Cannabis and Web3 Crossover: Tokenization

Since launching our Web3 practice group, we have been getting steady inquiries regarding cannabis and web3 crossover. In this post, I focus on the tokenization of cannabis business assets, which often occurs through ICOs (initial coin offerings). This is currently an unsettled area of law in the U.S., and we do not recommend trying to proceed without an experienced securities and web3 /blockchain lawyer at your back.

In the past 12 months, we have been helping clients with international and domestic DAO (decentralized autonomous organizations) establishment, governance, and finance issues (both on-chain and off-chain financings, including ICOs) (see here and here).

We work with NFT creators and studios (see here) in determining the best way to form business ventures together utilizing creative compensation structures that also protect both sides’ intellectual property.

Some of our tech clients are developing cannabis POS solutions and APIs that span the deep chasm between traditional banking, cryptocurrencies, and cannabis (hemp and marijuana).

And we consistently warn our clients that smart contracts are neither smart nor comprehensive contracts upon which to establish business relationships.

What Does Tokenization Mean?

In the web3 world, tokenization refers to breaking the ownership, control, or some other rights associated with an asset into small pieces (tokens) that can be traded, held, bought, sold, and exchanged. This process is also referred to as fractionalization.

Before the advent of the internet, we generally referred to this tokenization as stock in a corporation or general contractual rights. Now that we are deep into web3 territory, the industry is developing new terminology built on the back of the distributed ledger technology that makes up web3.

And of course at the heart of all of this are lawyers making creative arguments for their clients, for good, bad, or otherwise, to help them raise funds and build their businesses. The cannabis industry is no exception, and thanks to creative lawyers who can do virtually anything with a contract, the lines among these tokens can be and are often blurred.

What is a Cannabis Tokenized Security?

“Tokenized securities” are the simplest to explain because they have an analog in today’s common business world. You can think of cannabis tokenized securities as stock in corporations or ownership in LLCs, along with their myriad equity- and debt-based variants like convertible notes, preferred ownership interests, and SAFEs (simple agreements for future equity).

But in web3, cannabis tokenized securities can be much more than simple ownership rights and profit-sharing rights in licensed or affiliated cannabis entities. These securities can carry additional characteristics beyond voting rights like access to certain markets utilizing an issuer’s token or preemptive rights beyond normal preferred stock. Because tokenized securities are embedded in web3 technology, those rights will proliferate as quickly as the underlying technology does.

“Security tokens” are similar to tokenized securities, but they only carry traditional rights relating to traditional ownership with minimal web3 components.

What is a Cannabis Utility Token?

Cannabis “utility tokens” offer something of practical value that is different from traditional ownership in companies found in security tokens and tokenized securities.

Web3 utility tokens contain only the non-ownership components of tokenized securities and security tokens that can be stripped away from the economic benefits of ownership. These include voting rights, access to people, places, specialized products in the metaverse and the real world, and digital-only assets like NFTs.

These also can include preferential purchasing rights for future merchandise or free swag like those found from companies raising early-stage capital on traditional crowdfunding platforms without giving any ownership interests in the company to those “investors” providing capital.

Where cryptocurrencies are involved, cannabis utility tokens can be minted (issued) to provide access to a specific cannabis marketplace or a cannabis-focused DAO (decentralized autonomous organization). Cannabis companies can use a platform like Ethereum to create their own utility token as a springboard to marketing their products or services.

What is a Cannabis NFT Token?

NFTs (non-fungible tokens) are utility tokens. They are digital assets that may have tie-ins to the physical world (see here). At this stage in web3 development, NFTs are generally digital goods (artwork, videos, or GIFs) or rights (concert access, etc.).

Ownership of NFTs can be fractionalized (tokenized) the same way ownership in any asset or business venture can be divided among owners. Sometimes people say, “Let’s NFT this X,” which can mean either creating digital goods as NFTs or creating a tokenized security.

How to Learn More About Cannabis and Web3 Crossover

If you are a cannabis company trying to understand cannabis and web3 crossover and feeling overwhelmed with this new technology explosion, take heart. I have attended web3 conferences where even the die-hard defi (decentralized finance), crypto, NFT, and DAO aficionados acknowledge that they once felt like they were drowning in the deep end of the pool. They all say that the technology and terms are proliferating so quickly that no one is an expert in all things web3.

In my corner of the cannabis legal world, issuing securities is not something we take lightly (see here), but even the SEC (U.S. Securities and Exchange Commission) is still trying to figure out how to classify the various types of tokens (see here).

Start in your area of interest and educate yourself. Talk to experts. Attend conferences. Join web3 groups (often DAOs) you are interested in. And you can join our new Web3 Law group on LinkedIn for real-time discussions about practical legal aspects of web3.