An overview of digital assets and how this “new money” might work for you.
Cryptocurrency and one of its main underlying technologies, Blockchain, seem poised to transform many industries. Real estate, which tends to be a conservative, slow-to-change industry, is ripe for transformation by these technologies. How can real estate investors take advantage of Bitcoin and Blockchain to set themselves apart from the crowd and improve their investing strategies and techniques?
Cryptocurrency strategies are cutting edge. To date, they have been used only a few times, but the concept has been proven and the potential is there to make cryptocurrency a staple of real estate investing; there may come a time when everyone uses these techniques just as everyone now markets real estate online.
A cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets. – Wikipedia
Bitcoin, which was created in 2009, was the first decentralized cryptocurrency. The decentralization is critical. Every wallet that holds Bitcoin and every exchange ever done with Bitcoin is stored in a distributed ledger called a Blockchain. The ledgers are maintained by independent parties. Anyone can host a copy of the ledger on their own computers. About every 10 seconds a new set of entries (called a block) is added to the ledger. This block is the latest in a chain of blocks that goes back through time and captures all the entries and transactions (thus, the term blockchain). There is a mechanism that allows each new block to be validated in conjunction with all previous blocks.
Without going into too much detail, it is this validation mechanism combined with the nature of the blockchain itself, combined with the public and distributed attributes that give users of cryptocurrencies confidence that the blockchain is accurate and immutable. It is also this combination of factors that made Bitcoin unique from all previous attempts at creating a digital currency (there were several). It is not necessary to trust the Bitcoin founders in order to trust the Bitcoin currency. To the extent that other cryptocurrencies follow this formula, they, too, can be trusted — at least with regard to the validity and immutability of transactions.
Cryptocurrencies really came into the public consciousness in 2017 when numerous cryptocurrencies issued initial coin offerings (ICO) and several of them raised hundreds of millions of dollars in investment. Speculation ran wild and Bitcoin reached nearly $20,000 per coin. The amount of money raised caught the interest of regulators and both the IRS and the SEC issued opinions about tax treatment of cryptocurrencies and whether they were securities under U.S. securities law. In 2017, just about anything with blockchain in its name appeared to be investable. Numerous approaches to cryptocurrency were launched. The speculation market has calmed considerably and in its place is a more considered treatment of cryptocurrency that recognizes that, in fact, there are different types of tokens that have varying regulatory treatment and are useful for different purposes.
Today, several different types of cryptocurrency are recognized, and authors categorize them in varying ways. The types of cryptocurrencies derive their value in different ways and have different regulatory treatments. We will also distinguish between a coin, which has its own blockchain and a token, which is recorded on another blockchain. For purposes of our real estate discussion, I want to divide cryptocurrency into the following categories:
These include Bitcoin and Litecoin and also include barter currencies like the Troptions (Trade Options) tokens and BC-REX (bitcoin for real estate exchange). Currencies are intended to act like digital money and are used to buy things. The IRS treats these cryptocurrencies as assets and the SEC agrees that they are not securities. Currencies derive their value from the markets that accept them for payment. In this way, these currencies are just like dollars, euros, and other national currencies (typically referred to as fiat currencies since they get their value because a national government says so). The value of a dollar is what you can buy with it just as the value of a Bitcoin is what you can buy with it.
There are many security tokens and these types of tokens, along with utility tokens, represent the greatest current growth in the number of new tokens issued. Security tokens derive their value from ownership of an underlying asset, like a company (acting like stock in a company), real estate (representing ownership of a property or the LLC that owns it), or artwork (own a piece of a Picasso). These tokens are treated as securities by the SEC so all securities laws must be followed when issuing, selling, or trading these tokens.
Utility tokens represent value within a particular company for its products or services. Examples include game companies that issue tokens that can be redeemed within a game for additional characters or capabilities. One of the best examples of a utility token (though not a cryptocurrency since it is not on a blockchain) is frequent flyer miles. Each mile is a digital token that is issued to airline customers when they buy tickets and can be redeemed with that airline for seat upgrades, free flights, etc. It would not be at all surprising for airlines to convert their frequent flyer programs to utility tokens; it would be a good fit and may have marketing advantages. There are a number of potential uses within real estate investing for utility tokens. These tokens are not treated as securities by the SEC.
Though other types of tokens and coins may be issued as smart contracts, I call out this category since it has broad implications in real estate. Smart contracts can implement numerous contract capabilities in an agreed upon and automated way. Since the entire process of purchasing, selling, or investing in real estate involves contracts, new, faster, automated methods for implementing the transaction can be done via smart contracts.
So how can these different types of cryptocurrency be used in real estate investing?
There are numerous approaches. Here are just five that may be some of the most interesting:
1. Purchase of real estate using cryptocurrency. This is one of the most obvious approaches. It uses currency tokens or coins and allows an investor to combine the rapid increase in value and some level of liquidity of the cryptocurrency with the stability, tax advantages, leverage of real estate. To date, most of the purchases of real estate with cryptocurrencies have been two stage transactions (sell the cryptocurrency for cash and use the cash to buy the real estate). But there have been some notable transactions of cryptocurrency directly exchanged for real estate. Cryptocurrency has especially strong potential for international sales since it is so easy to move the currencies without respect to borders (we will see how regulators end up addressing this.)
2. Issuing security tokens as part of a real estate syndication. Traditional real estate syndications have several challenges including managing the investors’ shares, handling the know-your-customer (KYC) and anti-money-laundering (AML) requirements in the U.S., as well as privacy requirements in Europe. Most important is the illiquidity of private offerings. Security tokens can address all of these issues. They can make all investor management much more automated and transparent and have the potential to increase liquidity as long as the tokens are available on an exchange that enforces all the securities regulations using smart contracts.
3. Real estate title on the blockchain. Nothing should be more immutable than a real estate title. Having it recorded on a public blockchain that is readily searchable by anyone and can include the necessary details (that are supported by smart contracts) can greatly simplify the search, management, and recording of a title. At present only prototype efforts are underway, but this application of blockchain to real estate has the potential to speed transactions and reduce the cost of title searches and title insurance. In a similar way, putting sale listings on a searchable blockchain may also impact the current multiple listing services and provide a better capability for real estate investors.
4. Loyalty programs for rentals. Utility tokens have a number of uses in real estate investments. If tokens are issued to renters at an apartment complex, they can be saved up for a new amenity (like a ceiling fan or complimentary cleaning), used to defray rent, or used for a desired service like valet trash. The tokens would act as a loyalty program, providing renters an advantage to staying at your property that could not easily be transferred to another property (just as the frequent flyer miles make you want to fly that airline to build up your miles).
5. Real estate contracts on the blockchain. Using smart contracts to implement letters of intent, contract offers, and all the legal stages of real estate can speed the negotiation time of an offer (since all parties can see the current state of the contract at all times) and actually execute important stages of the contract (such as distributing deposit funds) based on the contract terms. As the terms themselves become digitized, it will be easier to construct contracts from terms where the wording is more standardized, making for fewer contract disputes.
This is just a high-level overview of some of the potential synergies between real estate and cryptocurrency. These cutting-edge strategies are showing potential to make cryptocurrency a staple of real estate investing.