Tokenization under the MiCA Regulation: Limitations and Opportunities

Tokenization of assets has become one of the key trends in the modern financial market, which allows replacing traditional forms of ownership with digital tokens, opening up new opportunities for investors, reducing barriers to entry, ensuring diversification and increasing liquidity of assets. Today, tokenization is especially relevant for real estate, precious metals, works of art, and other types of assets that traditionally required significant investment.?

Asset tokenization projects have been successfully implemented in many jurisdictions, but until recently, the European Union was not one of them due to the lack of proper legal regulation. The Markets in Crypto-Assets Regulation, better known as MiCA, can solve this problem by creating a legal framework for the legal use of tokenized assets in the European Union. Its main goal is to protect investors, ensure the stability of financial markets, and create a uniform regulatory framework for all participants. The introduction of clear rules for the issuance, circulation and use of crypto-assets creates the preconditions for the wider implementation of tokenization in the European Union.

The MiCA regulates three types of crypto-assets:

• Asset-referenced tokens, ART (crypto-assets that stabilize their value against a specific asset and a basket of assets)
• Electronic money tokens, EMT (crypto-assets that stabilize their value against one official currency)
• Other cryptoassets that are not asset-referenced tokens or e-money tokens (e.g., utility tokens, which mean a type of crypto-asset designed exclusively to provide access to a product or service provided by its issuer)

Why ART?

ARTs are a special class of crypto-assets that provide a reference to the value of one or more assets (underlying assets), which may include fiat currencies, securities, raw materials, etc. In the context of MiCA tokenization, this type of crypto-assets is the most appropriate to use, as they have the following key features:

• Asset backing, i.e., the presence of a real financial basis that reduces the risks of volatility and uncertainty
• Stability due to the linkage to an asset, so ART can be used as a means of preserving value and protecting against inflationary risks
• Transparency, as this type of crypto-assets and the requirements for their issuance are clearly established by the Regulation, which ensures proper supervision by the competent authorities and increases investor confidence

The MiCA Regulation sets out several strict rules for the issuance of ARTs, the key ones being:

• Issuer requirements: to register a company in the EU and obtain the relevant authorisation from the competent authority of a member state (does not apply to licensed credit institutions);
• White Paper: develop and publish a White Paper for the crypto-asset that meets the established requirements and standards;
• Marketing communications: comply with the rules on marketing communications, including making them honest, clear and not misleading;
• Reserve of assets: to create a separate reserve of assets in a sufficient amount;
• Own funds: have sufficient own funds of at least €350,000, 2% of the average amount of the reserve of assets or a quarter of the fixed overheads of the preceding year;
• Communication with ART holders: to maintain honest, fair and professional communication with holders and potential holders of issued ART;
• Complaints handling: ensure complaints-handling procedures and keep a thorough record of them;
• Conflicts of interest: establish policies and mechanisms to identify, prevent, manage and disclose conflicts of interest;
• Notification of the competent authority: notify the competent authority of any changes in the management body and mechanism, and comply with reporting requirements.

Prohibition of Granting Interest

Nevertheless, in the case of building a tokenization project using ART, you should also take into account the prohibitions imposed on this type of crypto-asset by the MiCA Regulations. One of the key prohibitions is the prohibition of granting interest. In the context of tokenization, this is important and has significant consequences for investors and project developers.

The rule set forth in Article 40 of the Regulation reads as follows:

1. Issuers of ARTs shall not grant interest in relation to ARTs.
2. Crypto-asset service providers shall not grant interest when providing crypto-asset services related to ARTs.
3. For the purposes of paragraphs 1 and 2, any remuneration or any other benefit related to the length of time during which a holder of asset-referenced tokens holds such asset-referenced tokens shall be treated as interest. That includes net compensation or discounts, with an effect equivalent to that of interest received by the holder of asset-referenced tokens, directly from the issuer or from third parties, and directly associated to the asset-referenced tokens or from the remuneration or pricing of other products.

This provision of the MiCA prevents the use of ART as interest-bearing deposit instruments, which could pose risks to the traditional financial system

In this regard, ARTs cannot be used for staking purposes, as the income from such staking would be equated to interest payments and would be subject to regulatory restrictions. Moreover, it becomes impossible to use the popular real estate tokenization model, in which investors holding tokens receive income from the lease and operation of a tokenized property.

Alternative Models of Income Generation Through Tokenization

When considering this prohibition, special attention should be paid to the condition under which one or the other will be considered as interest: it must be related to the period of time during which the ART holder holds such tokens. This means that any passive income that will be regularly accrued to investors for holding ART will be prohibited. At the same time, the MiCA does not prohibit ART holders from receiving income that is not related to the duration of holding the tokens, which allows them to use alternative mechanisms for generating income.

Before discussing these mechanisms, it is also worth noting the following provisions of the Regulation:

• Holding an ART does not mean that a person owns the underlying asset to which the token is referenced. In the context of tokenization, this would mean, for example, that by purchasing an ART tied to real estate, the investor will not acquire ownership of that real estate. The token holder will only have ownership of the ART itself, being able to dispose of it at their own discretion: store, sell, transfer, etc.
• ART holders have a permanent right of redemption, which means that the issuer undertakes to redeem the issued tokens at any time when a request is received from the holder. The issuer must redeem the ART by paying an amount of funds (other than electronic money) equivalent to the market value of the token or by transferring the assets to which the token is referenced. This means that token holders can request the issuer to redeem their tokens at any time for the corresponding value.

Taking into account all the provisions, project developers and investors will be able to use a new tokenization model. Let's take real estate tokenization as an example:

1. Announcement of the project: the developer announces the construction of the real estate to be tokenized. At the same time, the process of issuing and selling ART, which investors can purchase to finance the project, begins.
2. Construction and marketing: after the construction is completed, the developer launches marketing campaigns, popularizes the real estate, and puts it into operation. This increases the market value of the ART attached to the real estate.
3. Redemption option: when investors believe that the value of the real estate has reached the appropriate level, they can exercise their right to buy back the ART. The redemption is carried out at the current market value, which allows investors to receive a significantly higher amount than they invested during the construction phase.

This model meets the strict requirements of the MiCA Regulation, will bring financial benefits to both investors and developers, and can be used to successfully implement tokenization projects in the jurisdictions of the European Union.?

Undoubtedly, the new rules introduced by the MiCA significantly affect the possibilities and potential models of asset tokenization, limiting the possibility of generating passive income in the form of interest used in some traditional formats. At the same time, the new European legislation leaves room for the implementation of alternative mechanisms for generating income that do not contradict the established restrictions and may open up new investment opportunities.?

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