TaxWraps: Unwrap the Financial Gift of Tokenization This Christmas

As tokenization takes hold, we propose a way to defer tax liabilities, bringing the tax efficiencies of ETFs to a wide market.

AccessTimeIconDec 20, 2023 at 4:45 p.m. UTC
Updated Mar 8, 2024 at 7:00 p.m. UTC

Asset tokenization is one of the more compelling concepts in the current blockchain development cycle. Dacoinmister’s Second Bitcoin Whitepaper (proposing to build MasterCoin on top of the Bitcoin network) first described it in 2012. In 2014, Tether launched as the first tokenized fiat “stablecoin.”

The overall market capitalization of tokenized assets has now surpassed $200B, with $128 billion in stablecoins and $1.3 billion in other real world assets (RWAs) including U.S. Treasuries, real estate and debt.

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    With increased institutional interest in crypto on the horizon, we expect tokenization to continue growing exponentially in 2024. With that in mind, this article introduces a new concept that could amplify tokenization’s growth: TaxWraps.

    To understand TaxWraps, let’s explore dividend taxation. When companies pay out profits as non-qualified dividends, recipients face immediate tax liabilities. ETFs (exchange-traded funds) are one tool to defer tax obligations. ETFs often reinvest dividends back into the fund, allowing value to grow tax-deferred until investors sell their ETF shares. This allows investors to defer tax obligations while compounding their wealth. With TaxWraps, our goal is to broaden the ETF-style deferral mechanism via tokenization.

    Consider a tokenized asset fund or trust (TAFs). A family office wishing to minimize their tax burden can perform in-kind transfers of income-generating stocks/assets to TAFs and, in return, receive tokens representing their ownership in the trust. Like ETFs, these tokens derive their value from the pool of assets in the fund.

    When the stocks/assets generate income, the fund will acquire more of the underlying asset (e.g. reinvesting the dividends) and the existing token pool’s value will increase. When the family office is ready to liquidate its holdings, tokens can either be sold or burned, at which point only the overall gains or losses are considered for tax purposes.

    Without getting into the complexities of tax codes and appropriate structuring of the TAFs, this simplified model could act as a beacon of tax efficiency achieved via tokenization. TAFs can delay tax liabilities connected with investing in digital assets and align with long-term wealth preservation strategies that were previously available via ETFs/ETNs and other structured products. Tokenization can even be considered as a way to democratize ETF-like products.

    Our team at Lindy Labs is behind the wealth management platform Sandclock. We have been exploring TaxWraps along with instruments like total return swaps, dividend swaps and ETNs to develop a derivative portfolio that would maximize tax efficiencies for family offices and high net worth individuals via tokenization.

    TaxWraps offer an intriguing blend of modern technology and existing tax law through ETF-style wrappers to empower the next massive surge in adoption and growth of tokenization.

    Edited by Benjamin Schiller.

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    Q Rasi

    Q Rasi, PhD, MBA Lindy Labs + Sandclock + Aura Protocol Blockchain Innovations for Greater Good