Tokenization Expands the Opportunities to Utilize Smart Contracts

A paper contract is not always clear-cut and its interpretation often requires the use of the legal system. With a paper contract one can question the authenticity of signatures and even whether it was modified after it was signed. Obligations stemming from a paper contract may also be difficult to enforce if one of the contracting parties refuses to cooperate. Smart contracts are an evolution in the world of law, a modern alternative to the paper contract and a centralized legal system. Smart contracts eliminate the problems of paper contracts, but nevertheless contain problems of another variety, which stem from the fact that the current world is not yet ready for the contractual freedom provided by smart contracts.

If we pose the question, what does a usual smart contract look like today? The first thing that probably occurs to us is the distribution of tokens within the framework of a process called an initial coin offering (ICO). Another example could be a depository of funds, units of certain cryptocurrencies, analogous to the multisig transactions well-known from Bitcoin. Atomic Swap enables the decentralized exchange of the units of one cryptocurrency for another. We mustn’t forget about games of chance in which one can bet and win units of cryptocurrency. What do all of these smart contracts have in common? The subject of the contract concluded by means of a smart contract is units of cryptocurrency, not objects in the real world. Ownership of units of cryptocurrency is demonstrated purely through cryptography and thus are unequivocal and cannot be taken without the volition of the owner. Ownership of objects in the real world are often disputable and can be taken by force.

Smart contracts are limited to the ownership of cryptocurrency units, a very narrow segment of the law market. Would it be possible to extend their scope to objects in the real world? The answer is tokenization. Within the framework of tokenization ownership of objects in the real world is tied to their purely digital form via tokens (Ethereum) or colored coins (Bitcoin). Changes in the ownership of tokens or colored coins is equivalent to changes in the ownership of objects in the real world. The concept of the tokenization of ownership rights to objects in the real world poses a challenge for the centralized legal systems of all countries around the world. At the current time it would be very difficult to enforce a claim to ownership of an object in the real world on the basis of the ownership of tokens.

It is currently very difficult to tokenize ownership rights. Nevertheless, there are other types of property rights that could be suitable for tokenization. Nowadays, it is common to issue vouchers in digital form for goods and services. It is even possible to conclude other types of contracts, for example, loan contracts, purely on a digital basis. These types of obligations are enforceable via centralized legal authorities and are moreover easily tokenizable.

From a loan contract it is only a step to the opportunity to invest in an actual company, which pledges to investors that it will pay out a share of profits or revenues. This type of contract is probably the summit of what can be tokenized in the current legal environment so that it is legally enforceable. Let’s call this type of contract company tokenization.

In the area of company tokenization we have seen the first attempts to connect companies requiring funds with potential investors. I have had the opportunity to become familiar with various approaches in this area, and in my opinion, the most comprehensive product for company tokenization is the methodology of the Initial Public Coin Offering (IPCO), which we have created at the Czech company XIXOIO. The IPCO methodology places great emphasis on the protection of investors. The tokenized company must demonstrate experience with business operations and the facilities necessary for the efficient utilization of funds obtained within the framework of the ICO process. The release of funds collected from investors is tied to the fulfilment of individual objectives (milestones).

I am personally a proponent of a free world based on purely voluntary commercial transactions. Tokenization of the real world and contracts concluded in the form of smart contracts are one of the possible ways of achieving this ideal. Our company XIXOIO with its IPCO methodology is taking the first step down this long path, which is the reason why I am participating in this project.

Did you find the concept of tokenization exciting and do you have experience with programming smart contracts? You too can help spread this idea in collaboration with XIXOIO.


© Jan Lánský