Real Estate on Blockchains: A Bad Idea That Refuses to Die
Amazingly, people still talk about this like it's going to happen.
Buying real estate is risky and complicated. From arranging viewings and finding the right property to lining up a mortgage and closing the purchase – it’s all hugely stressful. Presumably, that’s why at least nineteen web3/crypto companies are working to disrupt the industry, after all the past attempts from the 2017 crypto bubble failed.
Smart people think tokenizing houses and apartments on blockchains as NFTs or fractionalizing on-chain property could make buying cheaper and more efficient. Packy McCormick, the outspoken web3 investor defended the idea in a recent podcast and prominent crypto research firm Messari has a whole article titled “Crypto x Real Estate” (summarized here).
Needless to say, replacing a decently functional real estate system with NFTs is a bad idea. For argument's sake, let's assume that western governments would be fully onboard with replacing current ownership records with unique cryptographic tokens on public blockchains. Even then, with full buy-in from the authorities, the idea doesn’t work. Crypto just isn’t built for real estate. Here’s why →
1. Control is Essential
As everyone knows, blockchain databases are decentralized. No single person controls Ethereum and nobody can reverse a transaction once it has settled. Similarly, transferring assets requires the owner’s consent, which is granted exclusively through the private key of their digital wallet.
These are all meant to be the advantages of crypto, but they pose obvious problems in real estate. Consider these scenarios:
A court orders a bankrupt firm to sell its real estate NFTs to pay off debts. What remedies are there when the company runs off with the property tokens? (None. Without the private keys to the firm’s wallet, seizure is impossible).
A judge rules that you keep the beach house in a divorce, but your spouse transfers the NFT from the family wallet to an irretrievable address. What happens? (You’re out of luck).
Someone passes away without sharing the private keys to their real estate wallet. How do their heirs inherit their home? (They can’t).
A local government gains control of an abandoned parking lot after the owner misses taxes on it for 30 years. How does the state take ownership of the property NFT without the private keys? (It can’t).
Blockchains don’t have a central authority that can make transfers unilaterally or reverse transactions. As a result, real estate ledgers built on blockchains would stop reflecting the law as soon as any predictable contingency occurred. This poses a basic question: what’s the point of ‘putting real estate on the blockchain’ if the ledger won’t reflect legal reality?
At this stage, blockchain proponents often say that ‘smart contracts,’ the snippets of computer code that govern non-fungible tokens, can handle these common edge cases. They’ll say that NFT smart contracts can be programmed to deal with scenarios like death, bankruptcy and divorce. But it doesn’t work →
2. Contracts and Oracles
In the real world, contracts are complex. Even a basic apartment rental is pages of legalese full of promises between the landlord and tenant (about pets, heating, etc) and their rights and obligations in various cases (fire, lease expiry, etc). Obviously, including provisions for everything is impossible so when unexpected stuff happens, it's worked out over email , and if that fails, the legal system.
How would any of this work for a real estate NFT in a decentralized blockchain? Is it even possible to put contingencies like death, inheritance, and asset seizure in computer code? Assuming it is, what happens when unexpected contingencies that were never programmed occurs? I don’t imagine the answers to these questions are great. But there’s more.
For the smart contracts that govern real estate NFTs to carry out the law, the Ethereum blockchain would need to be regularly updated with huge amounts of information from the real world. For example, it would need to learn:
Which firms and people (wallets) have been blacklisted (due to outstanding debts, sanctions, etc).
When deaths, divorces and asset seizures (etc) have occurred.
If the seller of a property was found guilty of fraud and the transaction needs to be reversed (etc).
In crypto, computer programs that ‘tell’ the blockchain what is happening outside are called ‘oracles.’ For real estate, the oracle would have to be the government, since it’s the only entity that can reasonably report when people have legally died, divorced, or had their assets seized. This is fine by me, but it would give a single entity enormous power over the system, which is obviously at odds with decentralization, a key selling point of blockchains.
This all clashes with the idea that crypto is ‘trustless’ and the common crypto saying ‘don’t trust, verify.’ If the source of real-world information for the database is the government, then obviously you need to trust the government. Ultimately, the entire system just ends up replicating or relying on the legal system it’s supposed to disintermediate.
3. Solution-Driven Problem Solving
At some high level, problem solving to disrupt an industry should work like this. First, you state the problem: X thing is too expensive! Y thing is too difficult! Then, you think about products and solutions to fix the problem. These can involve financial, regulatory, software, or other innovations. Then you compare the costs, benefits, risks and timelines of the various options. And then you decide on what to do and start a company to do it.
The way a lot of the companies in the blockchain real estate space (and web3) are operating is different. It goes like this: There’s this database technology that venture capital really likes right now, public blockchains. Plus, company founders cash out much earlier than an IPO, before there’s revenue or even a product, by selling company tokens. Sure, public blockchains are slow and expensive and only useful in particular cases but everyone is into them! Real estate needs disrupting, so let's take some VC money and try to fix it with public blockchains!
The starting point of a lot of web3 is not the problem they are nominally trying to solve (real estate, climate, insurance). The starting point is an extremely niche database solution that is then mapped onto a problem it may be extremely poorly suited for.
4. Fractionalized Real Estate
Companies in the crypto real estate world are trying to do more than just put houses and apartments on the blockchain. Some are now selling fractionalized interests in on-chain real estate. This newsletter is not financial advice (never is!), but it seems like buying minority crypto-equity stakes in digitized real estate assets could be a very bad idea.
Will your fractional interest have liquidity in a secondary market? Probably not. Can the entity that tokenized a home and sold small pieces of it online just turn around and sell the whole property later in real life and forget about the blockchain? Possibly, yes.
Not investment advice, but if you want exposure to real estate, you can just get it at the New York Stock Exchange, where lots of real estate investment trusts (REITs) are listed, for near-zero trading fees. Many REITs are diversified geographically and across segments (high/low end, commercial/residential), are super liquid and pay dividends. Maybe these are better than minority crypto-interests in specific digital real estate assets with unclear legal status, but who knows...
5. What Does Real Estate Need?
In the developed world, companies like Redfin (US) and Zoopla (UK) have already massively improved the real estate experience with their apps and websites. On your phone, you can browse through whole neighborhoods, look at dozens of pictures, floor plans, get in touch with agents, see what prices properties have sold for and set up email alerts for new listings. This is a huge improvement from just ten years ago!
If the problem is that there’s no centralized ledger of property ownership, that too can change. Washington DC already has a great public database of all properties in the city. You can browse the sale history of every house or building in an interactive map and even get the name of the owner. Check it out!
Could the UI of this system and others like it be improved? Sure! Could this public database be set up in a standardized way across all cities? Probably. Could the government set up APIs for the private sector to build cool apps on top of the data? Certainly! There are lots of ways the status quo for real estate in developed markets could be improved, some private, some public.
Is crypto’s favorite database design, the blockchain, going to help? Probably not.
For completeness, a brief remark on the developing world, where governments and real estate markets are much more dysfunctional. In some emerging and frontier markets, it may be possible to make life easier for a subset of property buyers by disintermediating the local legal system with parallel property ledgers, which could be created and maintained by large private companies. To buy or sell one of their apartments or houses, you would record the ownership transfer on their private ledger rather than the official government record of property ownership, which would list the private company as the owner of the entire portfolio. This seems like it would be more useful for expats than locals, but who knows. Obviously, this ledger would need to be fully centralized, which rules out blockchains. A regular SQL database would work just fine.