Industry leaders, firms, brokers and lenders are starting to realize the blockchain is not just some quixotic idea dreamt up by young, upstart software developers and techno-libertarians. It has become increasingly evident that blockchain technology, distributed ledgers, decentralized networks, and token economics will propel industries all over the world into a new era of enterprise. In particular, how we think about real estate, finance, economics and technology is about to change drastically.
Even in the relatively short, but revolutionary lifespan of the internet, technology has remained a tool to get to the real estate transaction. The transaction was completed offline. In this new landscape of blockchain, technology will host every component of the transaction—from searching to listing to escrow and beyond—and it will only be done online.
In order to prepare for the coming changes, it’s important to have a basic understanding of what the blockchain is, how it operates, and the challenges that need to be addressed before it is intrinsically sewn into every real estate transaction from start to finish.
Once we overcome these obstacles, we will have increased access to new data and capital, enhanced marketing capabilities, transparent lending processes and new transaction tools. However, before we realize these gains, several obstacles need to be addressed. These hurdles include scaling the blockchain’s transaction throughput, ease and usability, chain interoperability, and regulation.
In this post, I will describe each component broadly to provide a basic understanding of the current challenges facing the technology. My team and I have encountered these obstacles first hand during the last 2 years of developing REX. We are engineering some exciting solutions that will be introduced in the coming months, and the active ecosystem of Ethereum developers is doing incredible work building the infrastructure required for blockchain to achieve its potential.
What are the benefits of storing transactions on a blockchain as opposed to a centralized database? Cost, privacy, a collective ethos? There are many, but one massive benefit is security. In a decentralized environment, thousands of people run nodes (computers), which process each transaction one at a time, and then assemble them into ascending blocks. A copy of these transactions is stored on every node, ensuring the data is correct and untampered. Altering these records for personal gain would be both time consuming and expensive.
You can think of security like this: Imagine you own 50 ounces of gold. You are growing concerned that someone could break into your house and steal all 50 ounces, leaving you with no retirement savings. With a single point of entry, it would not be that difficult for a thief to break into your house and do their dirty work. To ease your worries, you decide to store one ounce in a safe at 49 of your closest relatives’ home. Now, if a thief wants to steal your retirement, they would have to break into all 50 houses instead of just one. To the thief, one ounce of gold is not worth the trouble of breaking into your house. There is also no economic gain in breaking into all 50. This ensures your gold will be protected.
That’s just one way of explaining how blockchain provides security, but it gives you enough of a basis to understand the next aspect…
Remember, the Ethereum blockchain is currently only processing one transaction at a time. In the real estate industry, there are millions of global transactions a year, and that’s not including deposits, escrows, lending, compliance, tenant improvement allowance, inspections, title and taxes! How can we efficiently use a public blockchain in this environment?
Let’s start by focusing on transaction throughput with two of the largest blockchains by market capitalization: Bitcoin and Ethereum.
As of this writing, for every 4 transactions Bitcoin processes in one second, Visa processes 2,000. Ethereum is a bit faster, processing approximately 13 transactions per second for every 2,000 Visa processes. The pain points are already exposing themselves on the Bitcoin blockchain, where the current backlog of unconfirmed transactions is close to 30,000 transactions, which leads to 20-30 minute wait times for transaction confirmations.
However, Bitcoin and Ethereum are still in their infancy, with differing processes, and comparing them to Visa, which has been around since 1958, is not an accurate portrayal of comparison. For example: While Visa processes transactions internally in a centralized ecosystem, Bitcoin and Ethereum use public consensus protocols.
Let’s take a deeper look at that using an analogy. Here is how Bitcoin and Ethereum Process Transactions Today:
You own Link Brokerage with 100 agents. It’s Monday morning, 8:30am (you open at 9:00am) and have 100 potential buyers lining up outside the office. To distribute the leads fairly while getting as many buyers through the door quickly, you come up with the following strategy:
You provide each agent a copy of the company’s 10 Transaction Procedures. Each agent must process every transaction starting at step 1 and ending at step 10. Step 10 entails calculating the correct numbers in the closing statement. If the agents follow this process, you guarantee they will close the transaction. You tell your agents that each buyer will come in one at a time and provide the details of the property they want to purchase. All 100 agents will work on processing the transaction independently. The agent that processes the transaction the fastest and obtains confirmation from the other 99 agents that their closing statement is correct, is entitled to the commission. The broker can then collect their fee and add the transaction to Link Brokerages company ledger. It’s 9:00am and Buyer 1 walks through the door. All 100 agents begin working through the 10 Transaction Procedures as fast as they can. After 20 minutes, Alice raises her hand saying she completed the transaction first. Before Alice can record the transaction and collect her commission, her peers are required to verify her work. Alices 99 peers confirm and she records the transaction in Links company ledger then collects her commission. This is similar to how blockchain nodes calculate and record transactions.
It’s now 9:30am, and you still have 99 potential buyers waiting outside. You grow concerned that buyers may leave for another firm unless you can increase transaction throughput. You begin thinking of a more optimal strategy…
It’s Tuesday morning, 8:30am at Link. You are thrilled, because not only did you process all 100 buyers yesterday but you have another 100 potential buyers in line today.
But to process these 100 buyers quicker than yesterday, you decide to break your 100 agents into 10 groups of 10. You then break up your 100 buyers into 10 groups of 10 and assign each agent group to one of the buyer groups. You assign agent group 1 to buyer group 1 and agent group 2 to buyer group 2 and so on all the way up to group 10.
Each group independently processes their 10 transactions, then validates they have the correct closing statements. Once confirmed, the transactions are added to the company ledger and commissions are distributed to the group. It’s 9:30am and all 100 buyers are out the door, increasing the firm’s throughput 100x. This is all because the workload was distributed or broken up.
These are some of the ideas behind sharding the Ethereum blockchain—set forth by the brilliant Vitalik Buterin and other computer scientists—to increase the transaction volume potential of the network. There are other types of scaling efforts not discussed above, but sharding and derivatives thereof, are considered to be the primary solution for Ethereum’s growing pains. It is only a matter of time before public blockchains can meet and then surpass Visa’s transaction throughput.
Fred Ehrsam, one of the co-founders at Coinbase, gives another great scaling analogy using Facebook.
Another obstacle facing public blockchains is what I call usability. Let’s look at Ethereum as an example: Ethereum is a world computer where users pay for computation. In order to participate in the Ethereum Network, you are required to pay gas fees. Gas fees equate to a few cents per transaction paid in the cryptocurrency Ether.
Applications being built on top of the Ethereum Blockchain need to account for gas fees. We came across this at REX. Each time a user uploads a property or edits it, it creates a change to the property’s (and Ethereum’s) state, thus creating a transaction on the Ethereum chain.
Through testing our Alpha we quickly learned we have two groups of users. Those interested in purchasing eth and paying gas fees themselves, and those who just want to use REX without being bothered with the nitty gritty of gas and fees. Therefore, we had to get creative.
A solution we came up with is what we call the Gas Automation Contract. In short, the user deposits dollars, the dollars are converted to eth, the eth is stored in the contract and deducted each time the user engages in a transaction. This is a simplified explanation but it should illustrate the point.
This goes to show that there are new challenges with Blockchain that did not exist with building a traditional platforms. However, it stimulates new channels of communication between the engineers building the platforms and participants that will eventually end up using and owning the ecosystem.
In my last post, I briefly touched on the inter-chain communication channels being worked upon. There will be plenty of private/public blockchains in future. It’s imperative these blockchains communicate with each other. It’s a bit like using a debit card. For the sake of consistency, let’s use Visa as an example. Visa provides the ability to link your bank account to a virtual transaction service that allows you to spend your money conveniently without holding cash at any place that accepts Visa. The merchant has a combination of hardware and software that communicates with Visa’s network which then communicates with your bank making it easy for you to transact almost anywhere in the world.
The same communication is necessary for blockchains. You may find the Ethereum Blockchain has applications that make it efficient to draft and execute lease/escrow contracts but you prefer to execute rent rolls and tenant data in a permissioned environment. You may start by running most of your transactions on one chain, but realize there is a better technology that was later introduced and you want to migrate. In order to keep your transaction history protected, the new chain will need a way to reference the old chain. Ideas like this are being explored by Polkadot and ICON.
Regulation has been a hot topic lately. I recently attended Blockchain and Law with a respected panel of attorneys discussing regulation and compliance. The debate focused on the classification of tokens. Are they a security? Are they a commodity? Do they have their own classification? The answer is we don’t know yet.
How should we regulate the sale of tokens? There are new instruments being introduced like the SAFT: Simple Agreement for Future Tokens. This is an derivative of Silicon Valley’s SAFE: Simple Agreement for Future Equity. The SAFT is being marketed as a security, focused towards accredited investors. The contract states the investor will give the project money today in exchange for tokens at some future date. However, what happens when the contract is converted to tokens? Should the tokens be considered a security?
FinTech and blockchain law expert Marco Santori says no. He offers the following analogy: If I create a futures contract with a gold miner that stipulates I will give the miner money today so they can give me gold later. My money gives the miner the ability to purchase mining equipment so he can get me gold. The promise the miner is giving me in return for my money is the security: A promise to provide x ounces of gold at some future date. However, when the miner gives me my gold, than the agreement is complete and the miner passes me my gold which is the commodity.
The debate was incendiary at times, but raised some fascinating questions. Regulation is moving faster I think than anyone could have anticipated. Just a few months ago Doug Ducey, Arizona’s Governor, signed HB 2417 into law. This law clarifies enforceability issues and actually provides some legal precedent to the legality of blockchain and smart contracts.
As you can see, there are technical and regulatory hurdles to overcome before the blockchain can go “mainstream.” and provide the holistic infrastructure that improves every aspect of the real estate industry. However, these obstacles are being addressed quicker than I think anyone that has been in the blockchain trenches could have anticipated. REX is on a roadmap to launch our Alpha in 2018, and remains on the forefront of the technical, legal, and even social issues at play as blockchain technology continues to grow into a foundational underpinning of commerce.
The more people understand the infrastructure and challenges, the better they can plan and apply the technology to their business. 2018 will be an exciting year in blockchain, and we will begin to see practical real estate applications emerge. This will provide confidence and take an abstract technology into practical application.