Securitization of Physical Assets through smart contracts

The true power of the crypto-ecosystem and blockchains lies partly in the fact of creating legally viable “mechanisms” of trade that is overseen by the network, and is truely location agnostic. For example, if one were to own the rights for an asset (say a music streaming service or rights to a particular song), then one would have to negotiate with the musician or his/her representative directly to purchase the rights and then create a physical contract. This mechanism is true for any asset, physical or digital. In the research paper published in Managerial Finance on security tokens, I provide an architecture for converting physical and digital assets can be made tradeable – using ethereum based smart contracts. Deloitte consultancy recently released a whitepaper that outlines many advantages of securitization here.

Advantages of Securitization

Some of these advantages include – a reduction in trade friction i.e., in the example above, the buyer does not need to negotiate with the seller (i.e., musician or his agent each time), since the terms of trade are already existing on the network, or have been templatized and are accessible on the smart contract platform. Secondly, the buyers and sellers can engage in a partial trade i.e., instead of selling the whole right or property, the seller could part-sell his asset similar to equity. Thirdly, innovative financial instruments similar to options or reinsurance could be offered against these tokens- as smart contracts. Fourthly, while the physical world guarantees a value for an asset through a known mechanisms of “valuation”. E.g., home owners could find the values of their homes based on valuation metrics, etc. While these “valuation” metrics are usually based off – of past valuations, they often do not incorporate current price discovery based on market capacity.

A securitization exercise could often lead to a “price” discovered that is often different than existing “valuation” metrics, often providing a bigger advantage to both the seller and smart buyer. Finally, an advantage that is increasingly becoming important is that of providing an “extended unfettered” access to physical assets irrespective of location or country of origin or even source. For example, a buyer from Russia could own an asset in Zambia that has been securitized..

Each of these advantages, that were identified are now becoming a reality, slowly. For example the DAI platform recently voted to bring in physical assets. While the technical implementation of such a system that converts physical assets (or other virtual assets) into trade able securities is easily accomplished using smart contracts on a host of platforms, the socio-legal challenges for such an approach persist. For example, what would happen if a buyer purchases equity in a property at an inflated price e.g., a collection of songs from a musician. What happens if the owner decides to liquidate the property or decides to sell the rights to another buyer. How would jurisdictional prudence – play a role in enforcing the smart contract, suppose one of the parties to the contract. What jurisdictions would bind such an agreement? Are reputation systems sufficient to attract and maintain such a marketplace where real physical assets are bought and sold and valuations can quickly sky rocket?

Reference:

Subramanian, H., 2019. Security tokens: architecture, smart contract applications and illustrations using SAFE. Managerial Finance.