The Pathway to Decentralized Finance In Real Estate

As of April 2021, over $54 billion is held in decentralized finance (DeFi) contracts built off blockchain platforms. Blockchains and their representative tokens allow for the operation of novel platforms that will have a significant impact on finance, artificial intelligence, identity, supply chain management, and governance.

Cryptocurrency’s Inception

In 1983, David Chaum, an American computer scientist and cryptographer, published “Blind signatures for untraceable payments.” In the years that followed, additional research explored the type of ecosystem that would allow for the existence of a decentralized network and how it would operate.

Twenty-five years later, the Bitcoin domain was registered and the mysterious Satoshi Nakamoto released “Bitcoin: A Peer-to-Peer Electronic Cash System”. This would become the backbone of the Bitcoin Cash System. Since that time Bitcoin lives on as a widely successful proof of concept.

Blockchain & Smart contracts

The adoption of blockchain will be a paradigm shift in finance. Just as the Bitcoin blockchain is decentralized through a global network of computers, so too will the next generation DeFi decentralized apps (dApps) which function off many various blockchains.

While there are multiple blockchain platforms, at their core they create a trustless system and allow multiple participants to interact and complete a transaction without the need for trust. In simpler terms; a clear transaction history stage by stage, immutable, truly decentralized, public, and secure.

Like storing data on an excel workbook, a blockchain is a large-scale database that stores information in blocks or groups. A group of information (a block) is collected and when filled, this block of information is attached to the preceding block in a chain. All new information is added block by block to a chain as new blocks are formed.

First gen blockchains commonly use a ‘Proof of Work’ (POW) consensus platform, which is composed of a complex mathematical puzzle where ‘miners’ verify the legitimacy of transactions on the network. The mathematical puzzle is asymmetrical; solving the puzzle is difficult for the miner but simple for the network to reference. Multiple miners compete to solve the puzzle. The first to solve it receives a blockchain’s token as a reward. As competition increases, the processing power needed to verify increases correspondingly.

Ethereum, launched in 2015, added another important feature, ‘smart contracts.’ Smart contracts are simple, executable programs that progress as predetermined conditions are met and add utility to a blockchain. While Bitcoin and Ethereum represent important steps in the evolution of blockchain platforms, they do not offer the same capabilities as next-generation platforms.

Next generation blockchain

Transactions and smart contracts on Ethereum can be expensive, slow, and energy intensive. The development and implementation of Ethereum 2.0 should solve these limitations; however, this updated framework is not due for implementation until 2022-2024.

There are many next-generation blockchain platforms already in existence. Cardano, for example, which uses an Ouroboros Proof of Stake (POS) protocol. Built with the future in mind, Cardano is environmentally sustainable, verifiably secure (peer-reviewed through partnerships with multiple universities), and is a true decentralized platform. The company does not mine any of the tokens themselves.

POS is an algorithm fundamentally different from POW. POW incents competitive miners to solve a mathematical problem. POS systems select a ‘miner’  from users who have ‘staked’ or committed their tokens to a collective pool on the network. POS miners receive a reward as part of a fee of each transaction. POS does not solve puzzles via competition, therefore transaction time and electrical usage are significantly reduced. Currently, the cost of using the Cardano network is much less than Ethereum.

The foundation for DeFi is Ready for Primetime

While Cardano is poised for growth, other DeFi platforms have grown in parallel such as Avalanche, the UTXO-based Ergo, Stellar, and Algorand. In the coming months, we will also see the launch of multiple DeFi projects on the Cardano network including COTI, Liqwid, and the first Ethereum-to-Cardano cross-chain liquidity bridge, OccamFi.

DeFi In Real Estate

Thanks to the familiarity cryptocurrency has gained due to brokerages like CoinBase & Binance, the maturation of next-generation smart contract capable blockchains has provided a foundation that will benefit real estate.

Time intensive tasks will be reduced and/or eliminated with smart contracts utilized in renting, title searches, credit checks, review of property information, legal descriptions, management of cash flows and payments, floorplan verification, environmental and appraisal reports, maintenance records and applied to cross-border transactions enabling greater access to capital, completely bypassing traditional bank financing. Qualification of borrowers’ credit risks will be evaluated through a purchaser’s digital identity and next-generation, AI-assisted automated valuation models (AVMs) will streamline due diligence to days.

Tokenization and Fractional Interests

Perhaps the final frontier is the conversion of real estate to a liquid asset. Through the tokenization of real estate, property owners can issue tokens which represent equity through a blockchain platform. The token represents a certain number of shares or equity in a real estate asset and the purchaser of the token possesses a fractional interest in the property.  While fantastical, it has already been done – be ready to value the fractional interest ownership rights!

Do you have more questions about decentralized finance in real estate? Do not hesitate to give the Argianas team a call at 630.390.0113 or complete this form. To receive more real estate appraisal resources or our original thought pieces, be sure to join our mailing list to receive our e-newsletter.