Note: This article was originally published on wordpress in 2018. While somewhat dated, we are republishing it here in its original form, as MetaLeX has begun R&Ding similar “RWA” solutions aligned with the core ethos of this article, and we have gotten feedback from fairly recent readers that it remains a quite useful resource on the topic:

ABSTRACT

This article analyzes the potential motivations for representing corporate capital stock via cryptographically secured blockchain tokens and explores potential legal/technological implementations of systems that could do so. Tokenization of corporate capital stock is situated within a broader discourse regarding “tokenization of assets,” which refers to using blockchain tokens as a means of representing ownership interests in assets. It is argued that digitization of ownership interests is beneficial but can be achieved without blockchain technology; however, blockchain technologies are uniquely suited to enhance the individual asset sovereignty of stockholders. The article summarizes, at a high-level, some of the history and evolution of securities instruments, explores how that history has led to the current market dynamics for publicly held and privately held corporate capital stock in the United States, and diagnoses the resulting risks and inefficiencies. Various methods of representing capital stock on blockchains are explored, including those reflected in recent amendments to the corporate law statutes of Delaware and Wyoming. It is argued that, among these alternatives, a “tokenized stock certificate” approach whereby blockchain tokens are imbued with the legal status and functional dynamics of old-fashioned paper stock certificates would be best suited to leveraging blockchain technology’s potential to enhance stockholders’ sovereignty over their ownership interests in their stock.

OVERVIEW OF THE ARTICLE

First, I will provide a brief introduction to the concept of asset tokenization on blockchains and the potential benefits that are generally seen as being offered by such tokenization. I will situate the problem of tokenizing corporate capital stock as a sub-problem of tokenizing securities or rights/interests in assets more generally. I will argue that there are already numerous ways of representing rights/interests in assets, including electronically; therefore, for “tokenization” to be revolutionary, there must be something unique about the blockchain medium that is fundamentally different from what has been offered previously. To explore that, I will analyze the “unique selling point” (USP) of blockchain technology and argue that the USP of blockchain technology is that it furthers the values of individual asset sovereignty by creating the technological predicates necessary for ordinary persons to hold, manage and transact with assets in an environment that is trust-minimized while also being secure.

I will then provide a typology that divides securities instruments into their traditional dichotomies—bearer vs. registered and, among registered instruments, certificated vs. book-entry—and allude to the history and policy reasons leading to the dominance of registered instruments in contemporary finance. I will argue that the benefits of tokenization in light of individual asset sovereignty values exist along a spectrum, at one end of which are the (maximal) benefits of tokenizing assets (or interests in assets) via “bearer tokens” that can almost always trade freely on a peer-to-peer basis on any ledger without becoming detached from the assets they represent, and at the other end of which are the (de minimis) benefits of tokenizing assets (or interests in assets) via “book-entry tokens” that can only trade via an intermediary or a canonical ledger set up by a ‘consortium’ or a limited number of permissioned nodes that collectively function as a new (albeit distributed) intermediary. Therefore, the more an asset is (legally and practically) susceptible of being represented via bearer instruments or quasi-bearer instruments, the more reasonable it is to think that tokenizing that asset can open new markets or increase market activity by facilitating peer-to-peer transfers on open networks. Alternatively, the closer an asset is to being one that (legally and/or practically) needs to be tracked via a canonical ledger tied to real-world identities, the more there will be pressure to tokenize that asset only in a “walled garden” type of distributed ledger that does not go as far as possible in embodying the true open vision of blockchain technology as a means to enhance private ownership rights and peer-to-peer market transactional freedom.

Next, I will turn more specifically to the issues around tokenizing corporate capital as a sub-type of securities. I will review the distinguishing features of corporate capital stock as compared to other types of securities. We will explore how the ‘pre-blockchain’ status quo for contemporary stock markets divides those markets into markets for publicly traded stock and markets for privately held stock, each of which suffers from different problems that can be addressed using blockchain technology. The public stock market suffers from costs and risks arising from a high degree of reliance of securities intermediaries. On the other hand, the private stock market suffers from lack of automation, poor administration and lack of liquidity/price discovery.

Having established areas for improvement in contemporary stock markets, the article makes a high-level case for how blockchain technology might help with some or all of the relevant issues. The article cites the work of Vice Chancellor J. Travis Laster of the Court of Chancery of the State of Delaware to illustrate the manner in which blockchain technology can eliminate the difference between record stock ownership and beneficial stock ownership that lies at the root of most public stock market issues. The article builds on this work by detailing at greater length how blockchain technology can be helpful in the private stock markets as well.

The article next explores two potential methods of implementing a blockchain technology stock system. The first approach involves a corporation opting to treat its stock as uncertificated shares and uses permissioned distributed ledger technology to make a particular blockchain or set of blockchains the canonical statutory stock ledger for a corporation (the “PDLT approach”). The second approach involves a corporation opting to treat its stock as certificated shares, where the stock certificates are blockchain tokens, and is better suited to operate on unpermissioned peer-to-peer blockchain technology networks such as Ethereum (the “tokenized certificate approach” or “TCA”). I will summarize how, in recent years, amendments have been made to the corporation statutes of Delaware and Wyoming to facilitate a new, blockchain-permissive framework for capital stock tracking and transfers, but that such amendments have primarily been oriented toward allowing implementation of the PDLT approach. I will argue that the TCA solves most of the same problems with public stock markets as does the PDLT approach, while also creating greater asset sovereignty for stockholders by allowing them to trade their stock in reliable ways on any open blockchain, without necessarily worrying whether whatever blockchain the corporation deems “canonical” has been updated—just like is possible with paper stock certificates.

In the conclusion, I will note some of the questions that remain unanswered (or unasked!) and issues that remain unresolved in my article, will suggest topics for additional research and development and will provide a call to action for those who may be interested in lobbying the governments of Delaware, Wyoming or other states or nations to adopt legislative amendments that would facilitate the tokenization of corporate capital stock.

Tokenization of Assets—What Is It And Why Does It Matter?

Mad Hype for Asset Tokenization

“Tokenization of assets” has been broadly touted as an impending revolution in contemporary finance and markets. A great deal of ink (of wildly varying quality) has been spilled on its merits[1]. Some of such ink has been nothing short of effusive. For example:

• “Every asset in the world will be tokenized.”[2]

• “[T]he SEC will eventually mandate the adoption of tokenized securities.”[3]

• “Tokenized securities will be the first quadrillion dollar market cap asset class of crypto.”[4]

• “Blockchain’s ability to tokenize assets is pretty much limitless…Tokenization promises to […] democratiz[e] the process of owning everything from ideas to paintings […] Via the blockchain, ownership is slowly taking on new meaning.” [5]

• “[The] particularities [of DLT-based securities tokens] solve a whole bunch of pain-points in Capital Markets, including liquidity, undervaluation of assets and barriers to entry in term of investors base (the legendary “entry ticket”)…[and] [d]estroy all barriers to entry in a Global 24/7 free Market exposure.”[6]

So, What is Asset Tokenization, Really?

So, what exactly is this process of “asset tokenization” that has people waxing so lyrical? Frankly, I believe many people are confused about that. For example, here are some definitions/descriptions from the top Google results for “tokenization of assets”:

• “…[T]okenization is the process of converting some form of asset into a token that can be moved, recorded, or stored on a blockchain system…[T]okenization converts the value stored in some object…into a token that can be manipulated along a blockchain system…”[7] [emphasis added];

• “…[T]okenization refers to the digitization of an asset.”[8] [emphasis added]

Although many casual descriptions like this loosely characterize tokenization as if it involved converting a physical asset into a digital token or automatically imbuing a token with exactly the same value as a physical asset, no alchemy will be involved. More careful and thoughtful writers have offered better definitions of “tokenization.” The best I’ve noticed so far is this one by Stephen McKeon given in a CNBC interview: “you can represent an ownership stake on any asset with a token.”[9] A distant second place would go to Addison Cameron-Huff’s: “Tokenization is the process of converting rights to an asset into a digital token on a blockchain.”[10] Basically, “tokenization of assets” refers to using a person’s ownership and control of a blockchain token as a proxy or a means of representing that person’s ownership interest in a particular asset—just like someone holding a paper bank check from another person made out to the first person’s name represents that first person’s claim on dollars in an account, or someone holding a paper stock certificate made out to their name represents that person’s ownership of the shares of stock identified on the certificate.

To get more precise still, here is what I believe to be a relatively clear and distinct (although not perfect) definition of “asset tokenization”:

To “tokenize an asset” in the context of blockchain technology means to establish a technological, contractual and regulatory framework in which: (a) a person’s lawful possession of a particular blockchain-based token[11] (i.e., lawfully holding/having knowledge of the private keys that govern that token’s transferability at a given time) generally will be treated as representing or symbolizing the holder’s legal rights to or economic interests in a particular asset; and (b) lawful transfers of such legal rights/interests can and generally will be consummated through lawful transfers of that token from the prior holder of the rights/interests to the new holder of the rights/interests.

This definition is still somewhat imprecise and question-begging, but it’s progress. Under this approach, to “tokenize an asset” implies using a blockchain token as a kind of abstract financial instrument that represents an abstract set of financial interests or ownership rights relating to the asset. I contend that this is the only logical way of understanding “asset tokenization” for almost all practical purposes. Although in many cases such tokens will be securities under the law (at least in the U.S.), they may alternatively represent titles to physical property, play a role in an implementation of proplets for controlling physical property[12] or have other relationships to assets. Thus, to avoid getting bogged down in a securities law analysis and to keep the analysis as generic as possible, I will not be calling such tokens “securities tokens” in this article. Rather, I will simply call them “asset-right tokens” or “ARTs”.

SKEPTICAL INTERLUDE #1

One very interesting and relevant fact must be pointed out here: As a society, we already have many instruments and other representations of ownership/interests in assets. For example, we already have:

• Traditional stock certificates, which represent claims for payment out of the issuer’s equity/net assets

• promissory notes, which represent claims for payment out of the issuer’s gross assets

• leases, which represent tenancy claims on the issuer’s real property

• deeds of title, which represent ownership of various properties, ranging from automobiles to real estate

• licenses, which represent claims to the use of intellectual property

Furthermore, some of these instruments or representations are already digital or could readily be made digital without use of blockchain technology. For example, some privately held corporations issue stock certificates in PDF form rather than paper form, and, for years, the online platform Carta (formerly eShares) has been (without the need for blockchain technology) helping corporations issue and maintain both: (1) digital certificates for stock that is supposed to be “certificated” and (2) digital ledgers/book-entry representations for stock that is supposed to be “uncertificated”—and even got a legal opinion from DLA Piper saying this complied with Delaware corporate law (before the “blockchain amendments” thereto that I will summarize later in this article).[13]

So, if we already have lots of representations of the kinds of things ARTs could represent, and if actually plenty of those representations already are digital, would it not be fair to ask (in a politely skeptical intonation):

• Why/how are ARTs “revolutionary” when those other digital representations weren’t or aren’t or their revolutions already happened long ago?

• Why/how will ARTs dramatically democratize capital, increase liquidity and enhance price discovery more than those things could/already have?

• Isn’t this whole “asset tokenization” thing basically like 90% hype and 10% reasonably cool but fairly modest improvements to traditional infrastructure?

Rest assured, we will grapple with these questions more in the remainder of the article.

FIN SKEPTICAL INTERLUDE #1

What are the (Supposed) Benefits of Asset Tokenization?

Now that we know what tokenization is, we can see that, at its core, tokenization is one form of digitization. As such, we can begin to see how tokenization might have some of the benefits people have touted. The benefits of digitization—be it digitization of hardcopy library books or medical records into searchable and endlessly reproducible PDF files, or digitization of payment channels so that people can pay for transactions over the internet—are no-brainers. All the more so, digitization implemented on a public, open permissionless blockchain network is particularly valuable in that it offers what the kids call “security guarantees”. It is thus thought that by providing a particularly attractive form of digitization, tokenization can bring many benefits to the markets for both “hard assets” (like real estate, fine art, etc.) that trade and are priced only infrequently by appraisers or at auction and traditional securities, as well as more abstract, financial assets such as derivatives which already have thriving markets and thus good price discovery but may still carry significant transaction costs and other inefficiencies.

For traditionally illiquid or low-liquidity, indivisible assets with the potential for significant price appreciation like real estate, fine art, rare collectibles and numismatics, tokenization would work something like this: the record owner of the asset (e.g., Van Gogh’s “Starry Night”) could form a limited liability entity (e.g., an LLC) and assign ownership of the asset to that entity. Equity securities (e.g., membership interests) representing fractional ownership of that entity—which, indirectly, would represent ownership interests in the entity’s one and only asset (“Starry Night”), could be sold to other investors, who would receive “tokens” representing their ownership of those membership interests (and thus, indirectly, their ownership interests in “Starry Night”). While such “securitization” of assets is possible today without tokens, there currently is no thriving, liquid public market for such securitized interests the way there is for, say, the common stock of public companies. The hope (which, as we will see in ‘Skeptical Interlude #2” below as well as later parts of the article, may be different from the reality) is that by representing such securities in token form, you will make them cooler and more convenient to own—“eliminating the frictions of capital markets” as the tokenization hypemeisters might say—and that thus you would encourage more people to buy them, trade them and hold them more often, thus creating more of a market for them and improving price discovery and investment interest in these assets.

Even when it comes to traditional securities (which are intangible to begin with and thus already relatively liquid and transferable, but to varying degrees depending on the type of the security), proponents of tokenization will argue that it can provide many benefits. For example, the market for securities of privately held companies is currently very shallow, leading to poor price discovery that is mainly driven by the at times esoteric and idiosyncratic valuation methodologies of traditional venture capital funds. Tokenizing the corporate stock of privately held companies, the thinking goes, could make that stock—or fractional interests therein—more convenient and attractive to hold, track and trade on alternative stock exchanges, thus leading to greater liquidity, market depth and price discovery and increasing efficiency of the private equity markets—on the other hand, as we will discuss, the potential for improvement is very bounded so long as the corporation does not want to “go public”. For companies that are already public and thus already have highly liquid stock, tokenizing the stock could offer benefits by reducing the need for or importance of traditional institutions and intermediaries that are otherwise necessary for stock administration and trading, such as Cede & Co, The Depositary Trust Company, brokerages, Broadridge (a major corporate services company) and others. Eliminating or reducing the importance of such intermediaries could reduce transaction costs and trade settlement times—and thus, again, encourage participation, increase liquidity and improve price discovery.

SKEPTICAL INTERLUDE #2

For any given illiquid or not maximally liquid asset, there are a variety of factors other than the mere lack of digitization that have caused such asset to be illiquid or not maximally liquid. Advocates of tokenization (and I include myself among them) should be willing to ask themselves hard questions about these issues and about how, whether and to what extent tokenization really helps fix them. For example, we should ask why ownership interests in a particular tract of real estate tend be less liquid than, for example, shares of common stock in Apple Inc.—which anyone with a brokerage account can buy and sell a dozen times in an hour. And if we do ask such questions, in most cases it turns out there are good reasons for the difference, and that digitization generally (and thus also tokenization as a specific form of digitization) does not necessarily make a radical difference to that aspect of things.

To illustrate this by continuing with the real estate example, it is worth noting that real estate (particularly developed real estate) is notoriously non-fungible. For that reason, prospective real estate buyers typically conduct (or hire experts to conduct) extensive on-site due diligence, requiring actual trained people to physically travel somewhere and literally look at some soil, some borders and often some buildings. One can trust in third parties to evaluate the real estate, and such third parties might publish their reports for a price, but the reports have a limited shelf life and require trust, and economically it will not make sense for every single tract of land to have its own report—only very valuable tracts of land will warrant the investment of time, money and expertise by the report-writers. Dividing ownership of a piece of real estate into a million fractional interests represented by tokens instead of being a single interest represented by a paper deed really does nothing, in and of itself, to address these fundamental constraints on liquidity. Moreover, real estate investment trusts (REITs) already have made fractionalized interests in real estate available to the investing public. Thus, while tokenization of real estate might have some benefits such as making actual closing of a sale easier (e.g., by creating digital escrows, eliminating the need for escrows through private-key signatures and/or digitizing land titles to allow for faster registrations of ownership changes), there are real upper bounds on the social/legal lawyer to how much it can help.

Similarly, with traditional securities, there are impediments to liquidity that have absolutely nothing to do with the fact that securities have not been fully digitized or that securities transactions are often filtered through brokers and other intermediaries. For example, I would love to buy stock in The Boring Company (which is a privately held entity). I haven’t done so, not because there is no “Boring Stock Token,” but because no one wants to sell me The Boring Company stock—least of all The Boring Company itself. Why? Even though I am an “accredited investor,” The Boring Company will eventually be deemed an “Exchange-Act-reporting company” (i.e., a company that has effectively gone “public” without a big underwritten IPO event) if it ends up having more than $10 million in assets and either 2,000 record stockholders or 500 record stockholders who are not “accredited investors”[14]; going public in this manner would be extremely costly and inefficient for most early-stage companies. And since lots of people who are “higher quality” investors than me would like to invest in The Boring Company—people who are more sophisticated, richer, more patient and well-connected—there is no incentive for The Boring Company to take money from me instead of them. Indeed, The Boring Company almost certainly has contractual agreements with its stockholders that prevent such stockholders from selling to smaller investors even where legally possible—instead, the current stockholders of The Boring Company will likely be compelled to sell The Boring Company stock to each other, back to The Boring Company or to other very large, sophisticated investors. That just makes sense—it’s easier for The Boring Company to deal with a small number of very wealthy and influential investors than it is to deal with a bunch of “cat-and-dog”/”mom-and-pop” investors (even if they are technically “accredited”), unless and until it decides to go public. Not to mention the fact that if The Boring Company wants to raise money from everyday Joes like me, it can do so by selling us things other than that sweet, sweet, endlessly appreciating equity: for example, it can sell us those sweet, sweet, endlessly depreciating flamethrowers.

As much as we might hate to admit it: None of these particular issues will be solved, or even mitigated, by tokenizing assets. Rather, these issues are caused by a combination of regulations and market forces that will not be changed at all by the fact that one happens to choose to represent a security in token form rather than paper form. However, as we will see, tokenizing assets (including stock) via ARTs can solve or mitigate other problems.

FIN SKEPTICAL INTERLUDE #2

Since we already have lots of representations of rights/interests in assets, and since actually plenty of those representations already are digital or easily digitizable, to make the case for ARTs we should focus on what distinguishes them from other ways of representing rights/interests in assets. If representing stock via digital tokens stored/tracked on a blockchain technology network is to be materially better than representing stock via digital tokens stored/tracked on Carta’s servers (as summarized in “SKEPTICAL INTERLUDE #1”), then it must be due to the “blockchain technology network” part of the equation—because everything else is basically the same. To do that, though, we first need to take a brief detour into the unique virtues and benefits of blockchain technology more generally.

Blockchain: This Machine Kills Fascists

Given the vast amount of material that has been published explaining the design, promises and perils of “blockchain technology,” it would be hubristic of me to think I could explain blockchain better. Therefore, I’m going to assume a basic familiarity of how blockchain technology works and its by now well-established capabilities. Instead of rehashing that familiar ground, I’m going to focus on a question that often gets obscured in discussions of blockchain: that is, what is blockchain technology’s USP? What is it that blockchain’s not just capable of doing (which is practically anything), but that it actually does better than any other technology?

“Blockchains” in the most well-known sense—open-source, decentralized, public, peer-to-peer networks like Bitcoin and Ethereum—are some of the slowest and least efficient network technologies. Because they live on open, peer-to-peer networks where nodes can come and go but still need to all agree on the facts that constitute the state of the network, they face unique challenges in simultaneously maintaining “byzantine fault tolerance” (i.e., convergence on consensus despite the possibility of ‘dissent’) and “sybil-resistance” (i.e., defense against ersatz consensus created through spam formation of identities and/or transactions). Achieving byzantine fault tolerance and sybil resistance on an open peer-to-peer network imposes serious costs in both time and value.

Basically, from a pure performance point of view, blockchains suck. Worse still, there is nothing that blockchain technology can do that can’t be done on a network utilizing a so-called “client-server architecture” or “master-slave architecture”—i.e., a network that is built and updated by reference to a particular owner’s server and only needs to follow that owner’s rules to decide on its state. Worse worse still, since these “client-server/master-slave” architectures can rely on centralized coordination mechanisms to achieve byzantine fault tolerance and sybil resistance, they are faster, cheaper and easier to use.

Thus, blockchain technology’s USP for most applications is not “doing the same exact thing as centralized technologies, but materially faster, cheaper and more conveniently.” In other words, blockchain is not just a new and better platform the way “smart phones” were new and better platforms as compared to PDAs or PDAs were new and better platforms as compared to simple flip phones. If blockchain represents an improvement on traditional solutions, it must be for other reasons. Many leading blockchain technology thinkers and technologists are clear on this fact and have thus criticized so-called “distributed ledger technologies” (DLT) that cherry-pick aspects of peer-to-peer open blockchain technology and apply them in the context of “permissioned networks” where consensus is achieved by “trusted nodes” in order to pretend to achieve the same things as blockchain but at “client-server/master-slave” speeds.[15]

Blockchain’s USP, then, lies not in “performance” but in performing in a way that furthers certain values better than other technologies. What are these values? In this regard, I’d like to let some other authors and thinkers speak for me by providing a series of quotes form some leading thinkers about the two leading open, public blockchains: Bitcoin and Ethereum:

• “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”[16]

• “The secret to Bitcoin’s success is certainly not its computational efficiency or its scalability in the consumption of resources[…] Rather than reduce its protocol messages to be as few as possible, each Bitcoin-running computer sprays the Internet with a redundantly large number of “inventory vector” packets to make very sure that all messages get accurately through to as many other Bitcoin computers as possible. As a result, the Bitcoin blockchain cannot process as many transactions per second as a traditional payment network such as PayPal or Visa. Bitcoin offends the sensibilities of resource-conscious and performance-measure-maximizing engineers and businessmen alike. Instead, the secret to Bitcoin’s success is that its prolific resource consumption and poor computational scalability is buying something even more valuable: social scalability […] Whereas the main social scalability benefit of the Internet has been matchmaking, the predominant direct social scalability benefit of blockchains is trust minimization. A blockchain can reduce vulnerability by locking in the integrity of some important performances (such as the creation and payment of money) and some important information flows, and in the future may reduce the vulnerability of the integrity of some important matchmaking functions. Trust in the secret and arbitrarily mutable activities of a private computation can be replaced by verifiable confidence in the behavior of a generally immutable public computation.”[17]

• “The essence of bitcoin is the ability to operate in a decentralized way without having to trust anyone. The essence of bitcoin is to be able to use software to authoritatively and independently verify everything yourself—without appeal to authority… It is the first market-based security model, in which a series of incentives and punishments ensures what the ultimate result is: you can trust the platform itself, as a neutral arbiter that is not controlled by anyone, without third parties, without intermediaries.”[18]

• “Whereas most technologies tend to automate workers on the periphery doing menial tasks, blockchains automate away the center. Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customer directly.”[19]

• “The design behind Ethereum is intended to follow the following principles…5. Non-discrimination and non-censorship: the protocol should not attempt to actively restrict or prevent specific categories of usage. All regulatory mechanisms in the protocol should be designed to directly regulate the harm and not attempt to oppose specific undesirable applications. A programmer can even run an infinite loop script on top of Ethereum for as long as they are willing to keep paying the per-computational-step transaction fee.”[20]

• “On a blockchain, you can ultimately build anything that you can build on top of a computer. From a computer science theoretical point of view, in terms of what it provides, you can think about it as being a computer. But what it provides on top of that is these extra trust guarantees: the guarantee that the computer will run in the way that you expect it to run, and that a few people can’t make that guarantee fail by going out of business, getting hacked, dying, having their company go bankrupt, deciding to be evil one day, deciding they have some monopolistic interest to start acting differently one day, and all of those different issues.”[21]

The above quotes reflect a vision of blockchain technology as furthering what I will call “individual asset sovereignty values.”[22] Blockchain technologies enhance individual asset sovereignty by empowering users to hold, and engage in transactions with, units of value in a manner independent of, and relatively resistant to intervention by, established institutional and governmental intermediaries and authorities. Importantly, these quotes also acknowledge that “freedom isn’t free”—i.e., that open blockchain software architectures impose costs and inefficiencies that “client-server”/“master-slave” architectures do not—but that these costs are worth paying to achieve individual asset sovereignty. Critically, then, blockchain is not a “value-neutral” technology: if you do not value individual asset sovereignty, then for most applications[23], there is simply no reason to prefer a blockchain-based technological solution to a “client-server/master-slave” one—and, on the contrary, there would then be many reasons to prefer the “client-server/master-slave” solution, since it will be faster, cheaper and more convenient. Blockchain is like Woody Guthrie’s guitar, which he famously labelled with the phrase: “This Machine Kills Fascists.” Simply put: Individual asset sovereignty is, in my view, the USP and primary raison d’être of blockchain technologies.

Armed with a vision of what blockchain technology is supposed to achieve, we are now in a better position to assess the relative technological benefits of ARTs over preexisting methods of digitizing asset ownership rights. However, to fully assess and understand such tokenization, there is one more piece of background we need—namely, the corporate-law and corporate-finance background in the history of types of securities instruments and how they represent asset ownership rights. That is the subject of our next section.

HISTORY OF ASSET RIGHTS INSTRUMENTS

Overview

Historically, representation of rights in assets and other securities has taken three main alternative forms. We can refer to these as types of securities instruments. I will briefly summarize them and their main distinguishing features in the table below, then go on to explain them in somewhat more depth. The green-highlighted cells show features that are particularly conducive of individual asset sovereignty. Note: For convenience of reference, I am here using the term “securities instrument” somewhat loosely to capture different methods of representation, whereas the term is often reserved for transferable securities instruments and thus “book entries” for book-entry shares would not ordinarily be considered “instruments.” As such, there is one type of securities instrument (or form of representation of securities ownership, to be more precise) that I will be ignoring in this section—the so-called “securities entitlement” that was recognized in fairly recent amendments to the UCC. A good discussion of that requires understanding how the market for publicly traded corporate stock works, so we’ll get back to that one later in the article after we have covered that topic.

Asset Sovereignty PropertiesBearer CertificatesRegistered CertificatesRegistered Book Entries (Uncertificated)Can be Owned AnonymouslyYesNoNoCan be Transferred and/or Pledged AnonymouslyYesGenerally no. Potential exception if “endorsed in blank”.NoCan Be Issued Anonymously?YesNoNoCan be Transferred or Pledged Peer-to-Peer (without issuer mediation)YesYesNoCan Be Transferred Without Generating a “Chain of Title”YesGenerally no. Potential exception if “endorsed in blank”.NoCan be Reissued to Owner if StolenNo (or very unlikely, since will be very hard for owner to prove it was stolen vs. transferred for value)YesYes

Bearer Instruments

Bearer instruments are typically heavy-stock pieces of paper anonymously made out to “the Bearer” (i.e., whoever happens to “bear” (i.e., hold—or HODL if you like) the instrument at a given time). They make “the Bearer” the owner of the relevant right. The concept of a bearer instrument is that whoever physically possesses it is ipso facto the rightful owner thereof and is entitled to exercise the relevant rights associated therewith, such as the rights of a stockholder to receive dividends form the issuing corporation. There is no registry or ledger of bearer instruments identifying who owns which shares or what series of transfers the shares have gone through over time[24], and thus there is no readily ascertainable “chain of title” for bearer instruments. Accordingly, if someone holds and presents a bearer instrument (for example, a bearer stock certificate), they are entitled to exercise the rights represented by the instrument, and the relevant third party (for example, the issuing corporation) is both entitled and required to rely upon the fact that the holder possesses the bearer instrument as sufficient evidence of the legal rights and entitlement of the possessor with respect thereto, absent special circumstances, such as the issuer being on notice that the instrument was stolen.

While “bearer instruments” were once the standard and preferred method of representing most securities, they are rare in contemporary finance, having been largely regulated out of existence. For example, all 50 U.S. states, including the blockchain-friendly states of Delaware and Wyoming, expressly prohibit corporations from issuing stock certificates “in bearer form”[25]. The United Kingdom and most of the European Union have also prohibited bearer shares. Even Panama, notorious for making a cottage industry out of tax evasion, has recently amended its corporate law statutes to require that bearer shares be custodied with trusted authorities who maintain a register of the names and other relevant information of the shareholders. Similarly, tax rules (e.g., the U.S. Tax Equity and Fiscal Responsibility Act of 1982) have been imposed in many countries that make issuance of debt instruments in bearer form (such as the infamous “bearer bonds” of spy movie lore) impracticable by imposing excise taxes and other sanctions on entities that issue them. Thus, to the limited extent bearer instruments are still legal, they are highly frowned upon by regulators, who view them as facilitating anonymous ownership and thus tax evasion and money laundering. Sound familiar? Yes—not coincidentally, cryptocurrencies are very similar to bearer instruments and have come under fire from many regulators for the same reasons.

Registered Instruments

Most financial instruments in contemporary markets are not permitted to be issued on a “bearer basis,” and instead are legally required to be issued on a “registered basis”. This requirement is sometimes direct (e.g. under the corporate law statutes of U.S. states, which prohibit issuing stock certificates in bearer form) and sometimes indirect (e.g., through tax sanctions on bearer bonds). Issuing an instrument on a “registered basis” means that the issuer knows who originally bought the instrument from the issuer, issues the instrument in the name of that person and endeavors to keep a record of the chain of title for the instrument, tied to the legal names (and usually also addresses and other identifying information) of each successive transferee.

There are two main methods of issuing securities on a “registered basis”: in certificated form and uncertificated form. The issuer of the security elects what form of instrument to issue.

For example, if The Boring Company issues “certificated stock”, then if you buy stock in The Boring Company, it would issue you an official “The Boring Company” paper stock certificate showing your legal name and the number of shares you bought, signed by two officers of The Boring Company. At the same time, The Boring Company would add your name, mailing address, the number of shares you bought and your stock certificate number to its official stock ledger—which it is required to maintain by the corporate statutes of the state in which it is incorporated (likely Delaware). By contrast, if The Boring Company issues “uncertificated stock” then you won’t receive a paper certificate—but the same book entry will be made in The Boring Company’s stock ledger, and that (along with the stock purchase agreement you signed to buy the stock) will be the sole evidence that you own The Boring Company stock.

Both approaches are similar in that they require the corporation and the stock purchaser to know who each other are and to be in contractual privity with each other. However, they differ in one crucial respect: With “certificated” shares, it is possible for the initial holder of such shares (and any successive transferee) to sell the shares to a third party in a kind of “peer-to-peer paper transfer” without the issuer being informed of the transfer—i.e., a transfer may be completed (with the transferee having perfected rights in the stock) without the issuer knowing about the transfer, who the transferee is or having the opportunity to update its stock ledger with that information[26]. By contrast, with “uncertificated shares,” the transfer is not complete (the transferee cannot perfect its rights in the stock) until the issuer updates its stock ledger with a record of the transfer, including (at least for Delaware corporations) the transferee’s name and mailing address.[27] The rules for “stock pledges” are essentially the same as for “stock transfers”—if I want to pledge my shares in The Boring Company to a lender as security against a loan, then if the shares are certificated, the lender can take possession of the stock certificates to perfect its rights in the shares as collateral; by contrast, if the shares are uncertificated, then in order to perfect its security interest the lender will need to get the borrower to have the issuer add a notation about the pledge to the issuer’s official stock ledger.

Interestingly, there are loopholes whereby certificated instruments issued in “registered form” can be effectively converted into bearer certificates. Let’s go back to The Boring Company and assume for the moment that The Boring Company is incorporated in Delaware. Delaware (like all other U.S. states) forbids corporations from issuing stock certificates “in bearer form.”[28] However, that prohibition applies only to the corporation issuing the stock certificates—it does not apply to stockholders who may wish to effectuate secondary transfers of the stock. Thus, a stockholder may “endorse in blank” his stock certificate by signing transfer language on the back and leaving the name of the transferee blank—voila, the stockholder has just turned his “registered” certificate into a ‘blank check’ of sorts—in other words, into something very similar to a “bearer” certificate. The stock certificate, “endorsed in blank” by the original holder, can change hands in bona fide transactions any number of times without the name being filled in. Crucially, the Uniform Commercial Code—which governs the rights of transferees in stock—provides that a transfer of certificated stock is complete when the transferee receives possession of an endorsed stock certificate (assuming certain other conditions are satisfied, including that the transferee does not have notice of an adverse claim)—it does not require that the transferee’s name actually be filled in. No such possibility is available for uncertificated stock, which can only be fully transferred if, as and when the corporation makes a book-entry on its stock ledger.

So then, is there really any difference between a “registered certificate” and a “bearer certificate”? Well, yes—potentially. In order for a transferee to be a “protected purchaser” under the UCC, the transferee must “not have notice of an adverse claim” on the security. Because registered certificates are designed for a chain-of-title type system where transfers are tied to names, in any dispute about whether a given transferee really had good rights to certificated stock, it is possible that a court would view with suspicion that a given transferee did not undertake due diligence to confirm the chain of title. That is to say, if Alice buys stock from Otto via a stock certificate “endorsed in blank” from the original holder, “Bob,” and there were any doubt about Alice’s rights to the stock, a judge could view with skepticism Alice’s failure to confirm that Otto bought it from Bob, or if he did not buy it from Bob, that he bought it from someone who bought it from Bob. On the other hand, some courts have found that mere “endorsement in blank” is not sufficient to raise suspicion of an adverse claim.[29] In any event, such questions would typically not arise with fully fledged bearer certificates, which are anonymous by design. Still though, outside of such corner cases, registered certificates “endorsed in blank” are practically identical to “bearer certificates”.

Now that we know what tokenization of assets is about (representing asset-related securities via ARTs), what blockchain is all about (furthering the values of individual asset sovereignty) and the main types of securities instruments that have existed in the modern financial world, we can revisit the purpose of ARTs and discuss how best to achieve those purposes.

Tokenization of Assets—Why Does it Matter (Redux)?

As we observed above, digital securities instruments are possible without, and in fact preexist, blockchain technologies. A digital security instrument can be as simple as a digitally signed PDF stock certificate or PDF warrant issued by a corporation, or as sophisticated as an electronic stock certificate, stock option or convertible note issued through a platform like Carta, which even features “smart contract” functionality of a sort by tracking the vesting status and conversion conditions of securities and offering holders the ability to exercise, convert, or sell (e.g., in a private tender offer) their securities. Thus, if ARTs are to live up to their revolutionary potential, they must offer something beyond these already well-established features. But what?

The answer lies in the USP of blockchain—individual asset sovereignty. If ARTs could provide meaningfully superior individual asset sovereignty relative to other digital securities instruments, then they would represent a significant improvement over the status quo. I don’t know how Carta works “under the hood,” but it’s reasonable to assume that it utilizes a traditional “client-server/master-slave” architecture. Let’s assume that is the case and proceed to compare a hypothetical “e-share” issued on Carta, a hypothetical electronic PDF stock certificate and a hypothetical ART issued as an ERC20 token on Ethereum, each representing a share of common stock of a publicly held corporation whose stock trades freely^[2]. In setting forth the below comparisons I will be provisionally making some assumptions, omitting certain caveats and qualifications and simplifying certain details—but we’ll loop back and ‘re-complicate’ the important ones later in the article.

Functional PropertiesARTs on EthereumCarta e-SharePDF Share CertificatesNetwork ArchitectureDecentralized/open/P2PCentralized (client-server/master-slave architecture served through Web 2.0)N/A (not confined to any network)Network Operation & MaintenanceDecentralized—depends on miners/verifiers, users, voluntary software developers and independently existing Internet architecture. Network provides inherent incentives so that it is likely to continue in existence and being maintained indefinitely. Open-source software allows any willing volunteer to potentially help maintain the network.Centralized—depends entirely on the company owning the Carta platform remaining in business and either maintaining/operating its own servers or paying third parties to operate servers for it. Closed source software means that third parties cannot help maintain the network even if they had incentive to do so.[32]N/A (not confined to any network)Network ImprovementsFairly centralized (upgrades depend primarily on the Ethereum Foundation), but may become more decentralized over time.Completely centralized—the network will only improve if Carta improves it; no one else even has the ability to do so. Very unlikely to ever become less centralized.N/A—neither centralized nor decentralized; there will be no improvements.Privacy Protections

user/user: very good, assuming public key not extrinsically associated with IRL identity, but weak once a public key is linked with IRL identity—future improvements using zksnarks etc. are possible

issuer/user: depends on type of security instrument, but typically will be poor due to prohibited status of bearer instruments[33]

admin/user: same as user/user (or arguably N/A as there are no “admins” as such—miners are a special type of user, etc.)

user/user: presumably very good, in the absence of hacks

issuer/user: same as ARTs on

admin/user: presumably poor; Carta and its employees can presumably view all user information

user/user: very good, if PDF not shared or hacked; otherwise very bad

issuer/user: same as ARTs and e-Shares

admin/user: N/A—no admin

Protection Against Transaction Censorship, Confiscation and TheftDepends on implementation and type of security instrument, but potentially provides very good protection if the ARTs are deemed to be stock certificates (with the protection being extremely strong if they are bearer certificates and moderately strong if they are registered certificates) and the relevant smart contract does not have back doors and does not restrict transfers.

If the ART is a bearer certificate, confiscation or theft will mean obtaining the private key. This may be more difficult than stealing a paper certificate (particularly if a multisig scheme is used), but the consequences will be very bad as the issuer will not have an “override mechanism” to cancel the stolen certificate.

If the ART is a registered certificate, same thing. However, in the case of theft the issuer could refuse to honor the stolen ART and could issue a new ART to the rightful owner.

Very low. If the issuer (paying customer of Carta) wishes to block a stock transfer, Carta would likely accept the instruction (subject to applicable law). If a government authority wished to stop a stock transfer, it could enjoin Carta from processing it. If a creditor of a stockholder wished to foreclose on stock that had been pledged to the creditor as collateral, the creditor could get a court to order Carta to enforce the foreclosure.Pretty good protection overall; similar to an ART implemented as a registered certificate.

Weak protection against theft via fraud or counterfeiting (see below).

Protection Against Fraud/CounterfeitingExcellent protection; benefit from all security guarantees of Ethereum against double-spends etc. Trust in agents/intermediaries not required, or only required in edge cases.Good, assuming trust in and good behavior by Carta. Very poor otherwise.Very poor. PDF can easily be copied, counterfeited or altered.

While we have had to engage in some assuming and hand-waving, the above table of comparisons illustrates that, yes, just as blockchain generally offers opportunities to achieve individual asset sovereignty that other technologies do not, so, too, ARTs on a blockchain offer opportunities to achieve individual asset sovereignty that other ways of digitally representing securities do not. The USP of ARTs is, like that of blockchain generally, the enhancement of individual asset sovereignty. However, as our assumption-making and hand-waving have hinted, not all ART implementations are created equal. ARTs will only enhance individual asset sovereignty to the extent implemented properly, and, as we will see, there are potential implementations of ARTs that actually impair individual asset sovereignty.

SIGNIFIER VS. SIGNIFIED—MAINTAINING THE LINK BETWEEN AN ASSET RIGHTS TOKEN AND THE SECURITY IT IS SUPPOSED TO REPRESENT

Here is a law-school-style hypothetical that unpacks some of the question-begging and hand-waving we did in the prior section by illustrating a potential challenge to the feasibility and usefulness of ARTs:

• Block Corp. is a privately held Delaware corporation that issued “stock tokens” to investors in exchange for cash in a “private placement” compliant with Regulation D. Let’s say the private placement occurred at time

• Alice bought 100 tokenized shares of BlockCorp in the private placement, and is the sole person that controls the private key that controls transfers of the tokens—i.e., she is the legal owner of the shares, and also effectively owns/controls 100 tokens representing the shares—these tokens are a specific form of ART.

• Since BlockCorp sold the shares directly to Alice, BlockCorp lists Alice as the owner of 100 shares of stock on its official stock ledger in accordance with §219 of the Delaware General Corporation Law (“DGCL”).

• By time T + 1, BlockCorp has become extremely valuable—in Silicon-Valley-jargon, it is a “unicorn”: a privately held technology company valued at over $1 billion. As a result, Alice’s 100 shares in BlockCorp are now worth $5 million, and are by far Alice’s most valuable asset.

• At time T + 2, inspired by the success of BlockCorp, Alice gets her own blockchain technology idea: to design, build and sell a special refrigerator that cannot be opened except if you send cryptocurrency to a smart contract owned by Alice. The refrigerator will be marketed as providing a cryptographic disincentive to breaking diet goals. Alice will adopt a “Freemium” approach and give away the fridges for free in the hopes of making a fortune off the “long tail” of the fees from opening the refrigerator by people breaking their diets. She calls it “BlockFridge”.

• At time T + 3, BlockCorp still has not IPO’d and thus its shares remain relatively illiquid and potentially undervalued (so Alice either cannot or does not want to sell them yet), but Alice has decided to quit her job and move forward with BlockFridge. To do this, she wants to take out a $5 million loan. But the lender will not lend the money without collateral, so Alice pledges her 100 shares of BlockCorp to the lender as collateral.

• At time T + 4, BlockCorp still has not IPO’d, and Alice’s business has become a disaster. She spent over $5 million designing and marketing BlockFridge, only to find that almost no one was willing to even accept a BlockFridge for free—it turns out that people like to be able to open their fridges at will, even if they are dieting! She has missed several interest payments, and the lender has sent a threatening letter from its General Counsel that she must pay up or the lender will foreclose on the BlockCorp stock Alice pledged as collateral. On the plus side, BlockCorp just completed its Series D round at an even higher valuation, and Alice’s BlockCorp stock is now worth $6 million. Thus, Alice is not “bankrupt” (in the casual sense) or insolvent (in the strict sense), since her assets exceed her liabilities.

• At time T + 5, the lender has not yet foreclosed on Alice’s BlockCorp shares, and BlockCorp finally IPOs. Alice immediately sells her shares to Bob for $6 million. As part of selling her shares, Alice, of course, also sends her 100 BlockCorp share tokens to Bob’s wallet. Bob knows nothing about the lender, Alice’s debt or the fact that the stock has been pledged to the lender.

• At time T + 6 (which we will posit is immediately after T + 5), instead of paying back her loan, Alice converts all of the $6 million from Bob into untraceable Monero, calls up her local vacuum repairman and orders a dust filter for a Hoover Max Extract 60 Pressure Pro. Just like in Breaking Bad, she is given a new identity and whisked off to the Midwestern United States to live out the rest of her days working at the local Cinnabon and sleeping with one eye open in a sort of self-imposed witness protection program where the lender and his goons can never find her. That may be extreme, but maybe the lender is Tony Soprano.

Now, in true “Socratic fashion,” here is the law-school-style question: At time T +6, who legally owns the 100 shares of BlockCorp that used to be Alice’s: Bob, who ponied up $6 million at T + 5 and holds the tokens, or the lender, who ponied up $5 million at T + 3 and received a “pledge” of those same 100 shares as collateral, but does not hold the tokens? Before you read on, try to think about what you think the result should be and why.

H