By: Adeeb Bakhtavar
INTRODUCTION
The use of blockchain technology to manage the ownership of physical assets is now a reality rather than just an idea. This is happening on a global scale through experimentation by many types of companies and organisations (e.g., asset management firms) using these new blockchain technologies to create tokenised assets. Thus, India has an important regulatory decision to make regarding how to regulate tokenised versions of physical assets. What type of asset does the investor ultimately receive when a tokenised form of a physical asset is created and given to the investor? What type of regulation applies to the new tokenised version of the physical asset in law and practice?
The answer to this question will be determined by how Section 2(h) of the Securities Contracts (Regulation) Act 1956 (hereinafter ‘SCRA’) is applied in practice. Section 2(h) defines “securities” in a way that reflects the market conditions that existed before the introduction of digital technology. If tokenied versions of physical assets are treated as securities, then the Investor Protection regime constructed by the Securities & Exchange Board of India (hereinafter ‘SEBI’) will provide adequate protection for investors through the establishment of the appropriate minimum standards for the public disclosure of information, the establishment of the appropriate obligations to the investor at the level of each exchange, and the establishment of the appropriate minimum standards for market conduct. And, if tokenised versions of physical assets are not classified as securities and instead, provide investors with an economic return similar to that provided by securities, then there are few protections available to the investor because the protections provided by the regulatory structure do not meet the minimum standards required for investors in tokenised assets. Thus, the key research question that this piece aims to address is whether the existing language that defines “securities” in Section 2(h) of the Act will provide a sufficient basis to classify tokenised versions of physical assets as securities, and whether existing SEBI enforcement mechanisms are adequate to monitor cross-border token issuance and transfers.
UNDERSTANDING ASSET TOKENISATION
Tokenisation represents the conversion of rights to an asset into a digital token on a blockchain. Unlike cryptocurrencies, which may not have intrinsic value, these tokens derive their worth from underlying tangible or intangible assets ranging from real estate and gold to intellectual property and financial instruments. For example, (a) A ₹50 crore commercial building in Mumbai could be tokenised into 5,000 tokens worth ₹1 lakh each, allowing investors to own fractions of premium real estate that would otherwise be inaccessible. Or (b) A corporate bond could be tokenised to allow for fractional ownership and programmatic interest payments that execute automatically when due.
The process offers several compelling advantages: fractional ownership enabling broader market participation, enhanced liquidity for traditionally illiquid assets, programmable compliance through smart contracts, and significantly reduced transaction costs. Programmers develop smart contracts on blockchain platforms like Ethereum, defining token characteristics including total supply and divisibility, transfer restrictions and compliance parameters, and rights attached (dividends, voting, redemption options).
THE SECURITIES CONUNDRUM UNDER SCRA
The Securities Contracts (Regulation) Act, 1956 defines “securities” under Section 2(h)(i) to include shares, scrips, stocks, bonds, debentures, and other marketable securities. A closer examination of the SCRA definition reveals potential flexibility. The phrase “other marketable securities of a like nature” could potentially encompass tokenised securities, applying the ejusdem generis rule of statutory interpretation, which requires tokenised assets to share essential characteristics with listed securities categories. However, the procedural question, in the context of blockchain-based representations, becomes what constitutes “essential characteristics”?
The Hon’ble Supreme Court’s landmark ruling in Sahara India Real Estate Corp. Ltd. v. SEBI (2012) 10 SCC 603 established that instruments must be analysed based on their “economic reality and substance, not merely their form or label.” For tokenised asset classification, this precedent creates a procedural framework, that examines whether there is an investment of money (does the token acquisition involve monetary consideration), a common enterprise (are token holders’ fortunes tied to the success of the underlying asset), an expectation of profits (do token holders anticipate returns from the asset’s performance), and efforts of others (are profits derived from the managerial efforts of third parties), however, this leaves a critical gap which involves that it lacks procedural clarity for fractional tokenised ownership where traditional concepts of “common enterprise” become blurred across potentially thousands of micro-investors.
Tokenised real-world assets fall squarely within the securities definition under Section 2(h) of the SCRA. The Supreme Court’s Sahara India Real Estate Corp. Ltd. v. SEBI (2012) 10 SCC 603 precedent provides the definitive framework, substance over form governs classification, not technological medium. While BlackRock’s BUIDL fund has grown to $520 million in assets under management, representing the largest blockchain-based money market fund, JPMorgan’s Tokenised Collateral Network has facilitated tokenised collateral transfers between BlackRock and Barclays for OTC derivatives trades. It can be inferred that these transactions occur under existing securities regulations, proving that current legal frameworks can accommodate tokenised assets.
THE MEDIUM vs SUBSTANCE DEBATE
SEBI’s 2024 amendments to REIT regulations lowered the minimum investment from INR 50,000 to INR 10,000–15,000, which reflects clear support for fractional ownership. But this could also create some inconsistency as to why tokenised real estate faces different rules than REITs when both offer fractional ownership of real estate assets? REITs must meet strict requirements, including a minimum asset value of INR 500 crores, mandatory stock exchange listing, quarterly financial reports, and independent asset valuation. In contrast, tokenised real estate is often operated in regulatory grey zones, potentially avoiding these investor protections while offering similar investment opportunities. Another issue is how to classify these tokens under the law. Section 2(h)(ia) of the SCRA defines derivatives as contracts whose value comes from underlying assets. Should tokens that represent claims on assets (but not direct ownership) be treated as derivatives? If so, they would face rules like central clearing, margin requirements, position limits, and mark-to-market settlements. This could significantly change how tokenised asset markets work and affect their liquidity.
SEBI’S JURISDICTION AND REGULATORY VACUUM
The Securities and Exchange Board of India (SEBI), established to protect investor interests and regulate securities markets, faces a jurisdictional quandary when it comes to tokenised assets. There can be challenging situations in enforcing rules around tokenised assets. SEBI’s powers under Section 11 of the SEBI Act, 1992 are limited to India, which leaves gaps in oversight. For example, Decentralised Autonomous Organisations (DAOs) that issue tokens often don’t have a clear corporate structure, making it hard to take legal action. Foreign blockchain networks can be used by smart contracts to hold the assets beyond SEBI’s reach, and cross-border token transfers happen instantly without traditional banks that regulators can monitor. Similarly, enforcement of anti-money laundering (AML) and know-your-customer (KYC) rules under the Prevention of Money Laundering Act, 2002 (hereinafter ‘PMLA’) is tricky. Blockchain wallet addresses don’t show who really owns them, so the verification of foreign investors’ identity becomes difficult, and smart contracts can automate transactions without human oversight. Even though the PMLA Rules, 2005 require reporting suspicious transactions above INR 10 lakhs, tokens can be split into smaller amounts to avoid detection while still holding significant overall value.
Compared with the enforcement and jurisdictional frameworks of other countries, India lacks strong international coordination on this issue. Other countries have clearer frameworks. For example, Switzerland’s Financial Market Supervisory Authority (FINMA) offers neutral guidance for different token types, Singapore’s MAS focuses on the substance of its transactions rather than their form, and the EU’s Markets in Crypto-Assets (MiCA) regulation provides a comprehensive approach. SEBI has demonstrated awareness of technological evolution in the securities market as recently in 2020, SEBI constituted a Market Data Advisory Committee (MDAC) to explore the applications of new technologies including blockchain. In 2021, SEBI approved the frameworks for regulatory sandboxes to test innovations in a controlled environment. SEBI has shown interest in exploring blockchain for specific use cases within the securities market, including clearing and settlement, KYC processes, and securities issuance. However, comprehensive guidance on tokenised securities remains absent.
STOs vs ICOs: REGULATORY DISTINCTIONS
Initial Coin Offerings (hereinafter ‘ICOs’) faced regulatory pushback in India following the Reserve Bank of India’s 2018 circular prohibiting banks from dealing with cryptocurrency-related businesses. Though this ban was later struck down by the Supreme Court in Internet and Mobile Association of India v. Reserve Bank of India (2020), the legal status of ICOs remains ambiguous.
Securities Token Offerings (hereinafter ‘STOs’), in contrast, explicitly acknowledge their status as securities and theoretically should comply with existing securities laws. However, the absence of a tailored regulatory framework creates uncertainties for issuers and investors alike. India could follow the example of jurisdictions like Liechtenstein (with its Token and Trusted Technology Service Provider Act) or Singapore (Payment Services Act) by developing comprehensive legislation specifically addressing digital tokens. This would provide legal certainty but requires significant legislative effort. Alternatively, existing legislation could be amended to clarify that securities laws apply regardless of the technological medium. This approach is simpler to implement but may lack the nuance required for blockchain’s unique characteristics.
CONCLUSION
The existing classification framework is not nonexistent. Section 2(h) of the Securities Contracts (Regulation) Act, 1956 expands upon its list of listed securities and contains a broad category of “other marketable securities of a like nature”. Therefore, by structuring and marketing tokenised real-world assets to be sold as tradable investment instruments, the use of the substance-based application of Section 2(h) would allow tokenised real-world assets to be included in the definition of a security. This perspective has been consistently recognised by the Supreme Court’s ruling in Sahara India Real Estate Corporation Ltd. v SEBI that the law must follow the substance of economic reality as opposed to following the form or designation described by an issuer. The legal effect of the medium cannot also perform the function of law.
However, classification alone will not solve all the regulatory issues associated with tokenised real-world assets. Issuing Tokens through offshore exchanges, decentralised arrangements, and wallet-to-wallet transactions will create the largest enforcement issues. This is the core of how regulatory arbitrage occurs: where regulatory protections do not apply at the point of issuing and trading, products marketed to investors can resemble a security investment without meeting the disclosure and compliance requirements that would give investors the confidence to invest in a traditional form of investment.
The enforcement of regulation becomes more challenging when tokens are issued and transferred through non-regulated systems (offshore) and created via decentralised platforms (decentralised), or sent directly between individuals via a wallet (wallet-to-wallet). Thus, regulatory arbitrage arises because, if the law does not apply where tokens are distributed or traded, investors who use these products can obtain returns similar to those of other investment products while avoiding regulatory and market conduct obligations associated with traditional investment instruments.
The recommendations for SEBI to proceed are as follows: First, interpretative guidance should be provided regarding the application of Section 2(h) to tokenised Real World Assets that are based on substance rather than formal descriptions of the tokens, with practical examples of how they may be classified. Second, the regulatory authority must begin to regulate the platform itself by imposing obligations on platforms that facilitate the issuance or trading of tokens for Indian customers. Platforms would need to be registered with SEBI and would have to provide baseline disclosures and a system that allows for audits and prevents conflicts. In the third step, SEBI should develop and enforce a set of standardised asset-linked disclosures that detail what rights the token has (ownership), the process of verifying the token’s underlying asset, how to value the underlying assets, how to redeem/transfer the token and who is responsible if the token fails to perform. Finally, KYC and other compliance obligations must be enforced through both regulated on-ramps and investor-facing distribution networks. Although these measures will significantly reduce the gaps between domestic tokens and traditional securities, the gaps will still exist until there is a domestic statutory clarification that verifies the existence of an investment interest represented on the blockchain and cross-border regulatory cooperation. And overall, a narrow statutory clarification that recognises blockchain-based representations of marketable investment interests, combined with cross-border regulatory cooperation, would close remaining gaps.
(Adeeb Bakhtavar is a fourth-year B.A. LL.B. (Hons.) student at Dr. B.R. Ambedkar National Law University, Sonipat. The author may be contacted via mail at adeebbakhtavar31@gmail.