Legal Causality Of Gen2 Tokenized Asset

Legal causality in the context of tokenized assets refers to the ability of a blockchain event, like the creation or transfer of a token, to have a recognized legal effect. For instance, the 'Documenting the Asset' section earlier noted that an asset can be legally brought into existence simply through the act of registering it in formal records.

With Gen2 blockchains, as outlined in the prior section, there are key limitations in terms of legal causality:

• Immutability and Overwriting: Gen2 blockchains operate with immutable smart contracts and tokens. If any modifications are required, the original entry cannot be altered; instead, a new version must be deployed, leaving the old version on the blockchain.

• Lack of Legal Causality: Events on the blockchain, such as the issuance of a token, do not inherently carry legal weight in the public law domain. They are not automatically recognized by public registries for entities or real estate, for example.

The inability to alter historical records on a blockchain is an inherent feature that cannot be circumvented. However, to address the second challenge — the gap in legal causality — companies involved in RWA tokenization have developed workarounds:

1. They establish or lease the technology to design smart contracts and mint tokens.

2. They collaborate with legal firms or establish an in-house legal team.

3. They create legal entities into which asset ownership is transferred.

4. They issue tokens representing ownership stakes in these entities or in the assets they hold.

5. They produce legal documents affirming that the company is obliged to recognize the minted tokens as indicative of ownership shares in the entity or its assets.

This approach effectively creates a bridge between the technical operation of token issuance on a blockchain and the legal recognition of asset ownership. It relies on traditional legal documentation to impart the necessary legal causality to blockchain events.

- Entity wrapping process

Above process is referred to as ‘legal wrapping’ and uses private and corporate law to fill up the causality deficit of gen2 blockchains.

Note The approach of legal wrapping, while appearing to be a viable solution, involves significant compromises for asset owners. In essence, legal wrapping requires asset owners to relinquish their direct ownership rights, substituting them with a claim that is acknowledged only within the confines of a specific agreement. This claim is then governed by the civil (private) law chosen by the service provider, not by the asset owner. This shift means that unless the entity performing the wrapping is directly owned by the user — which is seldom the case — the original owners are essentially divested of their true ownership. Instead, they are left with a derivative right that depends entirely on the terms set forth by the service provider and the legal framework it operates under. This can lead to a scenario where the asset owner's control and rights over their asset are significantly diminished, transforming concrete ownership into a conditional claim that may not afford the same level of security or autonomy as direct ownership.