Tokenization has already transformed multiple digital industries. Developers are targeting the real estate industry in ways that have the potential to significantly disrupt current models. This is true across the board from the way government agencies record titles to the ways investors buy and sell fractional shares. In this article, blockchain lawyer Nick Oberheiden answers some questions about the legal issues involved.
How Can Tokenization Disrupt the Real Estate Industry?
Tokenization is disrupting the real estate industry in several significant and intriguing ways. In the U.K. and some European countries, authorities are already collaborating with blockchain companies to test tokenizing titles. We are also seeing tokenization coupled with fractional ownership—which has the potential to change drastically if tokenization reduces entry barriers. From financing and the mortgage application process to conducting title searches and transacting sales, tokenization could alter the entire real estate industry.
What are the Legal Implications of Tokenizing Real Estate Title Documents?
Theoretically, tokenizing real estate title documents may produce an energized process. Government authorities will manage their title records more efficiently, sellers will have an easier time proving ownership, and buyers will verify whether they are receiving a clear title. We probably have a long way to go before these futures transforms into reality. Authorities will want to know that tokenized records are just as secure as paper records. With blockchain’s current fallibility, this is not necessarily the case.
What are the Legal Implications of Tokenizing Real Estate Ownership?
Tokenizing real estate ownership has several remarkable implications. If tokenization streamlines the transaction process and opens investment opportunities to people who cannot afford to buy a property on their own, these are both positive outcomes. That said, the risk that someone’s ownership interest could be digitally hacked or that an error in the blockchain code could eliminate all evidence of an owner’s interest also present very real concerns.
Will Entities that Are Traditionally Slow to Adopt New Technologies (i.e., Government Agencies and Banks) Accept Tokenization in Real Estate?
The novelty of tokenization is one of the technology’s biggest hurdles to widespread adoption. Government agencies and banks will resist adopting, and this will delay tokenization’s disruptive impact. Ultimately, as government agencies and banks continue to grapple with cryptocurrencies, smart contracts and other blockchain-based technologies will likely speed up the acceptance of tokenization.
What are Some Other Challenges Standing in the Way of Tokenizing Real Estate?
Regulation presents another significant hurdle to mass adoption of tokenization. Here, tokenization faces challenges on two fronts. On one side, the lack of regulation will scare off many would-be adopters (including government agencies and banks). On the other, when regulators catch up, the implementation of after-the-fact regulations could create a secondary disruption.
What Happens When There is (Inevitably) a Dispute over a Tokenized Title or Property?
Disputes involving tokenized titles and properties will present unique challenges for parties and their lawyers. It will take time for the law encompassing tokenization to flourish. Early lawsuits will likely serve as test cases for future disagreements. Additionally, while clients currently rely on lawyers to interpret real estate contracts, lawyers will need to rely on software developers to interpret the code of the smart contracts underlying tokenized real estate. This will create a host of unprecedented legal and evidentiary issues, all of which will add to the complexity of resolving tokenized real estate disputes.
Will Buyers and Sellers Still Need Lawyers Once the Real Estate Industry Becomes Tokenized?
This is an interesting question. While many commentators have suggested that law firms, escrow agents and title companies will become unnecessary for closing real estate transactions once tokenization takes hold, I don’t necessarily take the same view. Tokenization will not impact all legal aspects of buying and selling real estate. Buyers and sellers will still need to make sure they are making informed decisions about various aspects such as warranties, waivers, and liability.
As You Noted, Current Blockchain Technologies Aren’t Infallible—What Happens if There is a Hack?
Hacking is perhaps the biggest concern associated with the tokenization of real estate. We have seen investors’ cryptocurrency wallets disappear. There is no reason to think that this will not be a concern for tokenized real estate. Even setting aside the issue of striving to restore investors’ ownership rights (which could entail conducting coordinated law enforcement investigations across the globe), hacks will lead to complex litigation involving multiple parties and a still nascent body of law.
Are There Legal Risks for Companies that Bring Tokenization to the Real Estate Industry?
Yes, companies that bring tokenization to the real estate industry will face many legal risks. To begin, it behooves companies to prioritize cybersecurity. If they engage third-party cybersecurity vendors, they will need to ensure that their indemnification rights are airtight. These companies will face liability risks related to coding errors, faulty updates, and a broad range of other technological issues. Given that these companies’ applications will be used on a broad scale with high-value transactions, overlooking any of these issues could lead to business-threatening litigation.
It Has Been Said that Tokenization Will Globalize Real Estate—Is This True?
Tokenization might globalize real estate. But several challenges persist. Some investors may view buying a fractional share of a property in a foreign country no different from investing in an altcoin (i.e., as a risk they are willing to take). These investors will likely comprise the small minority—at least for now. Additionally, as countries begin to regulate the tokenized industry differently and at different rates, navigating the regulatory landscape on a global scale will present significant challenges. Investors who cannot afford to lose the money they put into tokenized properties will also need to consider whether they are willing to pursue litigation in foreign jurisdictions.
Written by Callum Jackson