which is probably the first and best-known representative. However, the blockchain technology on which these currencies are based offers much more potential. A whole universe of new, decentralized financial instruments is currently emerging, giving rise to new services and business models. Assets are mapped as entries in the blockchain via so-called crypto tokens. These crypto tokens are an important component of the so-called Decentralized Finance (DeFi) movement. It stands for the effort to provide financial services without human intermediation and without central instances such as central banks, solely via blockchain technology. The Federal Financial
Supervisory Authority (BaFin) defines crypto tokens as a digitized reproduction of assets stored in a decentralized manner on a blockchain. A transfer occurs technically in the form of a computer code from one participant to another. Such a transfer is documented by a cryptographically signed transaction in the blockchain. Nonetheless, how crypto tokens and related transactions are to be legally classified is by no means yet clarified or assured.
Decentralized and disruptive
Crypto tokens are no longer just digital instruments of payment. Any marketable right, unless there are specific formal requirements, can be digitized and made tradable via such tokens. Financial instruments such as shares and loans, but also (future) claims to goods or services can be represented by them.
These digital reproductions of assets are registered in the blockchain and can be bought and sold via it - similar to what we know from securities today. The technology's claim is that it can do without central authorities such as banks, stock exchanges, and regulators. With this approach, the technology offers enormous disruptive potential.
• It eliminates the need for intermediaries and brokers, thus reducing transaction costs
• It reduces barriers to entry and makes even the smallest shares of large assets tradable
• It has the potential to make the availability of assets accessible to a larger target group and thus make previously non-transparent markets more efficient
Risks due to misuse
These business potentials through crypto tokens offer a great of scope for actions and design, but also open up options for misuse - although technically every transaction is recorded in the blockchain and thus, is transparent, they are usually carried out pseudonymously and still largely without any (legal) framework. To prevent misuse and access the potential of digital finance, regulators, governments and central banks are in the process of developing and implementing general parameters for digital assets.
This post kicks off a series on crytpo tokens, in which I present the various functions of decentralized digital financial instruments and highlight their opportunities and risks from a legal perspective.
Payment, investment and utility tokens
The series deals with the different categories of crypto tokens and their relevance, notably under regulatory and civil law aspects. The main focus is on those projects that are not subject to any regulatory obligation and can therefore be implemented under facilitated requirements. Crypto tokens can be divided into the three most common different categories, to each of which I devote a separate article:
• Payment tokens: These include the so-called cryptocurrencies such as Bitcoin and Ether. They are private-law instruments of payment that can be used to purchase goods and services. Their power for purchasing or exchange is based solely on the market participants' expectation of their future usability as a means of payment.
• Investment tokens: Via these tokens, assets such as membership rights or debt claims become tradable. They grant their acquirer a claim to future payments or rights. They have a profound investment component and therefore, are comparable to shares or debt instruments.
• Utility tokens: also called usage tokens. They grant their acquirer a right to goods or services. Due to the complexity of the possible services that can be reproduced, the legal structures are very complex and multi-layered.
The preparation and execution of such tokenizations and corresponding transactions are currently still poorly regulated and therefore associated with many uncertainties and queries. In addition to capital market law issues and the resulting regulatory obligations, companies face also numerous civil law and tax law challenges that require careful consideration.
We advise on projects in the field of digital assets. In particular, we support our clients in legally classifying the transactions in connection with crypto tokens, designing them in a compliant manner and implementing them contractually.