Real Estate Token (RET) Economics
One of the most compelling use cases of blockchain technology is the real estate sector. Ownership transfer of real estate assets is slow and expensive with multiple frictions. Selling your house is an experience worthy of Kafka’s attention. In response, the Real Estate Token (RET) market is developing rapidly promising a smooth, fast and cheap asset exchange experience. But the technology that makes bitcoin work does not necessarily transfer to all theoretical use cases — how can we be sure that RETs really are a successful application of blockchain?
What features must your RET demonstrate to have a chance of being a successful use case of blockchain? Can the underlying economics of bitcoin be applied to the RET use case? Answering these questions in reverse order:
Can RETs be valuable?
We really don’t know yet why the value of one coin will be greater than another. There are no longstanding tested theories that explain why bitcoin for example could be worth $20,000 or $100 at any given time.(By the way, something similar can be said of stocks.) However, initial correlations indicate that it is high turnover that leads to high prices. The harder the tokens work inside the ecosystem, the more ‘network’ value they are creating; a busy coin is a valuable coin. Coins are not just ‘busy fools’ but network value accrues because they genuinely deliver a better service then the extant centralised processes.
Economic theory on the value of money can be adapted to tease out the ‘high turnover = high price’ feature of cryptocurrencies. One school of thought is that the key driver in this dynamic is something that economists refer to as ‘velocity’ — ie the number of times in a given year that the total stock of money in an economy is turned over during the course of trade — buying and selling products and services.
Translating this into the world of crypto, the average network value of a coin equals the total transaction volume divided by the velocity or:
Average Network Value = Transaction Volume/Velocity
In short, this equation says that to get the value of your token to rise, you need to increase the traffic traversing your platform while keeping velocity low. Its critical to the use case of real estate (or indeed any token), that it can demonstrate that velocity does not rise with transaction volume — otherwise they just cancel each other out and the coin value will stagnate. In the case of bitcoin, achieving ever higher prices requires the coin to work excellently as a medium of exchange (generating high transaction volume) but for most of the coins to be locked a way as a store of value (lowering velocity) so that only a small proportion of issued coins are ‘busy’. The more traffic that is created by a small amount of coins functioning as a medium of exchange, the more valuable is the entire system as a store of value.
For an analysis of this issue, see Kyle Samani’s excellent piece https://multicoin.capital/2017/12/08/understanding-token-velocity/
RETs and velocity
In theory, real estate could produce valuable coins. Real estate inhabits a particular spot on the investment spectrum somewhere between gold and fixed income but with some equity like performance patterns. Its a clunky, immovable asset that is difficult and expensive to produce more of. It produces a steady but relatively low (net of costs) running yield but both yield and capital are largely hedged against inflation. As an asset class it mimics ideal characteristics for a valuable use case. Why? Because we hold it primarily as a store of value and turnover only a small proportion of stock each year. Velocity will be low overall as real estate has a medium to long term investment horizon but the day-to-day use case of the coin needs to keep transaction volumes high.
The risk of analysing the price drivers of your use case in the above context, is that you design your RET to generate parabolic price increases as opposed to a token that actually works for its users. It must offer a genuine solution to the problem.
Too often ICOs are launched without an indepth understanding of their own token economics. This may have been admissable in the early days of the ICO craze but increasingly sophisticated investors are bringing deep circumspection to the analysis of tokens. So, to answer the first question posed at the beginning of this article — what features does a good token need to demonstrate? The ability to Access, Play & Stay.
Access, Play & Stay
The following featues must be part and parcel of your use case in order to be a valid and potentially valuable use case of blockchain.
Access: the token gives you access to a desirable ecosystem that solves problems that outstanding centralised processes can’t.
Play: the token provides an easy and rewarding way to navigate the ecosystem, do some work with the token, contribute to the running of the platform and deliver on the promise of the new technology. This keeps transaction volumes up.
Stay: the play part is so good that you are happy to park your tokens within a wallet rather than flip into fiat even while you are not actively using them. This feature is important as it keeps velocity low.
Can a RET be valid and valuable?
Take a specific real estate orientated use case of a RET: fractional ownership. Fractional ownership refers to the ability for blockchain to divide the ownership of a piece of real estate to micro parcels for anyone to hold. A single apartment could be owned by 100 different people for example. Title is no longer the reserve of a single owner or an institutional landlord. This use case lives upto the key features of access, stay and play.
‘Access’ because it permits anyone to gain access to the world of real estate. ‘Stay’ because for the most part, real estate is considered a safe have asset where people are happy to keep wealth locked within bricks and mortar for long periods of time. The ‘Play’ part is important to get right as it gets to the root effectiveness of the RET — what jobs will it perform? What will keep it busy?
The work a fractional ownerships RET could do is being at a minimum the ability to exchange ownership between people quickly, cheaply and without the need for a central exchange. This ‘Play’ aspect could be extended for RET holders to vote on managing a specific property for example. A well designed RET that performs these tasks could be used by not just thousands but millions of people.
At first consideration, RET should provide a valid and valuable use case for blockchain. RETs exhibit the key features of access, play and stay. With the right use case behind it, a RET should be valuable as it has the potential to produce busy coins that keep overall coin velocity low. Moreover, the current centralised process of managing real estate is certainly ripe for modernisation given its slow, arcane and expensive procedures.
The economics may stack up but ultimately users will choose the simplest most trustworthy platform — they’ll not care how the token behind it is designed. In which case the next question to answer is whether the benefits of blockchain can be exacted using an outstanding smart contract platform like Ethereum without launching a new token? More anon….