Legal Guide for RWA Projects: Part I

When we say Real World Assets (“RWA”), we can think of all assets that we can physically access, buy and sell, and that can be subject to legal processes. Movable and immovable assets such as houses, cars, ships, etc. can be examples of RWAs.

Now that we have determined what RWAs can cover, let’s talk about tokenization. Tokenization can be defined briefly as the process of converting rights on an asset into a token or tokens by digitizing them on the blockchain. It is of course possible to develop the definition of tokenization from a technical perspective, but since the main subject of this article is RWA projects, I will continue my article assuming that my readers are familiar with the technical processes of tokenization.

When we consider both definitions, we call the tokenization of real-world assets, such as houses, cars, etc., represented on the blockchain by digitizing them and dividing them into certain amounts of tokens. If you are not familiar with the Web 3 ecosystem, you are likely to ask the following question: “Why RWA Tokenization?”. So let’s start by explaining this question.

Although tokenization is possible in many different areas, in practice it has mostly started to take shape in real estate, art and luxury investment vehicles. The number of active investors is quite limited, especially in areas such as works of art, classic cars and real estate, where initial investments are quite high. With the tokenization of these assets on the blockchain, it becomes possible for the average investor to easily invest by dividing them into many tokens and easily obtain the profit from this investment as a crypto asset.

For example, you own a very high-value office building. If we say that the value of this office building is 1 billion dollars, it is quite easy to say that you need high budgets to be able to invest. However, if you decide to tokenize this office building and divide it into 500,000 (five hundred thousand) tokens. You can also provide an average investor with the opportunity to invest in a business building with an amount of $ 2,000. Later, many offices in the relevant business building were rented and the business building now earns a rental income. Here, token owners can benefit from this rental income according to the amount of tokens they hold. In short, you do not need millions to get started. RWAs offer you the opportunity to obtain a piece of real-world value at a more affordable entry point. In addition, due to the transparency of blockchain technology, it offers you a clearer picture in order to see what you are investing in.

So let’s come to the answer to our question. So, why RWAs? – Increased accessibility, transparency, liquidity, global reach and efficiency.

Now that we have touched on RWA tokenization and why it is needed, we can now come to our main topic, which is how we can do this in the least problematic way while tokenizing RWAs. I say the least problematic way because the regulations in this area are still developing and include many issues that we cannot be “absolutely” sure about. After all, we are talking about digitizing real-world assets and benefiting people with tokens representing real-world assets with blockchain technology.

Before moving on to the legal part, it is necessary to decide how the users who acquire the relevant token after the RWA tokenization will be managed and benefited. This is where Decentralized Autonomous Organizations (“DAO”), Centralized Autonomous Organizations (“CAO”) or fully centralized organizations, which I do not look very favorably on, come into play. So why do we need these organizations and why do I not look favorably on the implementation of tokenization as a central organization?

After tokenizing the RWAs, the users who acquire the relevant token form the “community”. However, do not forget that a real-world asset is tokenized, and although users have rights over this asset with the token they acquire on the blockchain network, there must be a person or legal entity that legally owns this property, and it is necessary to somehow determine how this tokenized asset will be evaluated, sold, rented, and actions will be taken in the event of legal disputes. Here, a governance structure needs to be established in various forms, such as the DAO, CAO, and central governance organizations that I mentioned above, in order to manage the community in question.

Since the governance structures I will talk about are complex structures related to blockchain technology, I will not include their details in this article, but if you are not familiar with the relevant governance structures, I recommend that you learn about them and revisit the next section from here.

Organizational structures that we call DAOs, which are automated and have decentralized governance with smart contracts, are now widely used. In fact, several states in the United States have even created company types for the legal establishment of DAOs. In DAOs, the community of token holders has the right to take part in the decision-making mechanism in the management of the organization, usually in proportion to the tokens they hold, although this varies. For example, if the community exists as a DAO in an RWA project, the community has a say in situations such as the sale, rental, etc. of the relevant real-world asset. Although this system is quite democratic and secure, decision-making processes can be quite long, and there can be delays in taking action in the event of possible disagreements.

Let’s come to CAOs, CAOs, which again have an automated structure with smart contracts, do not have a decentralized structure and are managed by a few administrators, but basic operations are carried out with the rules assigned in smart contracts without human intervention. While decentralization and transparency are compromised, the actions to be taken are accelerated. This is one of the structures that I find most logical, especially when considering the purpose and scope of RWA projects. After all, the purpose of many RWA projects is to provide their users with the benefit of the relevant real-world asset in the best possible way without any problems. For this, speed of action is very important for us. I also think that CAOs are the most logical governance structure for the creation of a legal cover in the legal sense, which I will talk about in the second part of my article.

Finally, what I don’t find very useful and that I think could lead to many disputes is the use of a fully centralized corporate structure to ensure governance. There is no transparency here, all decisions should be made manually by one or more managers. It is also very difficult to put it in a legal wrapper, which we call Legal Wrapper. Even if it is possible for now, I think it could cause big problems in the future as regulations take shape.

In the first part of my legal guide series for RWA projects, I talked about the choice of governance form. In the next part, after we choose one of these governance forms, I will talk about what kind of strategy would be beneficial for us to implement the RWA project legally, in which country it would be legally safer for us to offer the relevant tokens to the users, and under what legal entity and in which country we should benefit our community.

I think that RWA projects will be actively used in many traditional sectors such as real estate, art, etc. in the next 5 years and that projects in this area will increase rapidly. It is very important to proceed in this gray area in compliance with current regulations and in preparation for future regulations. See you in our next article.