Tokenization Considerations

By Douglas Spencer

Tokenization of real-world assets is rapidly gaining traction across numerous industries, with the financial sector leading the way. At its core, tokenization involves linking a crypto token to a tangible asset or entitlement, establishing a legal connection that can facilitate ownership, transfer, and investment. As this innovative approach evolves, several critical considerations must be addressed to ensure successful and compliant tokenization.

Purpose

The first step is clearly defining the purpose of the tokenization. This involves identifying the specific asset or entitlements the token represents, its expected lifespan, target investors, target jurisdictions, and applicable regulations.

For example, tokens might represent: a 5-year bond with quarterly interest payments, rental income sharing from a property, capital raise linked to future profits, fractional ownership of artwork, private or mutual funds, stocks, options, royalties, employee payroll, or participation in illiquid asset portfolios.

Understanding whether the token will be marketed to investors residing in jurisdictions with regulations, such as the United States, Australia or Canada is crucial, as each jurisdiction has unique securities regulations and varying seasoning (holding) periods.

Since tokenization is still emerging, investor education and communications plans as to the purpose and value are vital to build awareness, trust and understanding of the token project within the target market.

Technological

Blockchain is an internet technology that manages a “ledger” keeping track of all token transactions with a distributed and immutable database ensuring accurate accounting. The secure, efficient, scalable, transparent, immutable nature of blockchain technology is what makes tokenization work.

Selecting the appropriate blockchain network infrastructure is fundamental. Key considerations include choosing the blockchain network suitable for the token target market, designing smart contracts, and adhering to standards like ERC-20 and ERC-3643.

Ethereum-based blockchains are popular choices due to their mature ecosystem, ability to run smart contracts, and compatibility with Layer 2 scaling solutions such as Arbitrum and Optimism, as well as sidechains like Polygon.  Compatibility with the Ethereum Virtual Machine (EVM) allows seamless deployment of tokens and applications across various blockchain networks, including Polygon, BNB Chain, Avalanche, Fantom, Celo, Base, Arbritrum and Cronos.

ERC-20 is a technical standard for enabling tokens on an Ethereum blockchain. ERC-20 is a set of rules that ensures tokens are interchangeable and compatible with smart contracts, wallets, and exchanges within the Ethereum ecosystem. This standard defines a common interface for tokens, which includes functions for transferring tokens, checking balances, and managing approvals.

ERC-3643 standard provides permissioning capabilities, enabling on-chain identity management and claims or rules that can restrict token access based on investor qualifications—such as being an accredited investor or jurisdiction. ERC-3643 is also useful to better enable self-custody of tokens while still ensuring enforcement of regulatory or other token specific rules.

Transaction fees (gas fees) vary across networks; for instance, Polygon offers notably lower costs compared to other networks, which can be advantageous for high-volume token related activities during the lifespan of the token.

Marketplace

Enabling a marketplace and how the tokens will be marketed, sold, and managed within regulatory frameworks is important. If issuing security tokens restricted to certain investors (e.g., SEC Reg D or Reg S offerings), compliance with marketing restrictions, having a workflow process for the investor purchase subscription agreements, and investor accreditation is essential.

After the Primary Offering and seasoning (holding) periods end, resale or secondary market trading will need to be supported. For tokens with expected high trading volumes, listing on exchanges may be appropriate. Conversely, tokens with limited holders or low trading activity require a strategy for resale and peer to peer transfer mechanisms.

Many tokenization providers are also crypto exchanges that enable via their platform the onboarding of investors, initial investment, secondary trading, promotion of the tokens to their investor base, and management of the transfer restrictions. This model works well, but usually requires all investors to register, invest, trade and maintain their token holdings exclusively on the provider exchange platform. There may be limitations of what jurisdictions investors can be accepted from. Investors must also trust the exchange to hold their tokens.

Providers using permissioning standards like ERC-3643, enable a marketplace to promote the tokens to a global investor community, manage the investor onboarding with KYC and accredited investor verifications, enable the initial investment subscription agreement signing process, and provide access to an existing pool of registered investors that are pre-qualified and familiar with investing in tokens. This permissioning model also allows investors to hold their token in self-custody wallets and opens the secondary market trading to a wider range of exchanges and other token trading bulletin board posting systems.

Legal

Legal preparations are vital and include drafting core documents such as the Token Statement of Entitlements (also referred to as a Master Token Agreement), technical token White Paper, Private Placement Memorandum for the token Offering, Subscription Agreements, and marketing materials. Ensuring these documents align with jurisdictional regulations helps mitigate legal risks and provides clarity to investors. Depending on the type of tokenized project and jurisdictions the token investment is offered in, there may be a range of legal and regulatory compliance considerations to be aware of.

Operational

Operational planning must account for ongoing management of the token’s lifecycle and ongoing related activities. This includes handling distributions (payouts, dividends, royalties), maintaining accurate records of token holders, and implementing secure wallet verification processes.

Tokens may have a fixed term—such as a 5-year bond—or be perpetual. In either case, provisions for termination (burning tokens), re-issuance, or cross-chain deployment should be considered. Additionally, mechanisms for stakeholder voting on token-related decisions can enhance governance and transparency.

Considerations for what happens if a token holder loses access to their wallet can include having the ability to confirm a token holder identity and legitimate situation, then enabling an authorized recovery or forced transfer of their tokens to a new wallet.

Administration

Finally, effective administrative controls are essential for maintaining token integrity and investor trust. This encompasses functions like minting, burning, recovery, forced transfers, lock-ups, and enforcing regulatory restrictions.

Investor administration involves onboarding, Know Your Customer (KYC) and Anti-Money Laundering (AML) screenings, wallet forensics, and ongoing compliance management—especially when tokens are restricted to accredited investors. Implementing robust systems ensures regulatory adherence and smooth operation throughout the token’s lifecycle.

 Provider

By carefully addressing these considerations, you can select a suitable tokenization provider (Virtual Asset Service Provider - VASP)  capable of executing your tokenization project in compliance with regulations and ensuring all the key aspects are taken care of, paving the way for successful asset tokenization.

Douglas Spencer
Founder
Monetaforge

Monetaforge is a Virtual Asset Service Provider registered with and regulated by the Cayman Islands Monetary Authority, offering compliant tokenization services in accordance with the US SEC and other jurisdictional regulations.