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Can NFTs be used in Real Estate transactions with the help of Blockchain?

Enes Akyol

Bilkent Üniversitesi Hukuk Fakültesi


 


I. Understanding the Blockchain Technology

Blockchain has emerged as a transformative force, challenging conventional systems of trust and record-keeping.  Although Blockchain serves as the foundational technology for cryptocurrencies such as Bitcoin, its applications extend well beyond the realm of digital currencies (Tapscott 2). Indeed, technically, blockchain is a decentralized and distributed ledger system that holds the promise of unparalleled transparency, security, and immutability. Each transaction of the blockchain is grouped into blocks, which are then linked together in a chain. Then, once a block is added to the chain, it becomes an immutable part of the record. As Satoshi Nakamoto (2008) stated in the original Bitcoin whitepaper: “The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work.” In real life, the use of blockchain technology spans sectors ranging from voting, supply chain, real estate, medical use, wine, identity, dispute resolution, and more with developments.

Transparency, one of the most important features of blockchain technology, has grabbed significant attention across industries. For instance, in the financial sector, blockchain promises to revolutionize the way transactions are conducted and recorded. Distributed ledger technology has the potential to make financial services more efficient, resilient, and reliable (World Economic Forum 3) Security is another paramount aspect of blockchain technology. The cryptographic techniques used in blockchain make it nearly impossible to alter or tamper with any data within the system (International Data Criminal 5) This security feature could be used in healthcare, voting, real estate, and so on... Thirdly, the immutability of blockchain records has important consequences. Once a transaction is recorded on the blockchain, it cannot be altered or deleted. This quality could be beneficial in supply chain management, where tracing the origin and journey of products is a necessity (The Conservation 3).As blockchain technology gains momentum, its versatility becomes apparent. Beyond financial services and supply chain management, blockchain is making inroads into healthcare, government, energy, real estate, wine, voting, and various other domains (Corrales and Fenwick 65). This revolutionary impact of blockchain could strengthen democracy and governance as well. This means that understanding the real meaning of blockchain technology goes beyond its association with cryptocurrencies; it is a transformative force that offers transparency, security, and, immutability across various sectors and its impact on our society is just beginning to unfold.


II.  Introduction to NFTs

The emergence of Non-Fungible Tokens (NFTs) in the digital realm has sparked a revolution in how we perceive and interact with digital assets. While cryptocurrencies like Bitcoin are fungible and interchangeable, NFTs are the digital equivalent of a certificate of authenticity.  At the heart of NFTs is the concept of uniqueness. In a world where countless digital content is created and shared, NFTs ensure a means to prove ownership and can make the intangible item tangible in a way. Beeple’s auction -which was one of the most important events made for NFTs in March 2021- proved that NFTs are a new way of authenticating, and owning the distinct digital item, from art and music to real estate and in-game items.

            NFTs are not confined to the art world. The music industry, too, has felt the effect of this technology. Musicians also have started to explore the world of NFTs, releasing exclusive content as digital assets that their fans can own. They also started to release unreleased tracks, concert tickets, or even exclusive backstage access as NFTs. For instance, RAC, a Grammy-winning artist and DJ, believes that NFTs have the power to redefine the relationship between creators and their audience, allowing for more direct engagement and financial benefits. For game developers, NFTs have introduced the concept of true ownership of in-game items, allowing players to buy, sell, and trade virtual assets, giving rise to a virtual economy. Games like “Axie Infinity” gained popularity at that time by allowing players to earn and trade NFTs within the game’s ecosystem (Finextra 2).  Moreover, NFTs are allowing a new dimension of ownership in the virtual world, which is called Metaverse. Metaverse is a virtual reality space where users can interact with each other. These items can be bought and sold as NFTs, which ushers in a new era of virtual property ownership. With these developments, it can be said that NFTs are not just transforming digital and virtual ownership; they are expanding into various sectors from sports to fashion. In sports, NFTs offer a new way for athletes and teams to engage with their fans. For instance, NFT Top Shot, a platform that allows fans to buy, sell, and trade officially licensed NBA collectible highlights as NFTs, gaining popularity (Nba Top Shot 1). In fashion, brands have started exploring NFTs as a way to create unique digital fashion items that consumers can own and display (3Dlook 4).

 

 

III.  NFTs in Real Estate

The traditional world of real estate has long been associated with mortar and brick, deeds and contracts, and a complex web of transactions involving physical properties. Yet, the digital age has ushered in a transformation that challenges these conventions, introducing a novel concept that promises to revolutionize real estate transactions and ownership: Non-Fungible Tokens (NFTs). These unique digital assets, made possible by the underlying technology of blockchain, are quickly extending their influence beyond the art and entertainment sectors into the world of real estate. It also redefines how we interact with property. These unique digital assets, underpinned by blockchain technology, offer a multitude of advantages, by being faster, cheaper, more inclusive, and reliable. However, like any transformative technology, NFTs in real estate also come with their share of challenges, including regulatory uncertainties, environmental concerns, and the potential for speculation.


A)    Benefits of Tokenizing NFTs

One of the most important benefits investors see in real estate NFTs is in the transaction parts. For instance, companies have to go through title records that may be scattered in different places to determine a property's ownership history, which takes approximately ten to fourteen days. However, the CEO of Propy reported transferring a studio apartment in just 22 minutes using an NFT. This speed appeals to younger generations like Gen-Z who are accustomed to making high-value purchases online and expect a seamless experience when buying real estate. In this way, blockchain serves as a digital public ledger recorded on an ongoing database that is always accessible and verifiable to third parties. This verification system could serve as more transparent and accessible to people.

Another important advantage investors see in real estate NFTs is fractional property ownership (Sarkman 13). RealT enables fractionalized, token-based investments in rental properties, making real estate investing more accessible to the average person without the need for additional financing. Through tokenization, a property can be subdivided into multiple units, each represented as an NFT available for individual purchase. For instance, consider a 100,000-square-foot office building with an estimated worth of 5,000,000 million TRY. It can be divided into 500 equal units, making it feasible for 100 individuals to invest as little as 10,000 TRY to own an equal share of monthly rental earnings. Alternatively, the division can be further increased or decreased as well. This innovative approach can both serve as a novel funding mechanism for real estate investments and as a means for smaller investors to participate in the real estate market.

Another benefit of blockchain is its reliability and inclusiveness. When an asset is tokenized as an NFT on a blockchain, the ownership information is recorded on the blockchain, the ownership information is recorded on the blockchain. Blockchain technology is known for its immutability, meaning once information is recorded, it cannot be easily altered or changed by others. This provides a reliable and transparent record of ownership. Secondly, tokenization can reduce the need for intermediaries in transactions. Direct peer-to-peer transactions are possible through blockchain technology which reduces costs and makes it more inclusive by eliminating the need for middlemen. Certain companies like Propy are exploring the idea of migrating local land records to a blockchain. They partnered with the city of South Burlington, Vermont, to test the use of blockchain as a recording system. The ultimate goal is for Propy to become South Burlingston’s official recording system.

B. Challenges and Concerns

Existing real estate laws do not facilitate NFT real estate transactions. These laws require the use of mortgage documents to grant the lender an interest in land as security for a loan. Secondly, given the current absence of regulatory frameworks governing NFTs within contemporary legal systems, it is foreseeable that individuals may encounter challenges and adversities associated with this emerging asset class. To mitigate the risk of individuals falling prey to such issues, it becomes imperative for states to collaborate and institute new regulatory measures about NFTs. It is noteworthy that jurisdictions characterized by a centralized governing authority may exhibit reluctance to embrace systems founded upon decentralized structures. For instance, the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA) provide special protection for homebuyers in traditional mortgage transactions. However, the protections may not be applied to NFT Real Estate transactions for now.

Transitioning from traditional land recording systems to blockchain-based ones presents significant challenges as well. First of all, moving from a paper-based system to an electronic one can be costly. Updating systems and providing the necessary training to government employees can require significant financial resources. Additionally, as it is known, countries depend on the revenue generated from recording fees generated by their Recorder of Deeds offices. Implementing a blockchain-based system could potentially lead to a loss of revenue as it reduces the need for traditional recording fees. Thirdly, preserving trust in the recording system is paramount. Blockchain systems are frequently overseen by anonymous nodes, a factor that may not inspire the same level of trust as established government institutions. Overcoming the challenge of instilling public confidence in the new system is of considerable importance. For instance, in the case of Delaware, they attempted to integrate blockchain for corporate records, illustrating the practical difficulties in implementing new systems. Despite legislative changes to recognize blockchain as a method for maintaining corporate records, issues of trust, cost, and practical implementation remain.


IV.Real-world Examples of NFTs and Possible Future Trends

Beyond property ownership, NFTs can serve as a means of property financing. Notably, LoanSnap, a mortgage lender, has announced its intention to create seven residential mortgages in the form of NFTs. This initiative operates through LoanSnap’s Bacon Protocol platform, which is established on the Ethereum Blockchain. The platform permits homeowners to exchange a property lien for an NFT that represents a share of the property’s value. Borrowers subsequently make mortgage payments directly to Bacon Protocol, with interest rates offered ranging from 1.5% to 3.1% (Samkian 7).

Other companies and investors have also embraced the use of NFTs in real estate transactions. For instance, a collaboration between One Sotheby’s International Realty, Voxel Architects, and Meta Residence is in the process of creating the “first-ever NFT luxury mansion” in the physical world. This collaborative group is constructing a high-end residence in Miami, Florida, and replicating it 1:1 in the Sandbox metaverse game. Ownership rights for both properties will be represented as NFTs and auctioned via One Sotheby’s. Another instance involves the blockchain startup Propy, which recently completed the sale of an apartment in Ukraine as an NFT. The company has intentions to extend its real estate-backed NFT program to the United States and is actively engaged in developing the necessary technological and legal framework for converting into NFTs.

However, like any emerging technology, real estate NFTs come with potential risks and drawbacks. For NFTs to gain widespread adoption in the real estate industry, they must receive legal approval and standardization across different municipalities, a process heavily reliant on government acceptance. A major obstacle lies in ensuring compliance with government regulations and establishing blockchain as legally recognized record-keeping. Nevertheless, several cities and states are becoming more open to adopting this technology. Regarding the utilization of NFTs for property fractionalization, challenges persist in determining the legal authority to control the property.


V. Conclusion

NFTs, essentially digital certificates of authenticity, embody the concept of uniqueness in a world inundated with digital content. From Beeple’s groundbreaking auction, which marked a turning point in the perception of NFTs in March 2021, to the realms of music, gaming, and the emerging Metaverse, these unique digital assets offer a tangible means of proving ownership in the intangible digital space. The realm of real estate, historically tethered to physical deeds and contracts, is undergoing a radical transformation fueled by NFTs. These unique digital assets, underpinned by the blockchain, promise a paradigm shift in real estate transactions by making them faster, cheaper, more inclusive, and more reliable. The advantages are diverse, encompassing expedited transaction times, fractional property ownership, and heightened transparency through the verifiable and accessible digital public ledger inherent to the blockchain. The allure of NFTs, particularly for younger generations such as Gen Z, lies in the seamless online experience they bring to high-value transactions. However, there are some problems. For instance, legal impediments, regulatory uncertainties, and environmental considerations present obstacles that demand careful navigation. The integration of NFTs into the traditional real estate landscape faces resistance from existing laws that do not readily accommodate NFT transactions. Bridging the gap between decentralized blockchain systems and centralized legal frameworks poses a considerable challenge, requiring collaboration between innovators and regulators. Furthermore, government acceptance and regulatory frameworks are pivotal in ensuring compliance and establishing blockchain as a legally recognized record-keeping system. It is also evident that the transformative journey is both promising and challenging. The collaborative efforts of stakeholders, from tech visionaries to legal authorities, will determine the trajectory of this revolution. In the foreseeable future, we may witness a reshaping of the real estate landscape, where digital uniqueness converges with tangible properties, ushering in an era where NFTs become a mainstream tool for property transactions, ownership, and investment. The path forward requires not only technological innovation but a harmonious synthesis of legal, regulatory, and societal acceptance to truly unlock the potential of NFTs in revolutionizing real estate.

 

 

References

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