The Next Wave of Web3: Tokenization of Interests, Not Assets
Introduction
The evolution of blockchain technology has been fascinating to follow. What began with the immaculate conception of Bitcoin as “digital gold,” then boldly expanded into immutable “smart contracts” with Vitalik Buterin’s decentralized supercomputer, and boomed-and-busted through “digital beanie babies” (commonly known as NFTs) will likely experience another growth cycle by representing quantifiable, legal ownership interests that are transparent and independently verifiable. Ensuring that represented interests are legal as well as efficient and widely accessible will lend credibility and sustainability to blockchain technology.
Tokenization as an Industry
The recent Boston Consulting Group report estimated that tokenization could become at least a $16 trillion (USD) industry by 2030. Like all estimates, this is merely a calculation based on a snapshot of conditions at a singular point in time, but it carries with it a recognition that the nature of this technology will result in an efficiency and value-capture increase comparable to the current GDP of China. In fact, even China is recognizing the value of tokenization as they prepare their own state-run NFT marketplace, despite the fact that decentralized crypto is still illegal there.
In order to internalize BCG’s estimate, a few assumptions need to be thrown out the window, and our very concept of tokenization needs to become more robust. First, the year 2022 has proven that in most cases token valuation should not be based on its mere existence and association to certain parties (See: $FTT and $LUNA). This has been speculative fodder for gamblers at best and a get-credit-quick scheme for grifters at worst, which ultimately ruins things for the rest of us. Second, token functionality should not be so limited to a singular interest or function as it has been, with similar limitations tending to stifle the growth of Bitcoin beyond its status as a collectible tech commodity.
Tokenization of Legal Interests
A “legal interest” generally means any interest represented by a valid document. Although most contracts do not require documentation to be valid, without it the likelihood of recovery becomes virtually impossible, especially when considering real estate or commercial transactions. When considering the concept of a legal interest, an example from property law many former law students will remember is the “bundle of sticks” metaphor. While normally limited to real estate analysis, it is a very helpful concept that reveals just how diverse the concept of ownership can be.
The basic concept is that ownership of real estate can be divided into concepts including (1) the right of control, (2) the ability to exclude others from entering, (3) the ability to freely enjoy the property, (4) the right to sell or transfer the property, (5) the right to possess the property, and so on. Whether the property is rented, is subject to an easement, an ownership regime, or part of a homeowners’ association, it can substantially alter who owns which “sticks.” In time, other types of ownership have been added to real estate property rights, such as mineral and water rights.
Given how simplistic digital assets have been so far, it seems clear that the generative nature of tokenization has not yet been realized. The current generation of NFTs’ ability to bestow intellectual property rights to owners has been inconsistent at best, and certainly not at the level that would make most attorneys comfortable claiming that they do. To this end, possession of the digital asset that exists on the blockchain is easy to define, but what is missing is the attribution of rights associated with possession of the asset (as well as the concept of lawful possession, as Seth Green found out). The best solution would be to define at minting what it means to own the asset being tokenized, and work with blockchain architects to associate technical functionality with how these rights will evolve and be transferred over time.
In the case of tokenizing real estate, it will be important not only to preemptively perform a title opinion on the property before minting a representative interest, but also to memorialize existing interests found on the chain of title in a way that can be conveyed to their respective owners. For example, if an easement exists, associating that easement and its terms with a wallet address legally associated with the owner of the easement (and providing a method for transferring that association to a new wallet if access to the original is lost). In another example, providing that renter interests are validly conveyed only if they comply with landlord-tenant laws in the appropriate jurisdiction. These tokenized renter interests could be likewise associated to the renter’s wallet address and automatically expire at the close of a specified period and replaced with a month-to-month interest, or be renewed upon on-chain confirmation that offer and payment has been accepted by the tenant and landlord, respectively.
Interests in Internet-Native Organizations
This concept of tokenizing differentiable interests will benefit DAOs as well, allowing them to more clearly define and delegate the roles of leaders and fiduciaries without compromising privacy considerations many proponents of decentralization are now demanding. Many DAOs would benefit from delegating many aspects of management, like paying out distributions, managing membership, and implementing governance decisions, to a trusted third-party fiduciary. There has been much concern about joint-and-several liability being imputed to “known” DAO members when partnership principles apply or the corporate veil is pierced in DAO LLCs. A trust structure with delegation of basic fiduciary responsibilities seems to be the best solution in the interests of efficiency, liability protection, and privacy. There will be a lot of work for lawyers and trust officers in South Dakota once DAO members realize the benefits of this concept.
Conclusion
Our commonly-held belief is flawed — legitimacy and expansion will not arrive when the institutions do, but when the lawyers do. F.A. Hayek called law, language, and money the three interrelated paradigms of spontaneous, emergent order in society. Blockchain was a unification of language (through computer code) with the concept of money, with which Bitcoin shares many traits. The next stage of aggressive expansion will occur when this technology is united with the law. Trustlessness then, is not just based on permissionless decentralization, but a common understanding of what it means to “own” something under the law.
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