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As the NFT market is growing, it is important to regulate it to protect the consumers. Nevertheless, non-fungible tokens have certain specificities that make it hard to categorize them as a regulated asset. Therefore, this paper will compare the process of introducing an NFT on the blockchain (tokenization) to securitization (a regulated financial process). In traditional finance terms, securitization is the process of pooling different categories of assets into one vehicle and dividing such vehicle into a (more or less) large number of securities representing a fractional ownership stake in that vehicle, and consequently the assets inside of it. Typically these securities mimic the financial performance of the underlying assets that are supposed to generate interests. Securitization is an important part of what is commonly referred to as “structured finance”[1].

It will then present the recent decision of the Lebanese Central Bank (BDL) and its stance on NFTs.

Comparison of tokenization of digital assets and securitization of assets: Can tokenization be subject to the securitization legal framework?

This part is important in order to understand if the process of tokenization can be legally regulated as a digital securitization.

First of all, if we compare definition, securitization includes the process of pooling assets into a tradable security that produces interest. As for tokenization, it represents the introduction of the digital asset on the blockchain in order for it to be traded.

Second of all, the actors involved in these two mechanisms differ, as for the securitization it will most likely involve borrowers, a bank, a corporation and an investor. As for the tokenization, it consists of a smart contract between the developer and the minter.

Figure 1 Tokenization simplified[2].

In order to further comprehend securitization and compare it with tokenization, we were assisted by an economic expert[3] who further explained the securitization process.

What is securitization?

Securitization is a financial institution's mechanism for grouping various contractual obligations - such as a debt with interest. This institution, for example, will purchase personal loans (with a specific return and timeframe). For instance, the bank offers a $100 personal loan with a ten percent interest rate for six years. In exchange for the loan, the financial institution will pay the bank 110 dollars. As a result, you pay cash to the bank, and the bank grants you the ownership of the mortgage. This is done by the financial institution for assets such as auto loans, bonds, and so on.

The financial institution will have a variety of papers and mortgages, each with a different return. With these assets, you create a new type of asset that represents the collection of all those assets. It is then sold as a bond, a single security. The person who acquires the bond will receive a margin of interest, while the financial institution will keep the rest of the interest.

To summarize: the financial institution buys a bunch of different financial assets, and it groups them into one asset to sell it as a security with high return. It is the process of turning a large number of bonds and mortgages into a single security.

Figure 2 Securitization process simplified

How can we compare between the movement of NFTs and securitized assets? Do they follow the same pattern?

It moves around in the same way that a securitized asset does, but it isn't a securitized asset itself. It behaves in the same way because of the NFT's nature: the nature of a token in general.

It will be fascinating to see if we can secure NFTs so that we can compare processes. It will put the disparities between these two into perspective.

In terms of securitizing NFTs, there are many types of assets in a securitization, so can we place an NFT in a security? Is it possible to securitize NFTs?

The hypothesis of securitizing an NFT:

Imagine putting NFTs in a bundle of different classes of assets such as credit cards. It could work. Nevertheless, you can’t bundle NFTs and sell them as a securitized asset because they belong to the same category. It is like selling different classes of apple shares, it is not a securitized product, but rather diversified portfolio.

Moreover, when we look at securitized assets, we can see that they are not supply-demand priced. Take a look at any financial institution where there are car loans, house loans, etc. For example, suppose you buy a property for $300,000 and take out a 10-year mortgage with a 5% interest rate. We can figure out how much we'll have to pay each month term by term. On the other side, NFTs are supply-demand pricing, which means the price is always changing, and I'm not sure how to turn it into a security through securitization. It doesn't work to have a security, equivalent to a bond, with constantly shifting prices. There is no way to price a security that has a constantly changing price. There is a massive financial risk involved.

Following on the “diversified asset” point, NFTs nowadays are within themselves gathering different kinds of assets rather than just art. Some give access to communities, music, and even land on the blockchain. And that land also gives certain compensation, since it can be rented. So there is a sort of constant payment. Does that affect what we already discussed?

NFTs do not generate cash flows in the same way that securities do. A mortgage generates cash flow in the form of an investor paying the debtor on a regular basis. An NFT, on the other hand, is a token that you acquire and does not have a cash flow. Because it is a static asset that does not produce the same type of cash flow, we will not be able to determine a price for a security that integrates an NFT.

Thoughts of the expert on securitization and tokenization: can they be put under equivalent legal regulations, since their circulation mechanism is similar? Even if the types of assets involved aren’t the same?

From a legal perspective, an NFT does not find itself in the securitization process because it does not produce cash flow and is a digital asset rather than a physical asset.

However, by comparing the two processes rather than integrating NFTs into securitization, we can observe where they intersect and where we can legally collide them. As they are quite similar in many characteristics, but they are highly different in fundamental places.

That’s why the very best way to approach it is in a comparative table that allows us to understand which legal regulations can apply to the tokenization process.

As such, the following table shows the similarities and differences between securitization and tokenization.

Table 1 Comparison between securitization and tokenization

The result of the interview and conclusion:

After comparing securitization and tokenization, we can see that these two mechanisms cannot be put under the same regulations. First of all, the nature of the securitized assets differ from those that are tokenized and therefore cannot be put under the same legal nature. In addition, the people involved in the tokenization process are not the same as those who are involved in securitization. The latter being mostly controlled by national financial institutions who are already subject to national regulations within themselves. This cannot apply upon the people who transact NFTs since they are usually individuals or people who are not registered as financial institutions. Moreover, even though the movement of the money might seem to follow the same pattern, knowing both mechanisms are a source of money to the originator, there is no method that we can apply in order to regulate a fixed interest and a random profit. This all results in two completely different assets: a security and a digital token.

In conclusion, even though securitization may collide with the idea of tokenization, this isn’t enough on its own. NFTs should be regulated by a specific law that takes into consideration their nature, parties and their own kind of profit or investment.

The recent decision of the Lebanese Central Bank (Banque du Liban - BDL) regarding NFT trading and its impact on the classification of NFTs.

The Lebanese Central Bank issued a statement on May 17^th, 2022 advising financial institutions and citizens against the trade of NFTs.

In its announcement number 948[4], the Lebanese Central Bank stated eight reasons that clarify this instruction. More specifically, BDL considered the following legal risks of NFTs:

1. The possibility for the seller to keep the property of the token whilst tricking the buyer that they transferred that right.
2. The lack of transparency of the related contracts and their complexity making buyers sometimes unaware of possible additional charges. (May be referring here to smart contracts).
3. The possibility for the seller to counterfeit the asset before or after the sale.
4. The difficulty in fixing a price for these tokens since they solely depend on a volatile market price, and the lack of instrument that helps track a specific price since these assets are new.
5.  The spoilage of the material asset before or after the sale, which can lead to its loss of value.
6. The possibility for the seller to scam the buyer by selling NFTs that belong to third parties without their knowledge or prior consent.
7. The lack of laws and regulations regarding this matter.
8. The potential use of these tokens to finance money laundering and terrorism.

Therefore, BDL advises against the trade of non-fungible tokens.

The main takeaways from this announcement are the following: the Lebanese central bank has an unfavorable opinion of NFTs. Nonetheless, we might deduce that NFTs are classified as financial assets by the Lebanese authorities. Furthermore, the Lebanese central bank is concerned about NFTs because they are not yet regulated, as evidenced by point 7. As a result, we believe that this announcement is the first step toward regulating such tokens. Instead of creating a safe trading arena, BDL, in my opinion, merely provided scammers ideas on how to employ non-fungible tokens.

Conclusion and recommendations:

As discussed in this paper, tokenization and securitization cannot be put under the same regulation because of the specificities of non-fungible tokens. Moreover, the Lebanese Central Bank refuses to recognize NFTs.

Therefore, these recommendations can be formulated:

1. A special authority of technology, business and legal experts should be put in place in order to study the technicality of an NFT and a way to regulate it.
2. NFTs need to be officially recognized by authorities as assets or financial tools, or given a special term or legal existence in order to start with their regulation. This way, courts can fully understand their uses and apply the right laws accordingly.
3. It would be a good idea to introduce a special regulation for NFTs into anti-money laundering and counter-terrorism financing acts in order to control any illicit use for this asset. This would also contribute to a bigger trust in these instruments as a financial tool.