Article
Digitalization and, in particular, blockchain technology offer a number of new opportunities for investors, including in the real estate industry. But Professor Fabian Schär of the University of Basel, a blockchain and banking expert, cautions against overestimating its potential, as there are still some legal hurdles.
May 18, 2022
"I wanted to invest about CHF 300 in a multifamily house in Detroit through a US provider in 2019," says Professor Fabian Schär, Head of the Center for Innovative Finance at the University of Basel. "The technical process related to the token functioned seamlessly." But then came something that made Schär cancel the transaction: "There were around 150 pages of legal documents that I had to read and sign."
This example illustrates why tokenization has not yet made significant inroads in real estate. Usually the legal basis has not yet been defined or the processes related to the entry in the land register and transfer of ownership are not digitalized. Despite this disappointing experience, however, Fabian Schär is convinced that blockchain, as the underlying technology and tokenization have a lot of potential – potential that the real estate industry should certainly take advantage of. Both investors and those offering real estate investments could benefit.
The tokenization of real estate is most often lauded for enabling transactions to be carried out automatically, i.e., without an intermediary or advisor, and much more quickly. Fabian Schär, however, cites transparency and the high level of security as key advantages. When these tokens, which represent ownership of a property, are traded via a public blockchain, the transaction is completely transparent for all participants.
In Schär's view, interoperability is the second important advantage . The tokens can, for example, be used as collateral in other financial protocols and benefit from the special features of open financial systems. Other advantages – such as the impact on diversification opportunities for investors – may be exciting but could also be achieved using other technologies.
Put simply, blockchain technology allows a database to be maintained in an open community. Anyone can connect to the system, carry out transactions, and verify that these have been executed without having to trust the other person or ask for permission. Public blockchains create an independent, fair, and robust basic infrastructure that is not dependent on individual institutions or intermediaries. Various services and exchange transactions can be processed using this basic infrastructure.
It will be some time before all of these advantages are in place and are available as consistently functioning offerings for investors. The technical situation is significantly hampered by legal hurdles, as real estate occupies a unique legal position. While other tokens have to clarify issues related to safekeeping and the type of promise – e.g., tokens that represent a promise for the delivery of gold – the situation is clearer and the legal hurdles much lower than with real estate, which enjoys special protection, making the legal situation more challenging.
Fabian Schär maintains that it is also important that the various stakeholders use a shared, open blockchain approach rather than relying on their own private blockchain solutions. This is necessary for the market to reach critical mass and enable interoperability, which will allow the true advantages of blockchain to materialize.
Decentralized finance (DeFi) is a new financial system based on blockchain technology, with assets represented by tokens. Using smart contract protocols, instructions and rules are transparently defined and stored. This has the advantage that interactions and transactions are secure against tampering and can, from a technical standpoint, be combined in any way. For real estate, tokenization is a process in which the ownership of a property is represented digitally on a blockchain as tokens. The individual tokens are units in the investment property and can be traded.
"Centralized databases can be very efficient. However, this also has the risk that those responsible for the centralized database will intervene for their own advantage," explains Fabian Schär. "There is also the problem that isolated data silos lack clarity, and the entries are difficult to aggregate or use in a comprehensive manner.
By contrast, with an open, completely decentralized system, no one can manipulate it, and all participants can follow the transactions or changes transparently." This transparency can counteract an economic phenomenon known as the hold-up problem, adds Schär, where a socially desirable result cannot be achieved because one party does not want to enter into a dependent relationship.
But Schär does not believe in fully automated transaction processing using real estate tokens. While many elements of the transaction can be governed by smart contracts and thus automated, the problem is that some data does not occur natively on the blockchain. Someone has to add this data, which can lead to certain dependencies and delays in the process.
In the blockchain world, there are so-called oracles that provide this external data. However, Fabian Schär is convinced tokenization has long-term potential for the real estate industry, even if there are still some hurdles that need to be overcome before it can happen on a large scale.
I considered buying a real estate token in 2019, but because of legal uncertainty, I ultimately decided not to go through with the purchase. In technical terms, tokenization is very simple and can be carried out extremely efficiently, but there are still regulatory questions.
What I find intriguing about tokenization are the high level of transparency and the potential interoperability, which make it possible to integrate the tokens in various blockchain-based financial protocols.
Will the tokenization of properties change the real estate industry and, if so, how?
It depends on the specific implementation. The more open the system, the more exciting the possibilities. There are few advantages, however, if the database is controlled by just one party.
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