This conversation was originally started on discord in the general section here
Discord down a ways I was asked if I could move the discussion over here.
There are a variety of legal questions raised by this video: NFTs Are Legally Problematic ft. Steve Mould & Coffeezilla - YouTube
I’d like to understand how CFG is addressing the concerns raised.
Hi Mark,
Thanks for raising this. These are interesting legal issues indeed, but not particularly relevant for the Centrifuge service or the Tinlake protocol. There are no purchases or sales of NFTs on Tinlake. The NFT minting process is an issuer functionality and is designed to provide a link between on-chain and off-chain transactions. The NFT does not itself represent any legal rights.
The legal rights in respect of the transactions are set forth in the relevant legal documents which are for the current pools the Subscription Agreement and Operating Agreement. These agreements are similar to the types of agreements that would exist in a TradFi financing and the legal rights are similar as well. The enforcement of the legal rights under these agreements does not rely upon the status or validity of the NFT.
I hope that this helps, but please let us know if you have follow-up questions.
Well, your documentation suggests that the NFT is an inherent and integral part of the process. https://docs.centrifuge.io/getting-started/understanding-tinlake/ “Through Tinlake pools, businesses or “Asset Originators” can responsibly finance real-world assets, such as invoices, mortgages or streaming royalties through DeFi and access bankless liquidity. They do this by tokenizing their financial assets into Non-Fungible Tokens (“NFTs”) and use these NFTs as collateral in their Tinlake pool to finance their assets.”
Yes, it is an integral part of the process. It is the link into the chain for the off-chain transfer of collateral to the SPV. But the NFT itself is not transferable and does not represent legal rights.
Questions re-NFT’s and Smart Contracts
My concerns are not with regard to NFTs in or as art nor the copyright.
For example, your documentation here https://docs.centrifuge.io/learn/legal-offering/ asserts
" The general flow of financing typically looks as follows:
The video asserts that NFTs and smart contracts aren’t legal instruments, instead NFT’s are more like receipts.
This response came to one of my posts on discord " 1. ## hardi — 04/29/2022
Yes this will answer his query
1
It’s minted onchain along with information. However not all info is shown owing to privacy of assets and clients. But offchain u have whole details of information"
My question, coming from my past experience in insurance and financial services regarding this response from hard was that could be a distinct problem with regard to the completeness of the NFT as collateral.
That raised the issue of the storage being “off-chain” which raises the question of immutability of the documents the NFT might reference which the video also brings up. One of the problems there is being able to reference the needed assets as needed.
It was very shortly after that, that I was directed to a link to one of the reference documents that might explain thing only to find the link was dead. The video also highlights that broken link issue as a norm, that is well demostrated daily in my life.
All this begs the question in my head and the video points out indirectly the same regarding the completeness of the contract and usability of an NFT as collateral since the specific definition of an NFT isn’t even close to that.
Other questions also come up if the application is filled out on line. Did the parties assent to the wrapper agreements of the website for cookies and did that include privacy terms that are now part of the contract? The video identifies that also.
I don’t have time to transcribe the entire video.
I’m sure the legal council y’all have can parse the video for the various issues.
As a secondary but related issue I think I’ve found because of the research around this subject, as I got to skim the example contracts for the drop and tin tokens is that, at least as a lay person, in at least the parts I read (quoted and referenced back on Discord) the contracts actually don’t give the token holders any enforceable claim on any of the counter parties involved in the cased of a default. It looks a lot like an un-collatertalized loan wrapped in a lot of words to me.
My hope is that there are good explanations for all these questions.
Thanks for your help.
Hi Mark,
There are a few questions here so I will take them one by one:
You mention that you are concerned “with regard to the completeness of the NFT as collateral”. The NFT as used in the Centrifuge service and Tinlake protocol is not intended as collateral. As was pointed out in Discord and as highlighted in the video you shared, there is no current way to create an onchain security interest in real world assets. As this is not possible under current law, we do not do this. The collateral held by the SPV and backing the DROP and TIN tokens, is held solely in the real-world and not onchain via an NFT or otherwise.
You also raise concerns about whether the parties have accepted the cookies on our website and whether this includes privacy terms. Like most websites, the Centrifuge.io site includes a pop-up banner where users accept cookies. There is also a privacy policy which can be accessed here: Privacy Policy | Centrifuge: Real World DeFi
Finally, you raised issues with the Risk Factor provisions in the pro forma Subscription Agreement also found on our website. Please note that is a form of agreement that we have provided for the issuers as a convenience, but that the actual subscription documents for specific pools will be different. In terms of the Risk Factor provision you cited, please note that it is standard for asset-backed securities that the investors do not have direct recourse against the collateral held by the SPV. Instead, in case of an insolvency of the SPV, there would be a liquidation of the underlying assets and the proceeds would be distributed pro rata to the investors. This arrangement ensures fair treatment for all investors and avoids that one investor gains a better recovery by accessing the collateral directly. The pools using the Tinlake protocol operate in the same manner; DROP and TIN tokenholders do not have direct recourse to the assets held by the SPV. That is the meaning of the provision that you have cited on Discord.
I hope that I have covered your concerns, but if I have missed anything please let me know. Thank you again for your engagement.
With regard to point 1. CFG’s own documentation claims the NFT has collateral value. Here https://docs.centrifuge.io/build/nfts/ for example it specifically it says …" User-mintable NFTs are a critical part of the Centrifuge ecosystem. Minting an NFT from a Centrifuge Document allows a user to [draw loans] against the NFT asset, or simply provides a way to easily transact in privacy-preserving way with a document asset. This flow can be seen in the image below:"… the “draw loans” link though is dead. Here again is another example …“These NFTs can be bridged to Ethereum to be locked as collateral into Tinlake to finance these assets.”… If NFT’s are not integral and legally enforceable as collateral I’d suggest that CFG’s documentation needs an update.
Links for above
https://centrifuge.io/technology/tinlake/
https://docs.centrifuge.io/getting-started/p2p-protocol/
With regard to #2
I did find the “entire contract” clause in the example contract that would exclude wraps as part of the contract.
With regard to point 3
…"4. Terms of the DROP Tokens
A. The DROP Tokens shall have the terms and conditions described in the
Offering Materials, which will be available to the Investor for review.
B. The DROP Tokens will not have a fixed maturity. Rather, Underlying
Assets will be generated, and collections will be made in respect of the Underlying
Assets, by the Issuer on an ongoing basis. The Investor will not receive any payments
of principal or interest in respect of any DROP Tokens until such time as the Investor
elects to redeem such DROP Tokens in the manner described herein. Until such
redemption, all amounts payable to the Investor in connection with the DROP Tokens
will be either (i) held in cash by the Issuer, free and clear of any liens or encumbrances,
or (ii) deployed by the Issuer to fund the generation of new Underlying Assets.
C. The Investor, and each holder of DROP Tokens, may redeem all or a
portion of their respective DROP Tokens by triggering redemption of all or a portion
thereof (each, a “Redemption Request”) in accordance with the Terms of the DROP
Tokens (as defined below). The Investor may submit no more than one Redemption
Request per each specified redemption period (each such period, an “Epoch”). The
initial duration of each Epoch will be specified to the Investor in the Executive Summary.
The Issuer may change the duration of subsequent Epochs upon written notice to the
Investor.
D. Payments of interest and principal by the Issuer to the Investor in
respect of any DROP Tokens will be subject to the terms of (i) the Executive Summary,
including any updates thereto in effect as of the date of the applicable Redemption
Request, and (ii) the smart contracts that govern the Tinlake Protocol (the “Terms of
the DROP Tokens”). The DROP Tokens have a fixed interest rate that gets paid first,
while the TIN Tokens receive the pool’s residual cash flows and are subjected to the
first losses.
E. Amounts payable by the Issuer to the Investor in respect of each DROP
Token redeemed by the Investor pursuant to a Redemption Request will be paid
promptly, but in any event no later than [two (2)] business days following receipt of such
[ISSUER SERIES] DROP TOKENS SUBSCRIPTION AGREEMENT
7
Redemption Request; provided, that, in the event that the Issuer has insufficient funds
available to fully satisfy all Redemption Requests received during an Epoch after giving
effect to any Priority Redemptions (as defined below), (i) the Issuer will fulfill the
Redemption Requests received during such Epoch on a pro rata basis among all
redeeming investors in accordance with the amount of their respective Redemption
Requests, and (ii) any DROP Tokens for which a Redemption Request was received
but not fully satisfied in such Epoch (each, a “Priority Redemption”) will be fulfilled in
one or more subsequent Epochs pro rata with any and all other Priority Redemptions
not yet fully satisfied. No amount will be paid by the Issuer in respect of any TIN Token
in any Epoch unless and until all Redemption Requests in respect of DROP Tokens
then outstanding have been fully satisfied, regardless of the Epoch in which the request
for redemption of any TIN Tokens was received.
F. From time to time during the term of this Agreement, the Issuer may
change certain terms and conditions of the Investor’s prospective continuing investment
in the DROP Tokens, including without limitation the ratio of DROP Tokens to TIN
Tokens outstanding, from those terms and conditions described in the Executive
Summary then in effect upon no less than [] ([]) weeks written notice, delivered via
email, of any such changes to the Investor.
G. The Investor understands the Investor will not have a security interest in
the assets of the Issuer in connection with their purchase of the DROP Tokens, and that
the DROP Tokens are non-recourse to the assets, funds and accounts of Issuer and
any affiliates and subsidiaries thereof, except to the extent of payments actually
received by Issuer in respect of the Underlying Assets.
H. The Investor understands that amounts due in respect of the DROP
Tokens will be payable only to the extent that payments on the Underlying Assets have
been received by Issuer from the Payment Obligors. In each Epoch, amounts due in
respect of the TIN Tokens will be payable only after payments due and payable in
respect of all Redemption Requests then outstanding have been paid in full."…
G and H, even if standard for the industry, seem to me to be a pretty specific part of the terms. These appear to my layman’s eyes, to sever any direct claim by any and all investors on the underlying assets and protect the issuer from any financial risk.
With regard to point #1, there are more than one type of NFT supported by Centrifuge. The user-minted NFTs referenced here are the art NFTs from our NFT Playground described here: https://docs.centrifuge.io/use/NFT%20Playground/ These NFTs may have value and can be bought and sold. Users are permitted to use these NFTs as collateral in P2P borrowing transactions. These art NFTs are not the same as the issuer-minted NFTs linked to the DROP and TIN token Tinlake lending pools.
With regard to point #2, I am not aware of any wraps used by any pool issuer so I am not sure why this would be relevant? What wrap contract has been excluded?
With regard to point #3, I think your understanding of H is correct. As explained earlier, it is a standard feature of all asset-backed securities that investors do not have direct recourse to the underlying assets of the SPV. This is to ensure fairness in any liquidation proceeding.
I do not think that your reading of G is correct. This clause would not protect the issuer from any financial risk.
Without an “entire contract” provision in the final document “the wrap” for cookies and privacy on the website could have become part of the agreement. I found the “entire contract” provision so don’t see that as an issue now.
There are in any case different contractual parties. The Subscription Agreement is between the issuer and the investor. The cookie policy is between Centrifuge and the website user.
I have not found where the issuer carries any financial or legal liability to the token holders except if and when the underlying asset performs. Instead, to my layman’s eye it looks as if they are solidly placed in the role of an administrator.
I’m not finding a place in the contract where the investors, as individuals or a class, are secured by anything more than the goodwill of the issuer and the goodwill of the underlying borrowers.
Please point me to where it indicates otherwise.
That distinction is definitely not clear to a casual user and is given a significant amount of press time in the CFG world.
The issuer liability is set forth in the respective Executive Summary (which is incorporated by reference in the Subscription Agreement). Here is an example:
Investors in asset-backed securities do not have a security interest in the underlying collateral. This is not a feature of this type of investment. A good explanation is here:
From the investopedia link you provided
…" What Is Asset Backing?
Asset backing refers to the total value of a company’s shares, in relation to its assets. Specifically, it refers to the total value of all the assets that a company has, divided by the number of outstanding shares that the company has issued.
In terms of investments, asset backing refers to a security whose value derives from a single asset or a pool of assets; these holdings act as collateral for the security—“backing” it, in effect."…
The underlying assets “holdings” seem to be clearly identified as real collateral.
That article seems to to me to suggest that investors regularly do have a real claim on the underlying assets.
The executive summary references back to the CFG terms as the basis and to my eye again does not establish anything new. It does describe what they will try to do from an administrative POV to recover money in case of default but does not establish any new legal tie to the assets for the investor.
Again, if I’ve missed something, please point me to it.
I think that I have explained this to the best of my ability and we will just need to agree to disagree.