corporates. Key drivers behind the exploration of retail CBDCs are for reducing the cost of management of physical money, a general trend towards cashless societies, and creating a means to more effectively to serve the public.
14 How Does Tokenisation Work?
In the case of a tokenised security, investor outreach, onboarding, and the process is generally simpler token issuance process. Investors than the issuance of a security invest funds in return for digital token, as tokenised securities are ‘security tokens’ representing an representing an existing security as equity stake in the organisation. a token on a distributed ledger. For After the conclusion of the security example, private placements can token offering, the tokens are be notarised and represented on a listed on a secondary exchange, distributed ledger custody platform where others will be able to buy to improve processes around and sell them. Lastly, depending checking, searching, or verifying on the terms and rights associated transactions. In this scenario, with the token, the organisation tokenisation is being applied to may pay out a dividend to token augment existing processes. holders over the course of regular operations. A similar process can The process of issuing a security be extended to issuing tokens token differs from a tokenised to represent other asset classes, security and could be similar to such as real estate or bonds. a traditional Initial Public Offering (IPO), depending on the asset This tokenisation process creates being tokenised. For example, an space for new players to appear organisation decides to issue a on the market, such as token token for the purposes of funding a issuance platforms, new digital project. After the proper strategic, asset custodians, and secondary operational, technical, and legal exchanges, placing pressure on assessment and planning, it legacy institutions to improve launches a token offering to their own operations and provide approved international investors, new services to meet market often through a service provider dynamics and demands. that provides support in the How Does Tokenisation Work? 15 How Does Tokenisation Work?
Figure 2 Security Token Offering Process Overview
The process is called a Security Token Investor KYC / AML Investors Offering (STO) and is created, allocated, checks and onboarding transferred, and managed through its life on the token platform cycle on the blockchain platform.
Organisations directly or indirectly involved 1 2 Blockchain Network across tokenisation value chain :
• Issuance Platform / Investment Banks Investors purchase Token issuance, • Courts and Arbitrators the security tokens listings, submission and provide capital of prospectus • Regulators to the issuer • Custodial and Non-custodial Exchanges • Third Party Digital Assets Custodians
Source: C4IR UAE analysis and expert interviews
Investors receive Issuance platform tokens that are stored selected for issuance in their digital wallet of tokens
The issuer receives funds from the token issuance
Apply for legal jurisdiction and approvals Identify the legal and technical frameworks
1. The blockchain network acts as the platform for the issuance and exchange of security token transactions. Issuer: Prepare financial Assess validity requirements, token of the project and economics, business 2. The tokenisation process involves multiple fit for tokenisation planning, and legal documentation parties along the value chain. The process overview selects a group of the key organisations for the illustrative purposes and is not exhaustive.
16 Potential Implications
Tokenisation and digital assets – whether to modernise existing financial market infrastructure as a more effective platform for the trade and settlement of securities, or as a mechanism to create new financial systems entirely – could have many implications. These opportunities could yield substantial benefits and advance global capital markets, from improving current systems to creating new solutions that address existing shortcomings. On the other hand, the development of new parallel platforms and marketplaces may involve new risks that would need to be appropriately addressed through legal and regulatory frameworks.
17 Potential Implications
OPERATIONAL EFFICIENCIES potentially saving billions of dollars AND TRANSPARENCY in processing time and costs. The same could also be applied to new As noted previously, tokenised infrastructure for security tokens securities and security tokens and other digital assets on similar emerged as a by-product of infrastructure and platforms. blockchain technology, applied in myriad ways. As such, they stand FRACTIONALISATION to benefit from the same benefits AND LIQUIDITY of blockchain as the financial industry – namely, operational While the underlying concept of efficiencies and transparency. fractional ownership is not new, as demonstrated in the initial From a back-office perspective, formation of joint-stock companies the application of tokenisation in Europe and the evolution of and a shared ledger could capital markets thereafter, there reduce the need for reconciliation are still substantial limitations in challenges and engagement today’s world. For example, certain of intermediaries through assets such as real estate, art, or streamlining the execution and partnership shares in investment settlement of transactions. funds are still characterised by Currently, completing a securities high barriers to investment and transaction from execution to limited liquidity. With the use clearing and settlement can of security tokens that could take days. Maintaining a shared represent fractional ownership ledger of transactions among of these assets, investment market participants has potential opportunities in certain areas of to achieve absolute certainty real estate, fine art, and other over ownership and origin. Such sectors that would traditionally systems could benefit from instant require significant capital and transaction execution and atomic longer investment horizons may settlement, eliminating counter- become more accessible to party risk. Assets, or tokens, can a wider group of investors. instantly be exchanged between recipients if a transaction is validated. The process introduces new efficiencies and agility,
18 Potential Implications
Smaller investment firms need for intermediaries when INTEGRATION OF NEW GLOBAL and retail investors could be trading tokens and automated MARKETS AND SECTORS able to diversify to a greater life cycle management. This degree and acquire returns could substantially reduce By extension, tokenisation could from investments that were the need for administrative also be a means to achieve previously inaccessible. operations, simplifying and market efficiencies, both streamlining deal execution. domestically and globally. This The arrival of secondary exchanges is due to the ability to integrate for these tokens can facilitate In a mature, robust ecosystem for traditionally illiquid assets, one of the most widely endorsed tokenised securities and security investments, and markets. For advantages of tokenisation tokens, a global marketplace example, by enabling a more in the form of increased liquidity could emerge for issuers to raise accessible global platform across asset classes as well as capital and investors to access to raise and invest capital, reduction in the cost of trading new investment opportunities. tokenisation could usher in traditionally illiquid assets. Requirements and processes for more robust frameworks for Investment in tradeable tokenised issuers could be standardised, capital markets in developing assets could enable investors to simplifying reporting and countries or provide access enter into transactions at a lower compliance requirements for and liquidity to niche projects investment level while reducing raising capital and investor and assets across the globe. the average holding period and management. This could enabling token owners to trade and significantly decrease the costs With minimised barriers to exchange without fear of penalty associated with raising funds investment, programmable discounts or high commissions. and thus make the process compliance measures and more accessible, particularly enhanced digital transparency, the GLOBAL ACCESSIBILITY OF for small and medium-sized investment market could become CAPITAL AND INVESTMENT enterprises (SMEs). It would need ‘flatter’ and more accessible to any OPPORTUNITIES to be accompanied by proper kind of issuers and investors, from regulation, along with investor institutional to retail. Investments As the ecosystem and underlying protections, to encourage the would no longer be restricted by infrastructure develops, technology growth of retail and institutional geographies, asset classes, or platforms can enable investor investment in such enterprises. sectors, instead being undertaken access, issuance of tokens, Depending on regulation and via a fully accessible global regulatory compliance and trading capital controls, tokenisation could platform for the issuance and at scale. The programmability of potentially balance compliance exchange of any asset or security. smart contracts on a blockchain and innovation to unlock a global or distributed ledger for security pool of capital and investment tokens could allow for automated opportunities, available at payments, contractual processes anytime, anywhere in the world. for ownership transfer, reduced
19 20 Industry Applications
Tokenisation has been steadily gaining traction as a means of Modernising financial market infrastructure and creating new alternative investments. As outlined previously, tokens can represent equity, debt, or existing assets, which by nature makes them applicable to virtually all industries for a variety of different purposes – from raising capital to fractionalising assets to unlocking liquidity. Some notable examples have already emerged across industries.
Figure 3 Real Estate What Can Be Tokenised?
Analysis derived from public announcements, US $18 million was raised in a tokenised real reports and initiative overviews provided estate offering that gave investors an ownership by the respective institutions. stake in the St. Regis Aspen Resort.
BTG Pactual launched the first tokenised investment fund in South America, aimed at investments into distressed Brazilian real estate in the urban areas of Rio de Janeiro and São Paulo.
Financial Services
In 2019 Societe Generale issued the first covered bond (EURO 100 million) as a security token on a public blockchain.
Banco Santander issued a tokenised US $20 million bond on a public blockchain.
21 Industry Applications
Government
The World Bank, in partnership with Commonwealth Bank of Australia, raised approximately US $108 million after completing two rounds of tokenised bonds issuance (Bond-i).
The Government of Austria, with the assistance from the Oesterreichische Kontrollbank (OeKB) issued EURO 1.15 billion of government bonds on a public blockchain.
Venture Capital and Start-ups
SPiCE VC launched in 2017 in the United Kingdom and sold tokens to investors representing the first fully tokenised venture capital fund.
The Global Opportunity Philadelphia Fund ‘GO Philly Fund’ has announced plans to raise US $35 million by selling GO Philly Fund tokens.
Commodities
Norlisk Nickel (NorNickel) has received approval from the Central Bank of Russia for its digital asset tokenisation platform that will be used to tokenise commodities such as gold and palladium.
JPMorgan Chase & Co. is planning to tokenise gold bars on their blockchain network.
22 Case Studies
Case 1: Real Estate REITBZ FROM BTG PACTUAL Investing in distressed Brazilian real estate
IMPLICATIONS BACKGROUND REITBZ is a cutting-edge example of the One of the fastest growing markets in Latin America is potential of digital assets being realised. The the distressed real estate market. With the economic backing of a well-capitalised investment bank difficulties that Brazil has experienced in recent years, with US $44 billion in assets is encouraging for there are many properties that can be considered the future and legitimacy of digital assets. undervalued, with high growth potential. There are two noteworthy real estate drivers in this market. • It may create a way to bring liquidity to The first is that the Brazilian real estate market is traditionally illiquid Brazilian real estate and maturing, with improving regulation and government provides investment accessibility to retail oversight, increasing investment appeal. Secondly, investors globally. there is a large housing shortage in Brazil that needs to be filled, with an estimated shortage of over seven • The investment information can be shown million homes. This presents a potential investment through a transparent dashboard that provides opportunity that would traditionally be out of reach constant up-to-date information at any time. for the average retail investor, especially those The profits obtained from the sale of the assets situated outside of the Latin American markets. will be distributed via dividends to token holders through the blockchain. DESCRIPTION • Regulatory compliance will be supported through The largest independent investment bank in Latin the use of an AI-powered system called Jumio. America, BTG Pactual, launched the first tokenised The service will use facial recognition to investment fund in the region in 2019: REITBZ. verify the identity of investors, process documents, Focusing on distressed Brazilian real estate in and carry out other administrative tasks. the urban areas of Rio de Janeiro and São Paulo, REITBZ’s aim is to increase access to such assets by • These technological improvements will changing the real estate investment landscape. The speed up the onboarding process and first security token offering for Brazilian real estate provide greater security for users. raised over US $3.3 million from retail investors in its initial round. Typically, BTG Pactual offers its services to wealthy institutional investors, and this was its first foray into enabling smaller investors to participate through a digital asset token3.
3. ‘White paper – ReitBZ powered by BTG Pactual’, ReitBZ, 2020.
23 24 Case Studies
Case 2: Venture Capital SPICE VC One of the first fully tokenised venture capital funds
BACKGROUND IMPLICATIONS
Venture capital has typically been a space that is SPiCE VC represents a promising start to applying closed off to the average investor with an interest tokenisation in the venture capital space. It is in taking stakes in start-ups and new technologies. one of the furthest along in the implementation Venture capital funds tend to be restricted to high of the technology, and the companies involved net worth investors and there are also challenges have been reported to be showing ‘significant around start-up investment liquidity. Once a growth’ since the inception of the fund. venture capitalist or early-stage investor places their money in such an investment, it is typically A tokenised fund could present several advantages locked in for several years until the start-up goes over traditional venture capital funds. public or is acquired. This is a further barrier to entry for retail investors and remains an issue for • Venture capitalists can lock in the capital they many investors of all levels. Moreover, this also require, without locking in the investor for an restricts the source of capital for start-ups seeking extended period. In a tokenised fund with the funding to a smaller group of people and firms. availability of a secondary market, investors can buy and sell tokens at any time. DESCRIPTION • With Fractionalisation, tokens representing SPiCE VC was launched in 2017 as one of the the investment can be divided into miniscule first tokenised venture capital funds, using tokens denominations and traded on secondary to represent its shares. On 31 March 2018, the markets. Beyond initial investments this further firm closed its first fund and built up its initial reduces the barriers to entry for smaller traders. investment portfolio of 12 companies. SPiCE invests in companies within the blockchain • A smaller minimum investment could give sphere, with the aim of further developing the venture capital firms the option to be more digital asset ecosystem of which it is itself a part. inclusive with their funds, and access new capital Its security token is listed on the OpenFinance from retail investors. network, a US regulated trading platform4. • The addition of smart contracts can further benefit the industry, helping ease the administrative burden on venture capital firms by enabling more effective portfolio management.
4. Self-reported from the SPiCE VC website, https://spicevc.com
25 26 Case Studies
Case 3: Financial Services VANGUARD Modernising Financial Market Infrastructure
BACKGROUND IMPLICATIONS
The blockchain technology mechanisms behind Digitising ABS with the use of distributed ledger tokenisation and digital assets can be applied to technology offers numerous advantages over the modernise or upgrade existing financial market traditional method of issuance in areas of operational infrastructure and address the limitations of legacy efficiency, transaction speed, and transparency. systems. In particular, asset-backed securities (ABS) are an attractive candidate for transformation. • With the use of smart contracts, the process Currently, the processes around the securitisation of pooling the assets to form the final financial and formation of ABS offerings are time consuming, product can be partly automated, saving time complex, and inefficient. ABS are generally not and bringing additional efficiency into structuring transparent with pricing, and loss of information on the offering. trading can lead investors to miss out on valuable information as well as on identifying adequate • Additionally, applying blockchain to the performance of the underlying assets. These issues improving of settlement time of ABS can reduce complicate the creation and trading of ABS. the processing time from days or weeks to hours. This reduction in transaction time could DESCRIPTION provide further cost optimisation and minimise exposure to risk for investors. The Vanguard Group is one of the largest investment companies in the world, with over US $6.2 trillion in • Transactions are recorded on the blockchain, global assets under management as of 31 January providing an immutable record for reference 2020. Vanguard has been exploring ways to integrate and auditing. This provides greater security blockchain technology in capital markets since 2017, and protection for ABS holders, as well as working closely with blockchain start-up Symbiont, providing additional clarity for investors on and American ABS issuers and institutions from the the quality, value and performance of the financial sector such as BNY Mellon, Citi, and State underlying assets and financial instruments Street on the modernisation of the ABS securitisation that were pooled to create the ABS. process. In June 2020, Vanguard completed the first phase of its blockchain pilot project, which was focused on the use of a blockchain platform to issue digital asset-backed securities5.
5. ‘Vanguard Advances Blockchain Technology Pilot To Streamline Asset-Backed Securities Markets’, Vanguard Pressroom, 2020.
27 28 Regulatory Landscape
Naturally, the response of a notably increasing interest in regulators to digital assets has applying regulatory frameworks varied around the globe. While to tokens has taken place and a several have become actively shift in approach towards active engaged in the opportunity and legislation can be seen across introduced progressive regulations the globe. For example, countries to foster the development of the like Liechtenstein and Switzerland nascent industry, others have have issued tokenisation taken a ‘wait-and-see’ approach. regulation, while China is working Virtually all regulators, however, on a digital currency that could are united in ensuring a risk- potentially pave the way towards based approach commonly in further adoption of digital assets. line with the Financial Action Task Force (FATF) guidance Whereas cryptocurrencies on Virtual Assets and Virtual native to a blockchain and not Assets Service Providers. necessarily connected with any asset can be grouped into areas Regulators are unified in such as payment tokens and their emphasis on consumer utility tokens, security tokens protections, as well as critical represent an attempt to merge anti-money laundering (AML), new tokens with traditional ‘know-your-customer’ (KYC) finance and regulation. and other requirements, and these principles are applicable As such, we define the current regardless of the regulatory global regulatory engagement position taken. Any platforms into the following categories: that take part in issuance, trade or exchange of tokens must thus comply with rigorous regulations on the screening and onboarding of assets, issuers, and investors.
An increasing number of start- ups, corporates, and governments have been investigating the core concept of tokenisation to apply it within the framework of existing or novel regulations. Recently,
29 Regulatory Landscape
Figure 4 Active Approach Regulatory Approaches
C4IR UAE – Developed based on analyses of Retrofitted Regulation global regulatory activity and industry interviews. Jurisdictions that have adjusted and created amendments to existing laws to accommodate the activities related specifically to the issuance, trade, and exchange of tokens.
Dedicated Regulatory Framework
Jurisdictions that have created a novel regulatory framework to address digital assets and the tokenisation process from the perspective of all involved stakeholders and processes.
Passive Approach
No Action
Jurisdictions where no regulatory framework has been developed or guidance issued regarding digital assets and related activities.
Application of Existing Regulation
Jurisdictions where tokenisation is fit into the existing realm of the regulatory frameworks with little to none modification. This approach could as well take a case-by-case evaluation method.
30 UAE Insights
31 UAE Insights
The United Arab Emirates (UAE) 2019 Global Competitiveness In addition, the Centre conducted continues to further its national Report as the most competitive over 25 in-depth interviews mandate of adopting and economy in the MENA region7. with key stakeholders across developing emerging technology This ecosystem continues to form various governmental, regulatory, for economic growth, social the foundations for emerging and operational, technical, and development, and government innovative opportunities, such as strategic roles, to understand efficiency. This is reflected in digital assets and tokenisation. how digital assets could affect initiatives and strategies such existing market infrastructure as the National 4IR Strategy, As digitalisation and business and regulatory policies, and the National AI Strategy and Dubai restructuring become even role these stakeholders play and Federal Blockchain Strategy, more important, particularly in overseeing, and managing as well as the emergence of post COVID-19, it is vital the development of any such national priorities such as the to continuously assess the digital asset ecosystem. digital economy and AI, under technology landscape to the Minister of State for Artificial understand the value, impact, Intelligence, Digital Economy and other features of new and Remote Work Applications, innovations. The first half of this and the newly formed Ministry report provides a background on of Industry and Advanced digital assets and tokenisation, Technologies. This is also seen including a set of considerations in the robust ecosystem of pro- and benchmarks to review. The business regulatory frameworks, second half of the report focuses tax laws, and free zones in the on the context of the UAE. UAE, established to encourage business start-ups and economic The C4IR UAE conducted a growth. The UAE was ranked survey of over 100 industry among the top 50 destinations stakeholders, across start-ups, for start-ups, the highest in the digital asset service providers and MENA region6, by Zurich-based community, government entities, research firm Start-up Blink, and regulators to understand the and has ranked 25th globally in current ecosystem and appetite the World Economic Forum’s for digital assets in the UAE.
7. Khan, S., ‘UAE remains most 6. Sharma, A., ‘UAE ranks among 50 top start-up competitive Arab economy as it climbs destinations, says report’, The National, 2020. up ranking’, The National, 2019.
32 UAE Insights
Figure 5 Survey and Interview Composition Stakeholder + Survey Respondents
100 In-Depth 25+ Interviews Government % and Regulators
22 Corporates %
31 Digital Asset 47% Service Providers
33 34 Industry Impact
When asked about the impact of digital assets across industries, survey and interview respondents cited financial services and real estate as the two key areas that have the most potential to be affected by tokenisation. These two areas play a significant role in the UAE economy, with Dubai being named among the leading global financial hubs according to The Global Financial Centres Index (GFCI)8, and real estate playing a vital part in the country’s development. Initial assessments suggest that these sectors would provide a logical first step to explore in unlocking the value of digital assets.
8. “The Global Financial Centres Index 27”, Z/Yen & China Development Institute (CDI), March 2020
35 Financial services and real estate have the most potential to be affected by
tokenisation. 36 Industry Impact
Figure 6 Financial Services 88% Which areas do you believe will be most impacted by tokenisation? (Top 10)
Source: C4IR UAE Tokenisation and Digital Real Estate 64% Assets Survey of industry stakeholders.
Government 49%
Venture Capital 46%
Commodities 45%
Start-ups 40%
Healthcare 33%
Hospitality and Tourism 27%
Retail 23%
Telecommunications 18%
37 Industry Impact
FINANCIAL SERVICES First, the financial industry has actively explored platforms to tokenise securities and streamline back-office costs, in areas such as the clearing and settlement of securities transactions. Using According to 88% distributed ledger technology platforms as a digital custody solution for private placements and tracking other assets has also been cited as an area of of respondents, opportunity by interviewees. Tokenisation may present a mechanism to tokenise fixed assets such financial services as collateral for loans, with the right infrastructure to tokenise, exchange, and redeem them. is expected to Second, using security tokens, tokenisation may add a much-needed layer to the financial ecosystem, be the industry connecting organisations seeking debt or equity financing with prospective investors in a more accessible, efficient, and transparent manner. most impacted by Investors could invest in tokens representing small fractions of assets, allowing individuals and small tokenisation and investors to finance companies they believe in.
Companies that need an injection of capital digital assets. immediately must currently go through a challenging process to get the loan they need as sources may be limited. Debt tokens could minimise the time needed to get financing through increased transparency, smart contracts, and reduced numbers of intermediaries. A shared ledger of transactions can connect the lender and borrower directly, cutting out the need for custodians and eliminating transaction costs. Smart contracts can pay out dividends and interest automatically.
When asked which areas of the financial sector could capture the most value from security tokens, the area most often cited by respondents in interviews
38 Industry Impact
was SME financing. According to the UAE Ministry of Economy, SMEs are the major driver behind job creation in the country (86% of the private sector workforce), representing 94% of the total number of the companies operating in the country9. At the same time, this segment of companies faces several challenges in terms of financial liquidity and access to the capital needed to scale their business. Furthermore, SMEs are amongst the most heavily affected by the deteriorating global market conditions due to the COVID-19 pandemic.
In this regard, digital assets may play a crucial role as a catalyst in accelerating the standardisation and accessibility of equity and debt financing for start-ups and SMEs. Such steps could be a key factor in driving down the complexity and cost of capital for SMEs, as a by-product of digital asset ecosystem maturity. However, to achieve the full value of tokenisation for SMEs, respondents emphasised that clearer financial reporting guidelines would need to be put in place to reduce complexity for enterprises, as well as to protect investors. As security tokens could enable this new marketplace for financing, new opportunities along with new risks would become available to smaller investors, potentially causing financial vulnerability if smaller investors lose a substantial amount in the buying and selling of a token. It is thus crucial to ensure adequate disclosures and the protection of investors in such a scenario.
9. ‘The impact of SMEs on the UAE’s economy’, UAE Government, 2019.
39 Industry Impact
40 REAL ESTATE
Real estate has been cited by proponents of tokenisation as one of the highest potential areas of application for the technology, and survey stakeholders corroborated this, noting potential advantages in fractional ownership and improving liquidity. The real estate sector has historically been one of the strategically most important areas for the UAE, with its activities listed among top contributors to the country’s GDP. In 2018, real estate and construction activities contributed 14.4% of the Gross Domestic Product (GDP) of the Emirate of Abu Dhabi10 and 13.6% of the GDP of the Emirate of Dubai11.
Ergo, both residential and commercial real estate is a top candidate for security tokens driven by fractional ownership of properties. Tokens can represent a relatively small portion of owner equity that could be purchased by an individual investor, enabling new investment opportunities and an inflow of new capital. With appropriate secondary markets for these tokens, tokenisation could greatly increase liquidity for the sector, with accessibility for smaller investors who were traditionally not able to enter due to investment barriers and relatively low liquidity as an asset-class.
It is worth noting that tokenisation does not mitigate traditional risks of real-estate investment. For example, investors may face risks related to construction operations, such as delays, structural risks related to project financing, or general systemic risks and market changes related to the economy, inflation, or demand.
10. ‘Statistical Yearbook of Abu Dhabi’, Statistics Centre, Abu Dhabi, 2019 11. ‘Annual Report: Real Estate Sector Performance 2019’, Dubai Land Department, 2019.
41 Industry Impact
OTHER AFFECTED SECTORS
GOVERNMENT
Government was ranked third among all sectors in terms of the potential impact of tokenisation and digital assets. Central Bank Digital Currencies (CBDCs) are currently a topic of interest for many central banks around the world. Most applications are related to the use of either wholesale or retail CBDCs. Wholesale CBDCs can be used as settlement instruments for domestic and cross- border transactions, accessible only to certain organisations, whereas retail CBDCs are designed for the general public, further advancing a cashless society. Retail CBDCs could also yield efficiencies in government services, such as distribution of government support and financial aid.
Digital assets could also be applied to restructure or issue new sovereign debt. Alternatively, governments could issue utility tokens representing a tax credit, essentially an income tax cut, reducing future tax revenues for immediate inflow of capital. Tokens could be also used to pay debts that the government owes to domestic businesses, preserving its cash position.
In debt restructuring, creditors could swap their debt instruments for tokens containing revised terms. New participants could also purchase tokens in the offering. This is closer to traditional debt restructuring that has underlying economic implications beyond the scope of this report.
42 Industry Impact
The core implication is that issuing such tokens, As tokenised venture capital funds could enable either as a utility or debt token, is the equivalent new investment opportunities for smaller investors, of injecting liquidity into the economy if the tokens it is important to note that investment in start- themselves are liquid, without altering the monetary ups and early-stage companies carries potential supply. This has many economic implications risks, such as delayed return on investment and potential risks that would have be evaluated and potential failure. While experienced angel further prior to deciding on implementation. investors and venture capitalists have a greater awareness and tolerance of such risks, smaller VENTURE CAPITAL new investors may not have the same familiarity. Thus, risks and conditions corresponding to Tokenisation of venture capital funds was also such investments must be adequately disclosed ranked highly in terms of potential impact, selected and managed appropriately for new investors to as significant by 45% of respondents. By tokenising mitigate outsized exposure to such investments. funds, venture capital firms can raise and lock in the necessary capital required to fund new investments, COMMODITIES without locking in the liquidity, yielding two key benefits. The first is a more inclusive opportunity to The UAE is a leading regional hub for the international small and large investors to diversify their investment exchange of commodities, particularly crude oil and portfolios or invest in start-ups. The second is to precious metals such as gold. The value of the UAE’s offer liquidity to their investors, given that traditional trade in raw and semi-worked gold and diamonds venture capital funds typically have at least a five amounted to AED 258.4 billion in 201813. According to seven-year lock-in period. A tokenised fund to the Ministry of Economy, the UAE was ranked could list tokens on a viable secondary exchange first in the Arab world and fifth globally in terms of where investors could liquidate their holdings value of exports and re-exports of precious metals. much earlier, providing them with more flexibility. For this reason, there is an opportunity to assess the impact of tokenisation on the commodities markets. In the UAE, several initiatives have been formed to develop leading innovation and technology Tokenisation could be applied to commodities ecosystems, such as AREA2071 and Hub71. in various ways. For example, gold can be According to a 2019 MAGNiTT report, the UAE represented as a tokenised asset, where gold received the largest share of total start-up funding sourced from more sustainable miners could in the MENA region, with 59%12. As venture capital yield a premium on the market. JP Morgan is continues to evolve in the country, the development actively exploring the tokenisation of gold by of tokenised venture capital funds could be a electronically tagging tamper-proof cases of gold strategic priority to advance the development of and tracking their journey across the value chain14. early-stage start-ups and the innovation ecosystem.
13. ‘UAE gold, diamond trade in 2018 totals AED258.4 billion’, Emirates News Agency, 2020. 14. ‘JP Morgan’s Quorum blockchain opens new world of trading 12. ‘2019 MENA Venture Investment Summary’, MAGNiTT, 2020. opportunities’, The Australian Financial Review, 2018.
43 Opportunities for the UAE
One of the main aims of the research conducted was to assess the specific opportunities around tokenisation and digital assets for the UAE, and what steps can be taken to apply the underlying technologies. This was done from the perspective of both business-cases: 1) Modernising existing financial market infrastructure; and 2) developing new platforms for investments and advancing liquidity in certain sectors. The following ranking illustrates the top four opportunities for the UAE as indicated by survey respondents.
44 Opportunities for the UAE
Figure 7 Utilise the Technology What are the top opportunities for the UAE? Which part of the ecosystem should Asset tokenisation could be applied in key areas in the UAE the UAE participate in? (Ranked) such as financial services and real estate in order to capitalise on potential digital asset benefits such as wider access to Source: C4IR UAE Tokenisation and Digital capital and investments, liquidity, and transparency. Assets Survey of industry stakeholders.
Attract Companies
By developing regulatory and operation foundations for tokenisation early on, the UAE could position itself as an attractive destination for foreign companies – whether for token issuers, or digital asset service providers and exchanges.
Attract Capital and Investors
By developing a robust digital asset ecosystem, with favorable regulations, consumer protections, enforcement and other measures; the UAE could enhance its position as a secure and transparent regulated financial hub, attracting retail and institutional investment and providing sophisticated digital custody services.
Attract Talent
In line with the UAE’s vision of becoming a vibrant hub for cutting- edge innovations and R&D, initiatives to attract talent and start- ups around providing digital asset services may position the UAE as a hub for digital asset platforms, exchanges, and custodians, advancing an ecosystem that can yield synergies in other opportunity areas such as attracting token issuers and investors.
45 Opportunities for the UAE
By nature, tokenisation entails a digital asset marketplace of issuers, investors, and many stakeholders. Consequently, both survey respondents and government officials raised important questions around the development of clear regulations and standardised end-to-end tokenisation processes. These would need to ensure that all parties involved in the value chain have fit-for-purpose regulatory assurances and requirements for issuers, compliance requirements for service providers and exchanges, and protections for investors. While to a certain degree this will also rely on how digital assets are dealt with in other jurisdictions, the UAE can position itself as a leader in this regard, pursuing several of the above opportunities simultaneously.
Currently, tokenisation still remains a largely unexplored opportunity for the UAE, but given its positioning and ability to attract companies from the region and globally, deploying innovative approaches to investments and financing could reap the benefit of attracting issuers, service providers, and investors, developing a thriving digital asset ecosystem.
46 Taking Action to Encourage Digital Assets Development
The survey also asked are already underway to engage respondents to note what the digital asset community actions they saw as necessary to and service providers, through encourage the development of this financial centres such as Abu field. Over 96% of respondents Dhabi Global Market (ADGM) and believed that the UAE should the Dubai International Financial explore and encourage digital Centre (DIFC), with their regulatory assets. Even as comprehensive agencies – the Financial Services regulation evolves, the sentiment Regulatory Authority (FSRA) and was that policymakers and the Dubai Financial Services regulators should work more Authority (DFSA), respectively. closely with other public and The Securities and Commodities private sector stakeholders to Authority (SCA) has recently understand the full direct impact approved its draft law after and the secondary consequences consultations on the matter, and of digital assets. This could be the UAE Central Bank is also done through the development of assessing tokenisation and other a ring-fenced ecosystem, such as financial technologies to various a ‘sandbox’ where use cases and degrees. These steps should be scenarios could be explored in a expanded and strengthened in the controlled environment. It could near future. While the secondary also be done via other incentives order consequences of developing for talent and companies. Through a digital asset ecosystem are the know-how and expertise not yet fully clear, these will be developed during these exercises, among the defining elements of regulation would be key to any ecosystem development. ensuring the long-term opportunity It will be key to expand the and growth prospects for a digital scope of collaboration to look asset ecosystem. This was also beyond areas of regulation, corroborated in several interviews compliance, and company with various industry stakeholders. licences, to questions such as the impact on existing financial Both approaches above are infrastructure, the integration of relatively straightforward low-cost existing industry stakeholders, and initiatives, especially considering marketplace awareness among the potential upside. Thus, it can both investors and issuers. already be seen that initial efforts
47 Taking Action to Encourage Digital Assets Development
Figure 8 What actions, if any, would you recommend the UAE take?
Source: C4IR UAE Tokenisation and Digital Assets Survey of industry stakeholders. %
96of survey respondents believed that the UAE should explore and encourage digital assets:
Incentives for Talent 68% or Companies
Regulatory Guidance 64% & Legal Frameworks
Promote Ecosystem 64% Development
Public-Private 52% Partnerships
Regulatory Sandbox 51%
48 Looking Forward: Next Steps for Digital Assets
As part of an exercise to determine organisations that would be provided they are kept in balance. the critical path for developing candidates for the issuance and As with any new technology, a a digital asset ecosystem, exchange of tokenised securities significant investment must also be respondents were surveyed on the and security tokens should follow made in education and alignment priority order of key milestones regulation. Building on the two with prospective beneficiaries. – regulation, issuer interest, and steps that set the foundations availability of service providers and for wider adoption, the third While it is clear that these exchanges. The three milestones step seen as next was the three activities must develop in were numbered by respondents proliferation of digital asset tandem with one another, and by order of importance. The first service providers and secondary in parallel with growing investor main step identified as critical exchanges (voted in third appetite, the following figure by a majority of respondents – place by 46% of respondents), provides an indicator of where 58% – was that clear regulations attracting stakeholders across the initial focus should lie. must precede any meaningful the value chain to further development of a digital asset develop and standardise the ecosystem. In terms of token digital asset ecosystem. taxonomy (see Figure 1), there must be clarity around the Respondents were particularly split classification, recognition, and on the second and third steps – regulation of various types of namely on which was the greater tokens prior to any large-scale priority between developing activity in the open market. market infrastructure and market This is an area in which several demand. Too much focus on initiatives by UAE authorities are one without the other would lead already underway that could be either to strong issuer demand supplemented by some of the without the necessary market proposed activities in Figure 8. infrastructure or robust platforms and exchanges without a market. Ranked second was the However, rather than serving as a importance of awareness and prescriptive order of activities, this demand from organisations to exercise should serve to illustrate tokenise equities, debt, and that while regulation is a clear first other assets. While less unified priority, the surge of new digital than in their opinion of regulation, asset offerings and growth in 43% of ecosystem stakeholders underlying market demand can voted that that early buy-in from subsequently evolve together
49 Looking Forward: Next Steps for Digital Assets
Figure 9 Step 1 What needs to come first for the UAE to develop a digital assets ecosystem? (Ordered) Comprehensive Regulation
• 60% of interviewed stakeholders have named Source: C4IR UAE Tokenisation and Digital formation of clear regulatory guidelines, frameworks, Assets Survey of industry stakeholders. and compliance requirements as the first step towards developing a digital assets ecosystem.
• Regulations must strike a balance to ensure that barriers are realistic enough for new entrants and innovative offerings, without 1 compromising on compliance requirements. Step 2 Awareness and Interest from Companies Looking to Issue Tokens
• Once the right regulatory infrastructure and guidelines are in place, there must be awareness and appetite from companies looking to issue tokens in order to drive the market for digital assets.
• Adoption will be highly dependent on the time and cost associated with token issuance and compliance.
• On the other hand, there must be a level of 2 awareness and comfort around digital assets from investors in order to make the market. Step 3
Proliferation of Digital Asset Service Providers and Exchanges
• The third step in developing the digital asset ecosystem is the proliferation of service providers and exchanges, driven by favourable regulations and market demand.
• This could begin a positive feedback loop by simplifying the costs, processes, and assurances associated with a token issuance, attracting 3 more talent, companies, and investors.
50 UAE Initiatives
Several initiatives are already underway in the UAE to explore, develop, and regulate the emerging digital asset ecosystem. These encompass both onshore and offshore activities and regulations. Both regulators and regulated entities in the UAE have already initiated regulatory frameworks, guidance and consultation, sandboxes, pilots, and in-principle approvals for operations.
51 52 UAE Initiatives
ABU DHABI GLOBAL DUBAI INTERNATIONAL DUBAI MULTI COMMODITIES MARKET (ADGM) FINANCIAL CENTER (DIFC) CENTER (DMCC)
The Financial Services Regulatory The DIFC has been actively The DMCC was launched in 2002 Authority (FSRA), responsible for engaged in encouraging by the Government of Dubai to issuing licences and regulating developments in financial establish a hub for the global entities in ADGM, first launched technology, with the creation commodities trade. As of 2018, a virtual asset (formerly crypto of the FinTech Hive, a start- it was recognised as the largest asset) regulatory framework in up accelerator for financial free zone in the UAE. In January June 2018. In May 2019, this technology. The DIFC also recently 2020 at Davos, it announced guideline was further updated, launched the DIFC Innovation the launch of the DMCC Crypto with increased detail and Licence to support cutting- Valley, in partnership with CV increased scope. The free zone edge technology companies, VC and CV Labs, with the aim is actively working to support the including digital asset service of fostering a blockchain and development of digital assets by providers. In June 2020, the digital asset ecosystem. The Free creating a dedicated regulatory Dubai Financial Services Authority Zone already has a Blockchain framework for digital asset (DFSA), the regulatory body of Licence and Proprietary Trading service providers, exchanges, the DIFC published ‘A Market Crypto Licence activity to make and other stakeholders. Overview of Custody for Digital operations easier for new entrants Assets’, a discussion paper and is actively exploring what expanding on the growth of other licence activities may be the digital assets market and offered to support the ecosystem. evaluating implications on digital asset custody and regulation, emphasising the need for close collaboration between regulators, providers, and consumers.
53 UAE Initiatives
UAE SECURITIES UAE CENTRAL BANK AND COMMODITIES AUTHORITY (SCA) The UAE Central Bank is currently experimenting with a digital On 15 October 2019, the UAE currency called Aber through a Securities and Commodities joint effort with the Saudi Arabian Authority (SCA), which is Monetary Authority (SAMA). responsible for regulating and A joint statement released by monitoring financial markets, SAMA and the UAE Central released a first draft of a Bank stated the project ‘is for framework for the regulation use in financial settlements of issuing and offering crypto between the Kingdom of Saudi assets. One year later, on 21 Arabia and the UAE through October 2019 the SCA formally blockchains and distributed approved regulation for the ledgers technologies’. The UAE issuance and exchange of digital Central Bank also works closely assets. This is a promising step with other authorities within the for the UAE in developing an UAE on such matters, and recently ecosystem for digital assets and announced it was launching a regulated onshore activities. FinTech lab in 2019 to support innovation in the banking sector.
54 Market Sentiment: Confidence in UAE Ecosystem Development
From both regulatory and ecosystem perspectives, initiatives in the UAE appear to be positively influencing market sentiment. Respondents expressed confidence that regulatory guidance and ecosystem development for digital assets will mature in the near future – 81% of respondents believe that established regulation will emerge within two years, and 78% believe that with the right conditions, initial mainstream adoption could be reached within four years. With the recent approval of digital assets regulation by the UAE Securities and Commodities Authority, regulation and ecosystem development is well underway. While this data represents a valuable indication of general sentiment, tangible impact will be heavily influenced by factors beyond regulation, such as:
Operational factors: development of digital-asset specific licences, processes and guidelines for digital asset issuance and exchange;
Legal factors: ownership rights and transfer, compliance, enforcement, and arbitration; and
Technical factors: interoperability, security, digital asset custody solutions, potential integration and / or competition with existing financial infrastructure.
55 Market Sentiment: Confidence in UAE Ecosystem Development
Figure 10 How long do you believe it will take for Market Sentiment established regulation to emerge around Source: C4IR UAE Tokenisation and Digital digital assets in the UAE? Assets Survey of industry stakeholders.
Less than a year 33%
1 to 2 years 48%
2 to 4 years 18%
More than 4 years 1%
How long do you believe it will take for mainstream adoption across industries in the UAE?
Less than a year 11%
1 to 2 years 25%
2 to 4 years 42%
4 to 6 years 14%
More than 6 years 8%
56 Challenges to Adoption
While the considerable potential of tokenisation is clear for several applications, the path forward For asset tokenisation will require a number of areas to be addressed, with several questions in domains such as to evolve and scale regulation, governance, and infrastructure remaining unanswered. As regulation remains unclear in up to the institutional many jurisdications, token offerings have applied a conservative approach, limiting their own risks and liabilities, often to the detriment of investors. In many market, there must be cases, these tokenisation initiatives are operating with limited legal and business frameworks, which a clearer conversation do not necessarily confer ownership or certain rights to investors and may not be providing clear about the structure and security and protections. This applies to voting rights allocation, financial reporting, how returns compliance of such will be calculated and distributed, and more. token generation deals, For asset tokenisation to evolve and scale up to the institutional market, there must be a clearer conversation about the structure and compliance of the risk involved, and such token generation deals, the risk involved, and how investors and their money can be protected. how investors and their Investors must know what they are investing in, if the token in question possesses legally binding money can be protected. ownership rights, and how these functions may overlap with existing civil and corporate law. Other classifications of digital assets such as payment tokens also face open questions around their exchange and usage. For the time being, many of these questions are still in the exploration phase.
57 Challenges to Adoption
Figure 11 Challenge Category What are the top challenges to digital asset implementation and adoption? Regulation 62% Regulatory Source: C4IR UAE Tokenisation and Digital Assets Survey of industry stakeholders. Operational and administrative challenges 59% Administrative (eg: banking, visas, IP protection)
Awareness and understanding 54% Education of stakeholders & Communication
Regulatory oversight, 41% Regulatory consumer protection, and law enforcement
Governance implications 36% Operational
Availability of secondary 26% Business and markets and exchanges IT Infrastructure
Disruption to existing 24% Business and platforms and systems IT Infrastructure
58 Challenges to Adoption
Within the context of the UAE, there was a clear indication that regulatory and structural challenges remain to realising the potential of digital assets. These challenges include the need for regulatory clarity and defined frameworks for oversight and governance, as well as operational and administrative questions specific to the UAE, such as banking matters, visas, protection of intellectual property, and other concerns. Resolving these challenges is a prerequisite to the development of any digital asset ecosystem. On the positive side, there are a number of Emirate- and Federal-level initiatives underway to support the continuous improvement of these operational and administrative requirements. Moving forward, it would be beneficial to identify overlaps with these existing initiatives when considering activities to undertake from Figure 8.
Although tokenisation promises many advantages and leaps forward in terms of improving existing financial systems and developing new platforms, there are several hurdles to overcome in terms of achieving broader adoption and attaining these potential benefits.
59 Challenges to Adoption
INFRASTRUCTURE AND Furthermore, many of the potential benefits ECOSYSTEM READINESS of security tokens cannot yet be realised as fundamental aspects of the ecosystem are in their The challenges in the infrastructure and ecosystem early stages, one example being robust secondary for tokenisation can be explored within two domains, markets for the trading of digital assets. business and technical. The business factors are related to market dynamics and the business Most importantly, there must be a certain degree rationale behind embracing digital assets, while of scale in order for the development of a robust the technical factors are around the readiness ecosystem. If a critical mass of adoption cannot and maturity of the technology platforms. be reached, then many of the potential benefits of tokenisation cannot reach their full potential. For example, increased liquidity will not be achieved The underlying if retail and institutional investors have no access to platforms where tokens can be purchased and infrastructure required traded. If tokenisation is to gain traction and evolve, it needs widespread adoption and infrastructure. for these systems to As tokenisation is an emerging technology, awareness succeed is not yet as and understanding of what the technology entails is limited and this can create a psychological mature as it needs to be. barrier to adoption that needs to be worked through. Some may have doubts, while others may Regulatory requirements overestimate the capabilities of the technology and expect benefits that may not be feasible. are often unclear and Tokenising securities and use of security tokens do not fix every challenge and limitation of current stringent existing securities that exist. Neither do they add liquidity on their own; rather they serve as a technological compliance measures enabler to new operational and business models. for financial institutions This risk of unrealistic expectations can also inhibit the adoption of tokenisation, and as with can act as a barrier to every emerging technology, there are strengths and weaknesses. In some areas, tokenisation new service providers. may prove very beneficial, while in others it may not yield the benefits that are expected.
60 Challenges to Adoption
REGULATION AND The uncertain landscape means that many companies GOVERNANCE STRUCTURE remain hesitant to explore tokenised securities as a funding mechanism. The new environment Regulatory considerations remain at the top of the can be intimidating for those who may not know list of challenges to the adoption of tokenisation. where to start or how to ensure a compliant and Tokenisation will need regulatory frameworks and successful security token issuance. A risk-based mechanisms to be adopted for the mainstream approach towards key areas such as KYC and market. Legal documentation and structures will need AML requirements, as well as ownership and tax to be created to link physical assets to digital tokens. implications, remains at the top of the agenda for Furthermore, legal regulation needs to shape the concerned regulators, though significant changes landscape around these tokens, so they can function in regulations could hamstring future development. as securities with all of the benefits that digitisation Generally, greater regulatory clarity is needed globally brings. Naturally, the challenge here is markedly larger for digital asset ecosystems to develop further. than simply that of tokenising existing securities to streamline existing clearing and settlement processes. There must also be additional clarity when it comes to the governance of tokenised securities. When However, the global regulatory landscape still an asset is potentially divided between thousands remains uncertain. If digital assets are not seen of owners, what is the governance model, and as property under the eyes of the law, then they how do stakeholders align? For example, in an cannot be owned; and if they cannot be owned, apartment complex that has been tokenised, they cannot be traded or exchanged. Tokenisation who pays the maintenance fees? Who deals and digital assets are moving at a rapid pace, but with the tenants? If the building is burnt down in regulatory systems around the world have not all a fire, how will compensation be dealt with? moved at the same velocity, leaving a gulf between Governance frameworks need to clearly define what could be possible and what is possible. rights and responsibilities of investors and owners, Additionally, although free zones are in place outside much as they do today with traditional securities. of the main UAE jurisdiction, for mass adoption of tokenisation to succeed, the evolution of onshore These are examples of issues that regulation activities as per the recent UAE SCA regulation could provide clarity on – if a framework is will be a key aspect of ecosystem maturity. developed, these challenges can be managed.
61 A risk-based approach towards key areas such as KYC and AML requirements, as well as ownership and tax implications, remains at the top of the agenda for concerned regulators. 62 INDUSTRY TRANSFORMATION AND DISRUPTION
Another major question around the proliferation of digital assets is the disruption to existing platforms, systems, and processes. The real estate sector can illustrate some of these challenges. Larger investors have economies of scale and can use their vast resources to physically inspect properties and value purchases. Smaller investors who do not possess such resources will benefit the most from the transparency that tokenisation brings, though this does not negate broader conditions and risks associated with such investments. Larger investors may feel threatened from this change in the status quo and might be reluctant to support such a technology.
Major players in the industry whose business models could be challenged include intermediaries such as debt servicers, brokers, appraisers, and lawyers. Automated payment streams through tokens could significantly reduce the need for debt servicers. The power of brokers could also be reduced as increased data transparency would drastically cut their workload. Immutable and comprehensive record keeping reduces workload and the corresponding need for appraisers and auditors. Smart contracts may require more time to set up from lawyers but would need less follow- up once implemented. This could change the pricing structure for legal firms in the industry.
63 Challenges to Adoption
TECHNICAL LIMITATIONS • There are also questions around how operational errors will be handled. If a transaction is There remain technical hurdles to overcome to mistakenly carried out, how will it be reversed? bring tokenisation into the mainstream, such as the Can it be reversed if one of the parties disputes limitations of smart contracts, interoperability between the transaction? These are questions that will blockchains, potential errors on an immutable need to be discussed. platform, and stability in a hyper liquid market. • Tokenisation could increase liquidity in certain • So far, it has been near impossible to have smart asset-classes and there are questions around contracts that are completely comprehensive. whether markets could become ‘hyper- Currently, it is not physically possible to record liquid’, as similar concerns have already every conceivable situation that could arise and been raised in commodities markets. As have an airtight contract. Therefore, there may be barriers to entry and market inefficiencies are inherent limits to the effectiveness of the smart eliminated, will hyper-liquidity be a risk? Will contract. platforms require additional management and governance measures to prevent this issue? • Another issue is interoperability between blockchains. There needs to be one cohesive These are some of the major technical challenges standard adopted by the tokenisation that will need to be addressed if widespread adoption community. If multiple platforms are used is to occur. It is notable that technical challenges to tokenise assets, a transfer can only take may vary depending on legacy systems and the place and be recorded on the platform where state of financial markets within any given country. it was initiated. This fractures the market and may negate some of the benefits of using the technology in the first place.
64 65 Digital Assets Consideration
Although the application of blockchain and distributed ledger technologies to modernise financial market infrastructure is well underway, these remain largely limited to back-end processes that stakeholders such as issuers and investors rarely see.
New investments in the form of security tokens and other digital assets are likely to entail new regulations, service providers, and secondary exchanges. Stakeholders must therefore be cognisant of the differences between new systems and those that they are used to. Hence, as organisations forge ahead with digital asset products and services, there are several questions potential stakeholders must ask about the opportunities, risks, and processes involved.
66 Digital Assets Consideration
ISSUER INVESTOR REGULATOR
• How does the process of • How can I educate myself • How do security tokens work, raising equity or debt financing to understand the real and what regulated entities are through a token offering differ opportunities and risks of involved in the process? What from existing methods? security tokens and other are the major risks or gaps that regulation would need to fill? digital assets? • Is there a practical and • What are the business, feasible business case for my • How are my investment technical, operational, and legal organisation to issue a security contracts structured? How implications – where does our token to raise funds? What are can I be sure that prospective role fit in? the costs and benefits of this investments are legitimate and approach versus others? legally tied to an asset? • When considering global networks of issuers, service • What kind of planning is • What regulatory jurisdictions providers, and investors in the required to understand are involved? Are there ecosystem, how do we account how tokens could affect my stringent regulations and for the roles and responsibilities of several regulatory capitalisation table, balance safeguards in place to protect jurisdictions? sheet, or tax obligations? investors? • How should we regulate new • How can I ensure proper • How does the process of service providers, exchanges, regulatory compliance and investment, ownership, and and custodians? Do we apply reporting across jurisdictions? trading change in this new or amend existing rules, or ecosystem? create new ones entirely? • Is there a sufficiently developed digital asset ecosystem • How will the value of my assets • How can we develop to ensure enough investor be established and managed regulations that will be demand? moving forward? Do I clearly comprehensive, but also align with international standards? understand what my digital asset entitles me to? • What potential governance issues can be expected? Who • What secondary markets will be legally responsible will be available to liquidate in heavily fractionalised my holdings? Will my digital investments, and will this affect assets be tradeable on other any other government bodies platforms? or authorities?
• How long will I have to wait • How will regulations be until a mature secondary implemented and enforced? Are there any legal market develops where I can precedents to deal with trade my digital assets? digital asset litigation?
67 Conclusion: Future and Recommendations
While the future direction of tokenisation is still contested, regulators, start-ups and corporates alike have already started to explore the technology. Despite the relative nascency of the market for tokenised assets, enterprising service providers and token issuers have forged ahead with their own innovative offerings. From Modernising legacy financial market infrastructure, to tokenising commodities, real estate, and investment funds, real-world applications of tokenisation are already in play.
68 Conclusion: Future and Recommendations
69 The UAE private and public The gradual evolution of the sector stakeholder see the tokenisation ecosystem, from opportunity in asset tokenisation regulation to live applications, will enable UAE organisations From an assessment of market to steadily evaluate and sentiment through the UAE digital adopt the right approach asset survey, as well as from in-depth interviews with industry As initiatives across the UAE stakeholders and regulators continue to evolve, the emphasis who are actively engaging will gradually shift from developing with the technology, a general regulatory frameworks to consensus is apparent that developing the ecosystem asset tokenisation presents an itself. As regulation matures, growing opportunity for the UAE stakeholders will encounter as one of the technology enablers second-order consequences of the future of finance. From with regards to new and existing discussions with government and financial infrastructure, digital regulators, anything that enhances asset custody, arbitration and the security, transparency and enforcement, and other areas. accessibility of the financial Where not all consequences markets in the UAE is welcomed, can be identified up front and as long as regulation, security, ‘unknown unknowns’ may compliance, and enforcement exist, many implications and are effectively implemented. challenges around digital assets may only become apparent as end-to-end tokenisation projects and operations begin to take place in a live setting.
Potential unforeseen barriers to tokenisation may still arise, even in an ideal regulatory environment. Hence, closer collaboration between regulators, licensing authorities, financial institutions, service providers, and corporates will be critical.
70 Conclusion: Future & Recommendations
RECOMMENDATIONS Identification and engagement As this report indicates, digital asset of the right stakeholders early on is a crucial for stakeholders are eager to collaborate ecosystem development with regulators and financial institutions To take such an approach forward, a concerted strategy to advance the development of digital is needed. One of the key challenges is identifying, gathering, assets. Correspondingly, regulators and onboarding the right stakeholders. Tokenisation entails and financial institutions are actively a marketplace or ecosystem – one of issuers, investors, digital exploring the technology and its asset platforms and exchanges, financial institutions, banks, implications. This is reflected in the custodians, and courts, among others. All of these entities have existing initiatives underway at Abu a role to play along the process, and proper understanding of Dhabi Global Market, Dubai International tokenisation and digital assets along with the implications on Financial Centre, and Dubai Multi their operations will be critical to ensure success. As regulations Commodities Centre. These Free Zones mature, the engagement of all these stakeholders early are already developing programmes and on is an important aspect of addressing secondary order licence structures to enable digital asset consequences and ensuring ecosystem development. operations and to attract digital asset service providers, issuers, and investors.
71 Conclusion: Future & Recommendations
UAE should leverage initiatives The emphasis needs to be Closing: The intersection to identify and evaluate the put on building awareness of regulation and market potential of digital assets around digital assets infrastructure is crucial
At a high level, the UAE has Answering questions related to Globally, regulators tend to several options. Industry the implications of digital assets prioritise compliance over the stakeholders have expressed is particularly important because finer details of how exactly rules interest in collaborative ecosystem the impact of the developing and requirements are met. Clear development through pilots, infrastructure and ecosystem regulations will certainly advance sandboxes, incentives, and public- will be limited without awareness the digital assets ecosystem, but private partnerships (PPPs) to and understanding from existing the true value will be unlocked develop the right infrastructure enterprises and investors. in practice through close and processes for digital asset Without a strong business case collaboration between regulators issuance and trading. Throughout for tokenisation, or the right and regulated entities – not only this process, the UAE should knowledge around the process to ensure regulatory compliance, evaluate the impact of tokenisation and compliance requirements, but also to develop effective in terms of both domestic and potential issuers will remain processes and solutions to international opportunities to cautious of digital assets. Without advance issuances, secondary guide an overarching strategy. the right awareness, protections, markets, and custody solutions. Key questions include: and liquidity, retail and institutional investors will also remain cautious. With the right strategy, regulation, • To what extent can a ecosystem development, and regulated digital assets positioning, the UAE can maximise ecosystem generate tangible the opportunity of tokenisation in economic impact? line with its vision of advancing its position as a regional and • How can the UAE global financial hub on the benefit from utilising the forefront of fintech innovation. technology, position itself Future research and hands-on more broadly as a hub for initiatives by the C4IR UAE will the future of finance, and aim to answer such questions also incentivise companies around end-to-end business to choose the UAE? processes and stakeholder implications, strategic positioning, and ecosystem development.
72 Acknowledgements
The Centre for the Fourth Industrial LEAD AUTHORS Anthony Butler Revolution UAE (C4IR UAE) is a Distinguished Engineer and collaboration between the Dubai Future Mariam Al Muhairi Managing Partner, IBM Blockchain Foundation and World Economic Forum. Lead, Centre for the Fourth Services, Middle East and Africa The first affiliate centre in the region, Industrial Revolution UAE, UAE C4IR UAE works alongside a multi- Aruba Khalid stakeholder community to develop Marek Termanowski Senior Research Analyst, Dubai technology governance and pilot projects Partner, Accelliance, UAE Future Foundation, UAE in the fields of artificial intelligence, blockchain, and precision medicine. Mark Balovnev Arul Jose Virgin Partner, Accelliance, Canada Head of IT, DIFC Courts This report was written in collaboration with Accelliance. Accelliance is a consultancy CONTRIBUTORS Bashar Kilani company, driven by entrepreneurs to Region Executive, IBM Middle East inject start-up energy and business value Abu Dhabi Digital Authority to organisations in the era of innovation UAE Ben Weisman and technological disruption. Its mission Project Lead, Financial Innovation is to help organisations create economic Abu Dhabi Global Market World Economic Forum value, achieve strategic goals, and UAE fulfil their innovation agenda through Christian Kunz applying the latest technologies. Dr Adrian Buss Vice President – Strategy, DIFC Authority Associate Professor of Finance, Dubai Multi Commodities Centre, UAE This report is based on numerous INSEAD, France discussions, workshops, and research. Dubai Land Department The Centre For the Fourth Industrial Ahmed Al Ali UAE Revolution UAE and Accelliance would like Information Systems Section Head, to acknowledge the valuable contributions Dubai Department of Finance, UAE Faisal Al Hawi of the following people in developing Head of Accelerators and Incubators, this document. Sincere gratitude is Alexandar Williams Dubai Future Foundation, UAE extended to those who contributed Director, Future Economy their unique insights to this report. Department, Dubai Department of Fayez Maarrawi Economic Development, UAE Senior Manager, Business Development DT World Amna Al Owais Chief Register, DIFC Courts
73 Acknowledgements
Hesham Ismail Matar Suhail Al Mehairi Salem Khalifa AlKaabi Acting System Development Division Chief Information Officer & Chief Senior Manager - IT Operations, Director, Dubai Department of Finance, UAE Innovation Officer, DEWA Department of Economic Development
HSBC Bank Matthew Atkinson Dr Salim Al-Ali UAE Business Analyst, Accelliance, Canada Assistant Professor Sharia & Islamic Studies Dr Hussam Al Talhuni Moza Suwaidan United Arab Emirates University Legal Advisor to the Minister of Director of Strategy & Innovation, Finance, Ministry of Finance, UAE Smart Dubai, UAE Sherif Talaat Project Manager, Dubai Iqbal Alikhan Muna Al Ali Department of Finance Banking Innovation Leader, Technical Support Section Head, CTO’s Office, IBM EMEA Dubai Department of Finance, UAE Sumedha Deshmukh Platform Curator, Blockchain James Bernard NASDAQ Dubai & Digital Asset Policy Head of Corporate Sales, Dubai UAE World Economic Forum Multi Commodities Centre, UAE Dr Patrick Noack Dr Yingli Wang Joseph El Kadi Executive Director of Foresight and Reader in Logistics and Operations Application Project Manager, Dubai Imagination, Dubai Future Foundation, UAE Management, Cardiff Business Department of Finance, UAE School, Cardiff University, UK Peter Smith Justin Baldacchino Managing Director, Head of Strategy, Zeina El Kaissi Managing Director, Supervision, Dubai Policy and Risk, Dubai Financial Chief Digital Director, Smart Dubai, UAE Financial Services Authority, UAE Services Authority, UAE
Mahmood AlBastaki Rashid Hazari Chief Operating Officer Chief Strategist, Future Economy DT World Department, Department of Economic Development Marwan Alzarouni Managing Partner, Accelliance, UAE Reem AlShihhe Chief Operating Officer, DIFC Courts
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