What Is Blockchain Technology?
Stating the obvious, blockchain
technology is extremely complex. Going into even a cursory explanation of what
a blockchain is and its multiple applications would not only make this article
very long, but also would it take far beyond its intended scope. Investopedia
has a great introductory explanation of the blockchain that offers a great deal
of background. It can be found here.
In its most simple form, a blockchain is a centralized record of information
and transactions that is stored on multiple servers and cannot be altered.
Blockchains offer an unalterable or, as industry insiders call it,
immutable record of transactions between anonymous parties.
Smart contracts are digital entries on
to a blockchain that have conditions. These entries take the form of scripts
and can essentially function as an autofill for documents that have a physical
counterpart. Smart contracts can also serve as a means of seamless transfer of ownership upon the execution of certain conditions or actions. If done
correctly, smart contracts offer a streamlined solution to the multifaceted
ritual of closing a real estate transaction and could even produce a record
that could be publicly recorded. For a deeper understanding of smart contracts
and their various applications, feel free to check out this
article by 101Blockchains.com.
The best way to explain how smart
contracts can affect a real estate transaction is the following an example. A
buyer and seller agree on the price of a house and enter into a contract. This
contract takes the form of a token containing a smart contract that references the buyer and seller, but also is dependent on certain actions, including the
inspection, the appraisal, the obtaining of a mortgage commitment. The smart contract
will update in status as each part of the transaction is completed and will
terminate upon the determined failure of one or more of these milestones. Upon
the completion of all of the predetermined transaction milestones, the smart
contract will be fully executed and the token will be transferred from the seller to the buyer,
thus transferring ownership. As an added step, a physical deed referring to the
smart contract will be printed and recorded. This physical document will refer
to the blockchain with the understanding that the true chain of title will be
continued on the blockchain through subsequent token transfers, as necessary.
What Role Can Blockchain Technology Play
In the Real Estate Market?
There are number of ways that real
estate companies are using blockchain technology. Companies like Republic and RealBlocks use
blockchain technology to facilitate real estate investment. This can take the
form of using a blockchain to record fractional divisions of a property or
issuing tokens to represent fractional property interest, but it can also mean
providing blockchain-based technologies that help manage real estate funds. Closinglock and StreetWire are
among the companies that use blockchain technology to ensure the security of
closing data for real estate transactions. These companies rely on the
blockchain’s immutability and decentralization, which makes it less vulnerable
to hacker attacks. Companies like CPROP and Figure run
exchanges in which tokenized real estate is exchanged. There
are companies that seek to streamline real estate transactions using blockchain
technology and smart contracts, such as SmartRealty and Propy.
Finally, the record keeping function of the blockchain can be pared with
adaptive artificial intelligence to enhance property management. Blockchain real
estate management companies incluce ManageGo and Blocksquare.
For a more extensive list of blockchain real estate companies and their
subcategories, feel free to check out Built In’s list
of 17 companies that are shaping the Blockchain Real Estate Industry.
Why Don’t We Make the Blockchain a Part
of Everything Real Estate?
The Blockchain does indeed have the
potential to revolutionize the real estate industry, but it is not a cure-all.
The increased security that comes with blockchain technology makes it a natural
fit for companies seeking to secure real estate transaction data. Also, the
pairing of blockchain technology with adaptive and predictive AI will certainly
revolutionize property management. Such technology could manage building
supplies, recommend preventative maintenance, predict maintenance issues, and analyze
and anticipate the payment habits of tenants. In these cases, blockchain
technology is merely an update to existing technology and offers added
efficiency and functionality.
The more problematic areas for
blockchain technology extension come from its use in real estate transactions
and investment strategies. Whenever a blockchain company involved in real
estate chooses to facilitate investment, the bottom line is that investments
via cryptoassets are still somewhat undefined by the Securities Exchange
Commission (SEC). At first glance, this may look like a great opportunity for
many investors and indeed the last twenty years in cryptomarkets have looked
like the Wild West. For an asset as illiquid as real estate, however, clarity the SEC's opinion of cryptoassets is essential to the outcome of the
investment.
Thr SEC's view on cryptos is evolving. For many years, it chose not to
employ a heavy hand when considering cryptocurrency. Six months ago, however,
that all changed. In June 2023, the SEC initiated a
major lawsuit against Coinbase for illegally offering securities. For
those who may not understand, the goal of most securities is to be exempt from
the SEC’s regulations. This is because the disclosure requirements of the
Securities Acts of 1933 and 1934 and the Investment Companies Act of 1940 are
typically costly and can render most small investments unprofitable. Although there
are many ways to avoid the federal securities regulations, one commonly used
way is to demonstrate that the investment is not considered a security. Without
going into the details of the Howey
case, which is a great read, the SEC has a specific way of defining a
security that is further outlined by a number of SEC guidance papers. For many
years, cryptocurrencies were able to operate as if they were not securities,
but the SEC’s new direction calls into doubt the offering costs that any
blockchain real estate investment company would endure when offering its
services to the public.
Beyond the public offering disclosure laws, there are various requirements that the SEC enforces for more esoteric investments like cryptocurrencies. These “Know Your Customer” requirements exist to ensure that investors have the capacity to fully understand the risks of these less traditional investments. Although there has been some guidance from the SEC on how to navigate these requirements, they are required of all companies involved in blockchain real estate offerings. The consequences of not collecting this data can be costly, depending on the type of violation.
The most important aspect of KYC compliance
for blockchain real estate companies is the ability to estimate compliance
costs. Although the SEC has provided guidance in this area, the path forward
remains unclear, with the looming reality that cryptocurrency may be
considered a security in the future.
Real Estate Blockchain and Real Estate
Law
Despite whatever lack of clarity maybe
present in the world of blockchain real estate investment, it pales in
comparison to how murky the water is with concern to real estate blockchain
companies and real estate law. This difference results from the way securities
law and real estate laws are drafted and enforced. Securities laws are largely
federal laws, made by the federal government and enforced by the SEC, a
federal organization. This legal centralization makes change more rapid and likely, as the market becomes more familiar with the way blockchain technologies
and cryptoassets. Moreover, securities law is primarily concerned with
the public and businesses. Change for these laws moves at the speed of the market. Real
estate law, in contrast, is made and enforced locally. Moreover, its legal practice is an
amalgamation of many customs that date back centuries and have been updated
over time.
An example of a legal real estate
scheme that blockchain real estate companies will have to navigate is document
recording. Not only do these companies have to deal with the thousands of
different real estate recording practices across the nation, but they must also
contend with the fact that the process for recording chain of title was created at a time that far predates digital
interactions. As a result of this incongruity, blockchain companies looking to streamline the real estate transaction process or
transfer real estate via smart contracts face an uphill battle.
Smart contract companies in particular may face
opposition with the production of recordable documents. Every municipality that
records real estate records requires that it be done in a specific manner
called “recordable form.” The requirements of recordable form ensure that every
document in each area have the same format, so that they can be compared,
catalogued and searched easily. The variations of recordable form differ
wildly amongst different local governments. The challenge for any blockchain company would be to produce a document
that could be converted into recordable form in many different municipalities
in a manner that is cost-effective. As technology improves, there will most
certainly be a move toward a uniform digital method of recordable form, but
this is not the current state of matters.
Another issue that may arise with smart
contract companies that wish to transfer ownership is the legal validity of a
digital transfer of ownership that does not have a physical counterpart. Most
legal decisions regarding real estate ownership are built upon the concept of
notice and the clarity of the public record. Any reference in the public record
to an external record of title, such as a blockchain, could muddy the chain of
title. The validity of blockchain title has not developed enough of a precedent in the courts to
establish any reliable expectations of the legality of tokenized ownership
transfers in real estate. Beyond the legality of the transfer, the issues of whether
these transactions provide notice to the public and the rights that any future
buyer may have regarding any lack of proper notice have yet to be fully addressed by the courts.
With the legality of several real estate
title issues not fully established, any blockchain real estate transaction that
takes place is subject to being overturned by any subsequent court at any time.
This state of affairs makes tokenized real estate transfers and blockchain
chains of title legally nebulous and very risky. One way to seemingly mitigate
some of the legal risk present with blockchain real estate transfers is to find a
way to translate what is happening on the blockchain into a more traditional
form of real estate documentation. Efficiency and cost concerns may arise in employing
this solution, but the determination on whether the expense of mitigating legal risks arises to the
level of being prohibitive must be made on a case by case basis. Eventually, if blockchain companies continues to persist in real estate for an extended time, the law will
catch up with the technology. Given the granular process of changing real
estate law, however,
one can expect that these changes will not come soon.
Blockchain technology seems to indeed be
the next wave in real estate. It is a clear technological upgrade and can work
wonders for real estate property management and transaction information
security. The ease of access and its decentralized nature seem to make
blockchain perfect for streamlining real estate transactions. When it comes to
investing in real estate and transferring title, however, the legality of its
usefulness of blockchain technology is still unclear.
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