This article aims to explain the concept and potential of asset tokenisation using blockchain technology in the real estate sector. It will explore the regulatory development in the field of real estate tokenisation, draw a parallel with regulations in the foreign jurisdictions, and suggest measures for Indian regulators to bridge existing gaps. 

This article aims to explain the concept and potential of asset tokenisation using blockchain technology in the real estate sector. It will explore the regulatory development in the field of real estate tokenisation, draw a parallel with regulations in the foreign jurisdictions, and suggest measures for Indian regulators to bridge existing gaps.

Asset Tokenisation – Concept and Advantages

Asset tokenisation has witnessed a rise in popularity in India, particularly in the real estate sector. The real estate tokenisation market is expected to have a market value of USD 1 trillion by 2030. ‘Asset Tokenisation’ refers to conversion of rights of real estate or other assets into tradeable tokens, which represent fractional ownership, with the help of blockchain technology. The process of tokenisation begins by fragmenting the asset (such as a property) using smart contracts, creating digital tokens for each fraction. A smart contract is a self-executing contract that is triggered upon the happening of certain pre-determined events. It is entered into by the parties through digital codes and integrated into a decentralized blockchain.

Asset tokens in the real estate sector are known as real estate tokens (RETs). These RETs are stored on the blockchain, allowing investors to buy and own fragments of real estate. Real estate tokenisation is a nuanced and blockchain-backed model based on fractional ownership of properties. Fractional ownership platforms (FOPs) typically offer fractional ownership of properties by issuing shares of unlisted special purpose vehicles created for the object of acquiring a target property, without any usage of blockchain technology. When such fractional ownership is offered without issuing shares of a special purpose vehicle, but is based on blockchain and is freely tradeable on an exchange, it takes the shape of an RET.

Investments via RETs are secure and liquid and the transactions are easy to execute. This has the potential to help small and retail investors to deal with high-cost and complex assets. This method of fractional ownership facilitates inclusivity for small investors without compromising on the corpus size for the issuer of such tokens. However, since the market of RETs in India is in a nascent stage, neither the government nor any regulatory authority has made laws on the subject, thus making the market susceptible to financial risks and fraud.

The IFSCA initiatives vis-à-vis the Real Estate Market

A positive step towards regulating this new market was taken by the International Financial Services Centre Authority (IFSCA), which constituted a seven-member “Expert Committee on Asset Tokenisation” on 12 September 2023. This expert committee was constituted for the development of regulations and policy guidelines for tokenisation of real and physical assets. The main aim of the committee is to assess the legal validity of smart contracts and develop a risk management framework for digital tokens. It has also been entrusted with examining the role of digital custodians in the asset tokenization model and developing operational policies.

The IFSCA has also taken the initiative for regulation of technology-backed offerings in the real estate sector. It has facilitated a regulatory sandbox for a private market investment platform, namely Terazo, and a tokenisation platform, namely Tokeny. This marked the first regulated tokenised real estate in the country.

Although tokenised real estate in India has not received much attention from the other Indian regulators, the market is growing, albeit at a slow pace. Platforms like ‘alyf’, ‘hBits’ and ‘RealX’ have attracted investors by providing fractional ownership of properties. While alyf and hBits operate as FOPs to provide fractional ownership of residential holiday homes and commercial properties, RealX, offers a real estate tokenisation product by using blockchain in addition to simple fractional ownership model.

Legal Position in India

The concept of real estate tokenisation is prima facie unregulated in India, with no dedicated legislation or regulator yet. However, certain legislations, as mentioned below, may apply to RETs in certain situations.

Taxation and Anti-Money Laundering

RETs may fall under the category of virtual digital assets, as defined under section 2(47-A) of the Income Tax Act, 1961. In 2022, the Union Budget imposed a 30 percent tax on any income from the transfer of a virtual digital asset.

Further, the Ministry of Finance has included the transfer, exchange, safekeeping and facilitation of virtual digital assets under the ambit of activities covered under the Prevention of Money Laundering Act, 2002 (PMLA). Thus, the Enforcement Directorate may have the authority to investigate any financial transaction concerning RETs under the PMLA. The legislature should, accordingly, clarify whether RETs fall within the ambit of the Income Tax Act, 1961, and the PMLA to avoid any potential confusion.

Banking Regulation

In January 2021, the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (Cryptocurrency Bill) was placed in the Parliament. It aimed to prohibit all ‘cryptocurrency’, barring certain exceptions. It is still under the consideration of the Parliament and has not been passed yet.

In terms of the Cryptocurrency Bill, an RET may potentially be treated as a ‘cryptocurrency’ as it is a digital representation of value exchanged with or without consideration. It also bears a promise or representation of having an inherent value in any business activity that may involve a risk of loss or an expectation of profits or income.

However, in the absence of a legal definition of an RET and any classification by the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), or any other regulatory or legislative body, there is no clarity on whether an RET qualifies as cryptocurrency.

State-level Initiatives

The Telangana State Government’s Department of Information Technology, Electronics, and Communications has released a guidance note on asset tokenization. This note offers insights into the technical complexities of tokenization and suggests a structured approach for companies and startups venturing into asset tokenization in real estate. The goal is to facilitate the adoption of blockchain technology and enhance transparency, immutability, and security in managing assets.

Inter-jurisdictional Analysis

Countries across the world are discussing potential frameworks and regulations for the governance of asset tokenisation. In line with the principle that ‘innovation always precedes regulation’, jurisdictions like the USA, Canada, Dubai, UAE, and certain EU countries amongst others, have implemented mechanisms to oversee the issue of RETs.

In the USA, RETs are treated as securities and are required to be registered with the Securities and Exchange Commission, barring a few exemptions based on criteria like income and net worth requirements, and the geographical location of offers and sales of such tokens. A similar approach is followed in Canada, where registration requirements must be met, if not exempted. Dubai has established the Dubai Virtual Assets Regulatory Authority under the law regulating virtual assets in the Emirate of Dubai.

Under UAE’s regulatory framework, governed by the Emirates Securities and Commodities Authority, security tokens are classified as securities, and the issuance and trading of security tokens are subject to the same regulations as other securities, including licensing requirements. Similar to the Indian legal landscape wherein virtual digital assets are covered under the PMLA and the guidelines thereunder, the UAE also has anti-money laundering and counter-terrorism financing measures.

Even in the European Union, countries like Switzerland, Luxembourg, and Liechtenstein have enacted legislation to cater to real estate tokens and have well-built frameworks around them.

Suggestive Measures

Tokenisation of real estate is a novel and rapidly evolving market in India, which makes it difficult for the regulators to frame legislations to govern FOPs and RETs. The regulations in different jurisdictions, as discussed above, can guide the Indian regulators to take smaller steps towards regulating this market. Some of these steps are discussed below.

Categorisation as securities

The IFSCA has signalled that a holistic framework is required to enhance the functionality of RETs. Along similar lines, the SEBI may consider implementing a framework for RETs and categorise them as legally tradeable securities, as has been done by the Securities Exchange Commission in the USA. Such categorisation would give RETs legal recognition, which will lead to building confidence amongst potential investors and customers. It will also allow more players entry into the RET market and ensure a level-playing field with better competition.

Asset Value and Net Worth Thresholds

As is the case in the USA and Canada, Indian regulators can prescribe eligibility criteria for entities or persons offering RETs based on asset value or net worth. The requirement of maintaining a minimum asset value or net worth will encourage participation from genuine companies and at the same time, restrict unscrupulous players from accessing the market. Additionally, the regulators may put in place a fit and proper criteria for the individuals occupying managerial positions of the issuer. This will ensure that persons responsible for the operations of an entity issuing RETs are credible.

Definition of virtual digital assets

Although the Income Tax Act defines virtual digital assets, the definition could be amended to include RETs and the legislature should ensure that a homogenous definition of virtual digital assets is included in all applicable laws. Accordingly, the Central Government should include RETs in the definition of virtual digital assets in the pending cryptocurrency legislation. This will enable stakeholders in the real estate sector and investors to avoid any potential issues with regards to the definition of virtual digital assets and make more informed decisions while transacting in RETs.

Regulatory Sandboxes

The SEBI has put in place an enabling framework for regulatory sandbox similar to the one facilitated by the IFSCA for tokenised real estate, is a foolproof way to ascertain the feasibility of the RET mechanism in India. Regulatory sandboxes may be put in place by the SEBI and the RBI also to test the viability of RETs before framing a detailed mechanism. The regulators must expand the scope of the present framework to include RET-issuing platforms in their jurisdiction, to ensure greater transparency, adoption of technology, and sectoral development. On the other hand, the RET-issuing platforms must ensure the highest level of compliance with extant legislation and be mindful of all regulatory waves in the industry.

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Bharucha & Partners – Vivek Mishra and Vatsal Srivastava