Legal Guide for RWA Projects: Part II

First of all, if you haven’t read my article titled Legal Guide for RWA Projects: Part I and are here to learn about RWA projects, I strongly recommend you to read the first article of this series. I would like to welcome those who read my first article and are here for the rest and those who are coming back after reading it.

In my first article, I talked about what RWA tokenization is, which asset types it is preferred to use, and what kind of governance model projects should prefer when considering running an RWA project, which is a very important issue. In this article, I will talk about where and how RWA tokenization projects can legally position themselves.

Before I start writing, I will frequently use technical terms such as smart contracts, DAO, CAO, token offering, and if you do not have enough knowledge about these concepts, I strongly recommend that you return to this article after reading about these concepts.

Before delving into the legal level, I think it would be much more useful to understand how RWA works from a technical perspective and to examine the stages here in parts. I mentioned that in RWA projects, the process begins with the conversion of physical assets into tokens.

This tokenization process is usually carried out using smart contracts on a blockchain network like Ethereum (Usually encoded with smart contracts that comply with ERC-20 or ERC-1400 standards). The physical asset is fragmented into tokens and now there are “x” number of tokens representing this asset. The process here varies entirely depending on the value of the physical asset and the project requirements.

Smart contracts are then coded to manage the buying and selling of these tokens, automating the purchase of tokens by investors, receipt of payments, and distribution of tokens.

Important Note: Up to this stage, tokens and smart contracts have been prepared. Now the tokens are ready to be offered to investors. One thing that should be noted in particular is the need to create interfaces and systems that will allow investors to complete identity verification and anti-money laundering (AML) procedures before moving on to the next stage, the token offering stage.

After all these stages, the stage of offering the tokens, which is a very important process, begins.

There are generally two methods used here. These are: Initial Coin Offering (“ICO”) and Security Token Offering (“STO”). Which of these methods will be used depends on the features of the created token. In practice, RWA tokens are considered security tokens. Since security tokens touch many areas of the traditional financial system and provide multiple rights to their investors, they are subject to licenses in many countries where crypto laws exist. For this reason, many RWA projects try to show the tokens they offer as utility tokens. So does this work? Yes, at the first stage, especially in countries where crypto laws have very broad definitions, this can be useful and licenses can be avoided.

Do I recommend it? No. The reason is simple, avoiding licenses in the short term will not protect you from past activities in the future when the token is found to be a security token, and any unauthorized activities will be penalized retroactively.

The reason I mention these is that the ICO method is mostly used for utility tokens and consists of the automatic distribution of the project’s tokens to investors by selling them for a certain period of time through smart contracts.

For security tokens, the STO, which has a more detailed process, involves the legal sale of tokens in accordance with various security standards. Smart contracts are structured to ensure that investors meet certain legal criteria and token distribution is carried out accordingly.

If everything goes as we want during these processes, investors now own their tokens and are ready for profit distribution.

The income stream, which varies according to the tokenized RWA, will generally be distributed to investors automatically through smart contracts and income from assets. What type of asset should the income obtained here be provided with? Is it possible to provide it with fiat currencies?

MiCA has imposed certain restrictions on stablecoins. Despite this, can stablecoins be used to distribute profits? Since this is a very broad topic, we may examine it separately in our future articles.

The revenues generated will be distributed to token holders at predetermined rates at intervals determined in smart contracts.

In addition to income distributions, projects can also use various mechanisms to provide additional income to token holders, called staking and yield farming. These need to be evaluated separately from a legal perspective and may be the subject of a separate article.

For now, let’s briefly define it as allowing token holders to earn additional rewards by locking their tokens for certain periods of time.

However, it should not be forgotten that as such variables within the project increase, a separate legal strategy will need to be created for each issue and brought together on a common platform.

Since the main subject of our article, which country, is a very important and detailed subject, we will discuss this subject in detail in our next article, part 3. In my previous article, I mentioned the governance forms that can be preferred for RWA projects. As the integration of blockchain technology accelerates, progressing on a legal level will also become easier. However, for now, it is very important to adapt to the development process. See you in the next article.