Tokenizing Real Estate Assets Introduces New Consumer Risks for Unproven Benefits
July 12, 2023
Cryptocurrencies, non-fungible tokens (NFTs) and tokenization may have lost some of the luster they enjoyed not too long ago due to the high-profile fall from grace of FTX founder Sam Bankman-Fried and ongoing turbulence in the valuation of cryptocurrencies. However, many are watching where, and if, the tokenizing of non-fungible assets should be applied to other industries.
Justin Lischak Earley, chief innovation underwriter at First American Title, studies the concept of tokenizing real estate assets, and has published thought-provoking perspectives on what is real and what is not in terms of NFTs in real estate. His thought leadership on the topic earned Justin an invite to a recent gathering of top economists, where he presented his in-depth research, “Bear With Me: The Bearer-Asset Dangers of Tokenizing Real Estate.” Below, Lischak Earley recaps some of the key points of his presentation.
Why are crypto enthusiasts eager to tokenize the real estate industry?
We must first understand what technologists and crypto champions dislike about the existing system. In general, the complaint is that the real estate economy is full of needless waste and unnecessary red tape. While companies like First American are making significant progress in creating a simple, fast and transparent real estate transaction experience, complaints about the traditional paper-based nature of real estate are frequent, and many of those are well-founded.
The larger issue goes beyond real estate’s historical reliance on physical paper documents. It speaks to a perception that the transfer of real estate is filled with unnecessary rituals that introduce delays and frictions into the transaction. The existing real estate system does indeed have rituals and checkpoints that can delay a transaction’s consummation, but many of these are there to protect consumers.
Why is the real estate transaction hard to integrate with “crypto culture”?
A faster and more liquid transaction does not necessarily mean a better or more secure transaction – especially when the purchased good involves high-value, non-fungible assets like single-family homes. Which, let’s not forget, are typically the largest purchase an ordinary person will make in their lifetime.
Significant transaction formalities have arisen around real property, and for good reason. Some transaction formalities surrounding this vitally important life event are not frictions ripe for removing; they are safeguards worth preserving. Blindly removing these guardrails in the name of technological progress could have catastrophic consequences for consumers and the broader real estate economy.
For example, the more liquid an asset becomes, the more prone it becomes to fraud and theft. In standard real estate law, there are tripartite deed formalities of execution, delivery, and acceptance. These are error-prevention mechanisms that the law has created to help ward off fraudulent, accidental, or otherwise undesired conveyances before they happen.
What’s so special about these formalities? If crypto technology can operate without them, what’s the problem?
Just because a technology can do something does not mean that it should—especially when there are deep historical reasons why it should not. Should crypto enthusiasts actually build the “frictionless” system that they envision, they would soon find that they would have to rebuild new “friction-inducing” legal rules similar to those that they just tore down.
Rather than suffering through the consumer harm that could arise from this misguided path, we should invest in digitizing and modernizing the existing system of real estate transfer. This would offer the same long-standing protections of current real estate law, but with a superior consumer experience that leverages technology in ways recognized to be positive.
What else should the real estate industry be thinking about when it comes to tokenizing?
A significant unanswered question is how to balance the “need-for-speed” that crypto enthusiasts seek with the regulatory and compliance obligations that the law imposes. One need only look at recent major regulatory actions against FTX, Coinbase, Binance, etc., to see the tension. Another unanswered question is whether crypto tokens would really provide investors anything that publicly traded real estate investment trusts do not do already.
At First American, we know there is more innovation to be brought to the real estate transaction, and we are creating and investing in products and services, like Endpoint, IgniteRE and ClarityFirst, that are designed to digitize the residential and commercial real estate closing process. And the Underwriting Innovation Team that I lead is always looking at how the latest cutting-edge technologies might be useful, such as the recent emergence of generative AI. Innovation for the sake of efficiency and an enhanced experience will always be a key focus, but we need to incorporate the appropriate checks and balances from our existing real estate framework to avoid introducing unnecessary risk into the most important transaction most consumers will ever undertake.
Justin Lischak Earley is chief innovation underwriter at First American Title.
Contact ALTA at 202-296-3671 or [email protected].