In recent years, a growing number of companies have considered doing business in which tokens on blockchains represent real-world assets and these tokens are traded online not just in Japan, but all over the world. Specific examples include tokenized rights to receive physical assets such as alcohol, gold, etc., tokenized rights to avail of services in hotels, restaurants, etc., and tokenized rights to intellectual property such as copyrights (e.g., art works).
Such tokens, which represent rights to tangible objects with real-world economic value, are often called as "RWA (Real World Asset) tokens".
The merits of the RWA token and the businesses that use it include the following:
- As producers of goods and providers of services can earn cash in advance by selling the right to claim future delivery of goods or use of services as RWA tokens, it is expected to be a new means of raising funds.
- The liquidity of real-world assets is improved by trading tokens that represent those assets on marketplaces, etc., which may lead to reduce operating and transaction costs relating to the transfer of assets.
- By tokenizing high-value real-world assets such as real estate usage rights, it is possible to break down these assets into smaller units
Currently, the term "RWA token" is not defined in Japanese law, and there are no specific laws and regulations governing RWA tokens. However, since there are various possible schemes for RWA tokens, it is necessary to consider the laws and regulations applicable to the RWA token on an individual basis, based on the structure of the RWA token and the real-world assets represented by the RWA token. In this regard, on April 4, 2024, the Japan Cryptoasset Business Association (the "JCBA")(*) published the "Approach to Key Regulations for Issuing RWA Tokens" as a reference to highlight the primary regulatory concepts currently applicable in Japan.
The following is a summary of the major issues and regulations related to the RWA tokens in Japan, including an introduction to the content published by the JCBA.
(*) The JCBA is a Japanese general corporation established to promote the development of a sound market and business environment for digital assets such as crypto-assets in Japan.
II.Legal issues inherent in RWA tokens
(1) Requirements to duly assert against third parties
As the RWA token is a digital asset and not real-world asset itself, holding RWA tokens is meaningless if one cannot assert ownership of the assets linked to them against third parties. Therefore, the legal issue inherent in RWA tokens is whether or not holding RWA tokens allows the holder to assert rights (particularly ownership rights) regarding the real-world assets linked to RWA tokens against third parties.
In the case of the transfer of real-world assets, the Civil Code of Japan (the "Civil Code") sets forth the following requirements for perfection in duly asserting ownership rights against third parties:
- For real estate, "registration";
- For movable property, "delivery"; and
- For claims, "notice or consent is made using an instrument bearing a certified date".
Based on these provisions of the Civil Code, even if RWA tokens are transferred, the perfection for the transfer of ownership of the real-world assets represented on such RWA tokens is not completed until the requirements are met.
Therefore, for example, if A transfers the RWA token representing the real estate to B, and then A transfers the real estate represented on the RWA token to C, and C completes the registration thereby perfecting such transfer, B (who has only received the RWA token from A) may not be able to duly assert his/her ownership of the real estate against C.
One way to solve this problem would be to use RWA tokens to represent the right to use or the right to demand delivery of something with a restricted transfer clause (i.e., to avoid the problem of potential double transfers/sales by making the real-world asset non-transferable). There are several other methods that could be considered and adopted, but in any case, resolving the requirements to duly assert against third parties is an unavoidable issue when deciding on the object and scheme of the RWA token in Japan.
(2) Counterparty risk
As mentioned above, at least some of the RWA tokens represent the right to use or the right to demand delivery from the issuer, in which case the holder of the RWA token is exposed to the risk of bankruptcy (counterparty risk) of the issuer, etc. by its very nature.
In order to avoid or mitigate this risk to a certain extent, it is necessary for the issuer to be subject to regulations that require the accumulation of capital in the event of the issuer's bankruptcy, i.e., for RWA tokens to fall under prepaid payment instruments or regulated securities, etc., and for financial regulations to be enforced (for details, see III. (1) below). However, this approach is often not realistic for issuers, and it is necessary to consider the possibility that bankruptcy risk is unavoidable.
III. Major issues and regulations corresponding to individual RWA tokens
In addition to the inherent issues that are common to all RWA tokens, the following issues and regulations may arise depending on the nature of the individual RWA token and real-world assets represented on the RWA token.
(1) Financial regulations
(i) Crypto-Assets
If RWA tokens fall under the category of Crypto-Assets under the Payment Services Act (the "PSA"), the act of selling RWA tokens is considered as providing crypto-asset exchange services and the person engaging in such activity is required to be registered as a crypto-asset exchange service provider.
The term "Crypto-Asset" is defined in the PSA as:
- proprietary value which can be used to pay an unspecified person the price of any goods, etc. purchased or borrowed or any services provided and can be sold to or purchased from an unspecified person (limited to that recorded on electronic devices or other objects by electronic means and excluding Japanese and other foreign currencies and Currency Denominated Assets; the same applies in the following item), and which can be transferred using an electronic data processing system (the "Type I Crypto-Asset"); or
- proprietary value which can be exchanged reciprocally for proprietary value specified in the preceding item with an unspecified person, and which can be transferred using an electronic data processing system (the "Type II Crypto-Asset").
According to the FSA Administration Guidelines on Crypto-Assets (the "Crypto-Asset Guidelines") issued by the Financial Services Agency of Japan (the "FSA"), one of the factors for determining whether a token constitutes a Type I Crypto Asset is whether it is "an asset capable of being purchased or sold with legal fiat currency or crypto-assets under socially accepted norms." Specifically, a token that satisfies criteria (a) and (b) below generally will not constitute a Type I Crypto Asset: (a) the issuer has made it clear that the token is not intended to be used as payment for goods, etc. to unspecified parties (e.g., by stating clearly in the terms and conditions of the issuer or its business-handling service provider, or in the product description, that use of the token as a means of payment to unspecified parties is prohibited, or that the token or related system is designed in a way that does not enable it to be used as a means of payment to unspecified parties); and (b) where use of the token as a means of payment for goods, etc. to unspecified parties is permitted, provided that at least one of the following conditions pertaining to certain requirements on the price and quantity of the relevant goods, etc., and on the technical characteristics and specifications of the token is satisfied:
- the minimum value per transaction must be sufficiently high (i.e., JPY1,000 or more); or
- the number of tokens issuable, in proportion to the aforementioned minimum value of a transaction, must be limited (i.e., must not exceed 1 million).
The same criteria applies to the assessment of whether a token constitutes a Type II Crypto-Asset.
In light of the definition of "Crypto-Asset" and Crypto-Asset Guidelines above, if, for example, both of the following conditions are implemented in the RWA token scheme, it is considered that the RWA token is highly likely not to fall under the category of a Crypto-Asset:
- Prohibiting the use of the RWA token as a payment method in the terms of use or system; and
- Setting the number of RWA tokens issued to less than 1 million, or the transaction price to JPY1,000 or more.
(ii) Collective investment scheme interests
If RWA tokens fall under the category of "Collective investment scheme interests" (the "CISIs") under the Financial Instruments and Exchange Act (the "FIEA"), the act of selling and handling RWA tokens is considered as engaging in financial instruments business and the person engaging in such activity is required to be registered as a financial instruments business operators.
"CISIs" are deemed to have been formed when the following three requirements are met: (a) investors (i.e., rights holders) invest or contribute cash or other assets to a business; (b) the cash or other assets contributed by investors are invested in the business; and (c) investors have the right to receive dividends of profits or assets generated from investments in the business.
In light of the definition of CISIs above, for example, if there is no promise of a dividend of profits or asset distribution generated from the business to holders of RWA tokens, it is considered that the RWA tokens do not fall under the category of CISIs.
(iii) Prepaid payment instruments
If RWA tokens are similar in nature to prepaid cards and can be used as consideration for goods or services provided by token issuers, they may be regarded as prepaid payment instruments (the "PPI") under the PSA, which are subject to the relevant regulations of the PSA.
The term "PPI" is defined in the PSA as:
- certificates, electronic devices, or other items (the "certificates, etc.") or numbers, markings, or other signs (including additions to the amount recorded in the certificate, etc. by electronic or magnetic means in exchange for the receipt of consideration equivalent to the additional amount recorded) issued in exchange for the receipt of consideration equivalent to the amount...recorded in the certificate, etc. or recorded using electronic or magnetic means (meaning in electronic form, magnetic form, or any other form that is impossible to perceive by the human senses alone; the same applies hereinafter in this paragraph) which can be used for the purpose of paying consideration for the purchase or leasing of goods, etc. or the receipt of provision of services from the issuer or the person designated by the issuer (the "issuer, etc.") by way of presentation, delivery, notification, or other means;
- certificates, etc. or numbers, markings, or other signs issued in exchange for the receipt of consideration equivalent to the quantity of goods, etc. or services recorded in the certificate, etc. or recorded using electronic or magnetic means (including additions to the quantity of goods, etc. or services recorded in the certificate, etc. by electronic or magnetic means in exchange for the receipt of consideration equivalent to the recorded additional quantity) which can be used for the purpose of claiming the delivery or provision of those goods, etc. or services from the issuer, etc. by way of presentation, delivery, notification, or other means.
If a PPI can only be used for payments to the issuer for its goods or services, that issuer will not be required to register under the PSA; nevertheless, it must still comply with certain notice requirements. By contrast, an issuer of PPIs that can be used not only for payments to the issuer for its goods or services, but also for payments to other parties designated by the issuer, will be required to register as an "issuer of PPIs" under the PSA. However, there are exceptions to the regulations on PPIs, such as PPIs that can only be used for less than six (6) months from the date of issue are not subject to such regulations.
Therefore, if RWA tokens can only be used for less than six (6) months from the date of issue, it is considered that the regulations on PPIs do not apply to such RWA tokens.
(2) Other regulations
(i) Deposit transactions
"Deposit transactions" include transactions in which a business operator receives a deposit of goods from a consumer and promises to provide the consumer with economic benefits in relation to such deposit or promises to purchase the goods at a fixed price in a few months.
From the perspective of consumer protection, business operators engaged in deposit transactions are obliged to deliver documents and prohibited from unjust solicitation. Furthermore, if there is a sales contract for goods, etc. carried out by the business operator itself or a closely related person in relation to a deposit, etc. transaction, such transactions are prohibited in principle.
Based on the foregoing, if, for example, the RWA token issuer deposits assets such as art works represented on the RWA token, but does not promise to pay the fees for the deposit or to purchase such assets, it is considered that the regulations on deposit transactions do not apply to such scheme.
(ii) Warehousing Business Act
The Warehousing Business Act may apply to a scheme in which goods deposited by users are stored in a warehouse and tokens representing the rights to those goods are issued.
Specifically, if the RWA token representing the rights to such goods falls under the category of warehouse receipt under the Warehousing Business Act, the issuance of such RWA token requires permission from the Minister of Land, Infrastructure, Transport and Tourism.
Based on the foregoing, if, for example, a scheme does not involve the storage of assets represented on RWA tokens in a warehouse, it is considered that the Warehousing Business Act does not apply to such scheme.
(iii) Secondhand Goods Business Act
The Secondhand Goods Business Act may apply to businesses that purchase and sell goods that have been used (including collectible works of art, etc.; the "Secondhand Goods"), or that purchase and sell Secondhand Goods on consignment (such businesses are referred to as "Secondhand Goods Businesses"). However, the definition of "Secondhand Goods Businesses" under the law excludes "businesses engaged solely in selling secondhand goods" and "businesses engaged solely in purchasing secondhand goods from counterparties to which the goods were sold" as defined therein.
If the Secondhand Goods Business Act applies, persons who conduct Secondhand Goods Businesses must obtain a permit from a prefectural public safety commission and have obligations such as confirming the identity of the user, etc.
Based on the above, if, for example, a business is conducted to sell RWA tokens representing Secondhand Goods that are purchased from a third party, it is necessary to carefully consider whether the Secondhand Goods Business Act applies to such business in light of the specific and individual business scheme.
(iv) Real-world asset-specific regulations
Depending on the type of real-world asset represented on the RWA token, specific regulations related to that asset may apply. For example, if the asset represented on the RWA token is alcohol, it is necessary to consider the Liquor Tax Act (whether or not a license is required for alcohol sales business), and if it is real estate, it is necessary to consider the Real Estate Brokerage Act (whether or not a license is required for real estate brokerage business), etc.
IV.Conclusion
The above addresses only a portion of the regulations and issues that may require consideration. Other issues and regulations may need to be considered depending on the business scheme or model involving RWA tokens. In addition, when selling RWA tokens to residents outside Japan, it is essential to consider the applicable laws and regulations of those specific countries and regions. On the other hand, with regard to the system of the requirements for perfection under the Civil Code, we hope for a review that takes into account technological innovations in blockchain and the emergence of new businesses using blockchain.
The JCBA's "Approach to Key Regulations for Issuing RWA Tokens" was announced in 2024, and while it does provide a certain degree of guidance, it does not address all matters. It seems likely that businesses using RWA tokens will continue to expand, so we will continue to keep a close eye on the development of RWA tokens and related Japanese regulations.
Originally published by Beaumont Capital Markets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
