Digital tokens could transform the economies of the Middle East and North Africa – if the governance keeps up

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Mirek Dusek Deputy Head, Centre for Geopolitical and Regional Affairs, World Economic Forum & Abdulla Bin Touq Minister of Economy, Ministry of Economy of the United Arab Emirates

• The integration of digital assets into economic structures could tackle the financing challenges faced by SMEs and provide a more standardized and accessible approach to funding.
• But those efforts need to be complemented by upgraded regulations or new ones to enable the transparent and efficient use of digital tokens by investors and SMEs.
• If the region gets it right, it could accelerate its economic integration, which is estimated to add $230 billion per year to regional GDP. It would also enhance resilience and digital readiness for the post-pandemic future.

The Covid-19 pandemic has been a disruptor like no other and its economic and social consequences are expected to outlast the health emergency.

As reported by the IMF, the Middle East and North Africa GDP contracted by 3.1% in 2020, putting the region’s already fragile resilience under pressure. Governments have taken unprecedented fiscal efforts to protect their private sectors and to mitigate the consequences of the pandemic.

Some examples are the $27 billion stimulus plan that the United Arab Emirates has deployed to facilitate lending, the $61 billion support package targeting the private sector or Egypt’s $6 billion economic relief plan focusing on Small and Medium Enterprises (SMEs) and consumer liquidity.

In this context, the World Economic Forum’s Regional Action Group on the Middle East and North Africa, a community of over 70 leaders from private and public sectors, has been working under the guiding framework of the 7 Principles for Stakeholder Capitalism to develop ideas that could tangibly transform the post-pandemic future of the region.

Small and Medium Enterprises (SMEs) have been severely affected by the pandemic both on the supply and on the demand side. The substantial loss of revenue, coupled with a drastic drop in capacity, has dramatically affected their ability to function properly and has created a large liquidity shortage for their operations, meaning many SMEs face closure.

In the UAE alone, SMEs constitute over 50% of the country’s non-oil economy, and contribute to about 54% of the private-sector workforce. The pandemic has also exacerbated the pre-existing hurdles for bank lending to SMEs, such as cumbersome registration and legal procedures.

In such a critical scenario, we have been studying together with Centre for the Fourth Industrial Revolution UAE, the Dubai International Finance Centre and the Dubai Financial Services Authority, the deployment of digital assets (also called asset tokenization) as an alternative to investments for SMEs to jump-start their post-COVID recovery.

How does asset tokenization work?

Asset tokenization (tokenization) concerns digital tokens that can represent either financial assets like stocks or bond, or non-financial assets such as real estate, land, or art on a blockchain network.

These “digital assets” may represent only a part of the underlying asset – otherwise known as a “fractional share”.

Tokenization therefore has three main functions: to facilitate access to capital for issuers, to facilitate access to investments for investors, and to enable the fractionalization of assets.

It is this last concept of dividing assets into smaller components (in this case represented by tokens) that offers the game-changing ability to distribute assets among multiple individuals who could, as a result, have a partial ownership over the underlying assets and gain benefits proportional to their ownership stake.

Traditionally fixed, illiquid assets such as real estate or fine art could be broken down and represented as tokens. Fractionalizing the underlying asset could bring new investment opportunities and liquidity. The benefit is lower barriers relating to minimum investment requirements and geographies, opening up a global pool of capital.

‘Security Token Offering’ – a win-win exchange, managed through blockchain

A pilot around asset tokenization, which was publicly announced during the session “Implementing Stakeholder Capitalism in the Middle East and North Africa” at the Davos Agenda 2021, has the dual purpose of helping SMEs with their financial woes and providing a more standardized and accessible approach to funding, allowing companies to reach a wider range of investors.

For private and smaller-range investors, who traditionally might have faced challenges in investing in SMEs, they benefit from being able to provide funding in exchange of tokens. The tokens that investors receive can then be listed and traded on emerging digital asset exchanges, similar to trading securities on a traditional exchange.

The process is called a Security Token Offering and is created, allocated, transferred, and managed through its life cycle on the blockchain platform, where digital tokens are both issued and exchanged.

The system could integrate and manage the needs of a range of organizations, including: issuance platform and investment banks, courts and arbitrators, regulators, custodial and non-custodial exchanges, and third-party digital asset custodians. The blockchain network acts as a safe marketplace where all of these parties meet.

The benefits of tokenization

• Tokenization could help SMEs receive the capital needed from a wider range of investors and, on the other side, allow investors to diversify their portfolios.
• Thanks to the traceability of the process, based on the use of blockchain for both creation and trading of the tokens, banks and financial institutions could effectively receive the collateral required and verify the underlying legal processes.
• Its versatility could allow tokenization to be applied across different sectors, from real estate to investing in fine arts, to restructuring debts.
• Tokenization has the potential of revamping the current financial market infrastructure by creating new and more effective financial platforms and by addressing existing market shortcomings. It could help for example in addressing limited retail investor KYC/AML verification and in streamlining reporting and compliance for issuers.
• It could ensure that SME financing processes are secure, transparent, auditable, and integrated with other digital channels such as e-KYC/AML for investor onboarding.

The challenges of tokenization

• A lack of harmonized regulations across jurisdictions could undermine the interoperability of the technology. Since regulations can vary significantly from one jurisdiction to another, this could be a limiting factor for both the creation and trading of tokens.
• Inadequate regulation could leave space for potential consumer protection concerns that could affect end-users, investors, and the broader economy.
• It is unclear how the tokens will be linked to the physical assets they represent and what kind of governance structure they will rely on. For instance, while investing in fine arts, if a painting is divided into multiple tokens and is owned by more than one investor, who acquires the painting and what happens if that painting gets stolen? Or if we consider an apartment unit which is divided into multiple tokens, there is little incentive for the owners of the tokens to bear the cost of the apartment maintenance and rent collection?
• It’s important to address some of the main questions related to smart contracts, as well as other possible ramifications of tokenization, such as industry disruptions and potential instability in a hyper-liquid market. Given that this is a new technology, there is not enough evidence to confirm its effectiveness and, while we are confident of its potential, the pilot could also show that the technology would be too costly or complex to be implemented.

What next for tokenization in the Middle East and North Africa?

While we look at tokenization as a positive means to help SMEs in their post-pandemic recovery, we are also aware that those efforts need to be complemented by upgraded economic policies that can help turn this opportunity into tangible results for SMEs and the wider economy. Part of this effort is also the crypto assets legislation approved by the UAE Securities and Commodities Authority as a first important step in creating the right regulatory environment for tokens.

What is the World Economic Forum doing about the Fourth Industrial Revolution?

The World Economic Forum was the first to draw the world’s attention to the Fourth Industrial Revolution, the current period of unprecedented change driven by rapid technological advances. Policies, norms and regulations have not been able to keep up with the pace of innovation, creating a growing need to fill this gap.

The Forum established the Centre for the Fourth Industrial Revolution Network in 2017 to ensure that new and emerging technologies will help—not harm—humanity in the future. Headquartered in San Francisco, the network launched centres in China, India and Japan in 2018 and is rapidly establishing locally-run Affiliate Centres in many countries around the world.World Economic Forum | Centre for the Fourth Industrial R…

The global network is working closely with partners from government, business, academia and civil society to co-design and pilot agile frameworks for governing new and emerging technologies, including artificial intelligence (AI), autonomous vehicles, blockchain, data policy, digital trade, drones, internet of things (IoT), precision medicine and environmental innovations.

Learn more about the groundbreaking work that the Centre for the Fourth Industrial Revolution Network is doing to prepare us for the future.

Want to help us shape the Fourth Industrial Revolution? Contact us to find out how you can become a member or partner.

We are also confident that the pilot run by the UAE will inform the potential scalability of the tokenization process across the region with concrete economic results. And to fully realize the potential there is an urgent need for economic authorities across the region to upgrade existing regulations or craft new ones to enable a transparent and efficient use by investors and SMEs.

For example, addressing existing regulatory fragmentation across the region, would be a steppingstone to use tokenization to address industry disruptions and the lack of stability that the COVID-19 pandemic has brought to the markets.

We are confident that if used widely across the region and if coupled with the right economic policies, tokenization can create a safe environment for trade, and it could accelerate the region’s economic integration, which is estimated to add $230 billion per year to regional GDP. It would also enhance the region’s resilience and digital readiness for its post-pandemic future.