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Tokenizing Real Estate: How They Work Explained

In this article, we’ll explain what tokenization means, it's benefits and challenges, and how the tokenization process works.

Tokenizing Real Estate: How They Work Explained August 15, 2020

Until recent years, blockchain was known for the technology powering Bitcoin. However, cryptocurrency is one of the applications of blockchain technology. 

Blockchain is a type of distributed ledger which secures identical copies of data across a network of authorized stakeholders. In contrast to a centralized database, there is no single point of failure for data stored on blockchain, and unauthorized access to or alteration of data is near impossible.

Accelerating the exchange of value

Tokenization is the process in which the rights of the assets are converted into digital tokens which represent a certain amount of shares of the underlying asset. 

Unlike traditional real estate, the assets are divided into shares that are sold to investors similar to crowdfunding. These tokens (also known as security tokens) are traded on a platform making it easier for investors to buy or sell real estate similar to stock market transactions. And as these tokens are backed by real estate assets, they carry far less risk than cryptocurrencies like Bitcoin which are highly volatile.  

Benefits

Fractionalization

Tokenization lowers the barrier to entry for investment by enabling fractional ownership across a wider pool of investors. Unlike traditional real estate, the assets are divided into digital tokens which represent a certain amount of shares of the underlying asset similar to crowdfunding.

Automated transactions

Executing a real estate transaction using a smart contract over a traditional lease permits transactions to be carried out between anonymous parties without the need for a third party. Smart contracts could trigger automated rent payments, security deposits when certain predefined conditions are met. 

Transparency

A digital identity of a property can enable transparency and consolidate information such as vacancy, financial history, legal status, and performance metrics. This could speed up the due diligence process and reduce the chance of fraud.

Liquidity

Tokenization unlocks liquidity by enabling fractional ownership and lowering the barriers to entry for investment in illiquid assets. Security tokens are traded on a platform making it easier for investors to buy or sell real estate similar to stock market transactions. And as these tokens are backed by real estate assets, they carry far less risk than cryptocurrencies like Bitcoin which are highly volatile.

Key Challenges

1. Lack of awareness: The principal challenge associated with blockchain is a lack of awareness of the technology, especially in sectors other than banking, and a widespread lack of understanding of how it works.

2. Disrupting the norms: Blockchain is a total shift from the traditional way of doing things. It places the control on a decentralized network rather than a single stakeholder. Adoption of blockchain could be challenging.

3. Regulation: Regulations have always struggled to keep up with technology. The potential of a token-driven economy can only be realized if it gains regulatory and government acceptance.

4. Costs: The speed and effectiveness with which blockchain networks can execute peer-to-peer transactions come at a high aggregate cost. The total running costs associated with validating and sharing transactions on the public ledger are estimated to be as much as $600 million a year and rising. This total does not include the capital costs associated with acquiring specialist mining hardware.

5. Security: Smart contracts require them to be linked to known identities and raise the important question about the privacy and security of data stored on a public ledger. The public acceptance of security tokens will likely mean proactively framing the discussion of privacy around concepts of value, security, and trust.


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