Blockchain and the democratization of real estate investing
One of the main indicators of the applicability of blockchain solutions to an industry is the presence of middlemen. In an almost directly proportional fashion, the more the number of middlemen, the more blockchain can positively impact the existing business models.
Commercial real estate is one of the key legacy sectors that is the most burdened with expensive middlemen, information asymmetry, bureaucratic hurdles and lack of auditable data and overall transparency.
All these factors, paired with high capital barriers of entry, have defined the real estate market as a speculative investment for the few and a highly stressful once-in-a-lifetime investment for the many.
As a matter of fact, the real estate sector, despite it being the world’s most valuable asset class with an evaluation that is around $200 trillion, is also a notoriously illiquid market. Housing market’s higher price point and compliance costs have historically hindered small investors from adding it to their balance sheet as a speculative investment.
This lack of flexibility won’t stand the test of time as new generational trends are set to shape the market. From millennials to generation Z, the future investors are digital native demographics whose consumer behaviour is deeply intertwined with internet mechanics.
As it is now, real estate is mostly a slow offline business: from a buyer’s perspective, it requires months to gather an adequate knowledge of the local market and from a seller’s viewpoint, the lack of market liquidity can prolong the transaction for months, if not years.
Blockchain technology provides a solution to both the information bottleneck and the financial bottleneck.
Single source of truth
Unlike the stock market, real estate assets are a non-fungible commodity which causes the market where they’re traded to be afflicted with information asymmetries. This means that the market is structured in such a way that one party, in this case the seller, possesses a greater wealth of knowledge than the other party, the buyer.
In fact, potential investors have to familiarize themselves with the specificities of the neighborhood and, eventually, rely on the more accurate knowledge of an intermediary who has also monitored past transactions in the local market. Blockchain is designed to be a tamper-proof record-keeping technology: it enables financial and social ecosystems with mutually distrusting agents or conflictual information to rely on an auditable and publicly accessible single source of truth, therefore boosting the transparency and enforcing an efficient dispute resolution mechanism. Albeit still in the early stages, this use-case has already been tested by state actors to implement nation-wide land registries and more countries are planning to join. Coupled with crowdsourced information and data aggregators, the capability of blockchain to produce immutable records empowers the end-consumer by reducing the gap of information between the seller and the buyer and disintermediating the latter from relying on third-parties, and it proves to be especially useful for markets that are not perfect information systems such as the real estate.
The above diagram is an example of a smart contract-based application to perform transactions of tokenized real estate properties on a blockchain network (specifically, ethereum).
Tokenization and fractional ownership
The local and non-fungible nature of properties as an asset class leads to an inefficient price discovery mechanism which has a detrimental effect on liquidity.
The function of blockchain as an immutable ledger of records makes the financial ecosystem more open and a level-playing field between buyer and seller, but there’s more to blockchain than being a record-management tool.
Another feature has the potential to stimulate liquidity and empower a much greater pool of investors who lack of significant amount of capital: tokenization.
Fractional ownership through tokenization allows to encode tokens, units of digital information that are meant to represent and keep track of the ownership of real-world assets, into a set of rules with smart contracts that are deployed on the blockchain network. In this particular case, a token is a measure of the percentage ownership in a property. The allocation of the tokens and the lower bound of this percentage can be as low as encoded in the rules of the smart contract, therefore granting more freedom to the seller. This will in turn lower the capital barriers to have a stake in the housing market since, rather than an entire property, it will facilitate the acquisition of just a fraction of it to a global pool of investors. At the same time, this approach also offers full transparency as the rules of the contract reside on the blockchain and are immutable. The housing market will hence be democratized as both a speculative and long-term asset.
Thus, the conundrum is not whether a blockchain-type of technology might have a use-case in the real estate sector, but, specifically, which flavour of blockchain is the most suitable. Whereas public blockchains, such as bitcoin and ethereum, are designed with a more adversarial approach in mind, as their users are either anonymous or pseudonymous, consortium and private blockchains, such as the hyperledger project, are designed for mutually distrusting competing actors who are nevertheless identifiable, hence the lesser degree of decentralization. This allows consortium and private blockchains to be more easily regulatory-compliant.
From KYC/AML to privacy-oriented legal frameworks such as GDPR, private and consortium blockchains are architected to be more institutionally-friendly.
Moreover, their more centralized nature still makes them more flexible than a relational database. Similarly to public blockchains, consortium and private blockchains have their own consensus protocol, but more modular and customizable according to the requirements of their use-case. This allows to embed a set of policies in their network to regulate the business logic among their actors and enforce immutability for record-keeping purposes.
Lastly, in a financial landscape that will be dominated by demographic cohorts that have been influenced by new economic paradigms, from the attention economy to the sharing economy, traditional industries are poised to face substantial transformation. The new generations are digital natives, demand more flexibility and data transparency and the trend of digitization of offline sectors is bound to expedite with the internet of things. Blockchain is one of the tools with which the fintech and real estate market can adapt to these structural changes.
In our next articles we will bring you more information about the comparison between consortium and public blockchains, and the rationale behind why here at BrikkApp we’ve decided to adopt such a technology to increase the transparency of the property investment market will be further detailed. Follow us and keep in touch!
