Introduction
One of the advantages of being a lawyer specialising in crypto and blockchain is that you get to see trends as they start to develop.
A current hot one is the tokenisation of real estate. The typical project sees the developer offering fractional ownership of a commercial property, and in return for investing perhaps just a few hundred pounds, you are offered a share of the property and a cut of future rental income.
Your investment goes to buy a crypto coin/token which represents a percentage of the ownership. Frequently the developer will be looking to fund the purchase of the property from the money made on selling the tokens. I currently have two such projects on my desk: one involves a hotel in the Middle East and the other a small apartment block in a major UK city.
Sounds good, huh? For a very small outlay you get to part own property and enjoy a share of rental income for years to come. Also, you hope that the value of your token will appreciate over time, so you can make a capital gain on that too. What’s not to like?
Is it a Scam?
So, what’s the catch? Is the whole thing a scam, or is it an example of very clever people spotting the next new opportunity?
As is so often the case with crypto, there are no doubt scams where the whole project is a fiction, and the “developer” takes the money and runs.
However, from my experience, I am usually dealing with honest, clever (but often somewhat opportunistic) entrepreneurs who don’t have an in-depth understanding of blockchain/crypto or the law of property. They just see the opportunity to tap a huge new and largely compliant investment group. In their gung-ho enthusiasm to reach these people with a short, simple and compelling sales pitch they can wildly oversell in genuine ignorance – quelle surprise!
Understanding Blockchain Tokenisation
Blockchain tokenisation involves converting rights to a property (or a company’s shares or loan note, or other asset) into a digital token on a blockchain. In the context of UK real estate, this means each property can be divided into numerous tokens, each representing a fraction of the property. These tokens can be bought, sold, or traded on a blockchain platform, enabling a more flexible and accessible real estate market.
Advantages of Blockchain Tokenisation
- Liquidity: tokenisation can increase the liquidity of the real estate market. Traditional property transactions can be time-consuming and costly and involve major transfers of ownership that can have contractual and other ramifications, but blockchain transactions can be micro-transactions which can be completed quickly and cheaply, making it easier for investors to buy and sell interest in properties. Well, that’s the theory anyway.
- Accessibility: tokenisation allows (again, in theory) for fractional ownership of properties. This means that investors can buy a fraction of a property, rather than having to buy the whole property. This opens up the property market to a much wider range of investors and allows significant customisation and differentiation of the offering to different groups.
- Transparency: blockchain’s immutable and transparent nature ensures that all transactions are recorded and visible to all parties involved. This can (in theory) help to reduce fraud and increase trust in the property market.
- Access to new sources of development funds: tokenisation offers the opportunity to effectively crowd fund developments from a literally world-wide investor pool.
- Personalisation: crypto currencies are fungible – which means they are all the same and thus interchangeable in the same way that real money is. However instead of using crypto currencies as the tokens on a project, a developer might choose to use NFT’s (non-fungible tokens). Each NFT is unique (although if you could tell the differences between the thousands of Bored Ape images then you have a better eye than me!). As each is unique, each can be tailored, e.g. to allow a different percentage of ownership, and to perhaps pay out a different rate of return over a different time period – or to offer other benefits such as building naming rights or time-share occupation rights, etc.).
Challenges of Blockchain Tokenisation
Despite these theoretical advantages, there are a number of real-life problems hampering the emergence of this new “utopia” for developers. Be under no illusion however, the world’s big financial players see the potential for huge new profits and much reduced costs and liability from tokenising assets. It’s going to happen - and sooner than you think. But what are the issues that currently make the offer of fractional ownership of UK real estate unrealistic?
Apart from the general lack of a trading framework for something so new, the legal framework for property ownership in England is the biggest challenge. It is complex and well-established. Adapting this framework to accommodate blockchain tokenisation will require massive changes in the law. For example:
- The presumption is that whoever is named as the owner on the Title Register held by Land Registry is the legal owner. The system simply is not designed to accept, and couldn’t possibly cope, with hundreds or thousands of people claiming fractional ownership - and possibly changing that ownership on a daily basis if the relevant token is one which is traded.
- Who would speak on behalf of the owners? The majority or (like now) 100% of the named owners?
- Transfers of real estate in the UK must be recorded in writing and comply with certain criteria. The way that crypto currency tokens are bought and sold goes nowhere near meeting this requirement.
- Before the Land Registry will allow property to be transferred it will require proof that all the current owners agree. If only from a practical perspective, how likely is that they will get written agreement from the perhaps thousands of fractional owners?
- Property transfers in the UK are subject to stringent anti-money laundering checks that deal with source of funds and the identity of the parties involved. Again, it is hard to see how the system could be adapted to actually work with a global band of “mayfly” investors.
- UK property is a tradable asset, and that is what tokenisation is focusing on improving. But UK property is also present in the real world and there are real-world legal obligations/legal risk that automatically arise from being an owner (e.g. building maintenance). Who is liable, and how they are held accountable is yet to be determined.
- Offering tokens to the general public is very much straying into financial services and all the regulatory obligations that implies. For now at least (but do watch this space…) crypto currency mostly sits outside of FCA regulation unless one is actually offering it for sale or providing a platform to do so. I think tokenisation will be seen as securities trading and regulated accordingly (and rightly so).
Most of the above problems can be dealt with by the fractional investors taking shares in a company and that company being the owner of the property. BUT that directly contradicts the offer of being a part owner of property.
It also rather undermines the need to complicate matters by involving tokens at all. Instead, the company could just issue different classes of shares with different rights to different investors.
So why are developers so interested in tokenisation? The main answer is that it unlocks access to a literally global pool of investment funds not previously available. There’s also the added advantage that such small individual investors are unlikely to ever challenge the developers’ control of any holding company or the property itself. To be fair however, tokenisation also allows developers and owners to be very flexible about how, who, when and on what terms the property is owned.
Conclusion
Blockchain tokenisation has the potential to revolutionise the UK real estate market, making it more liquid, accessible, and transparent. However, until significant changes in the law are made, potential investors need to look very closely at what they’re actually getting for their money.
Most times there is no actual nexus between property ownership and purchase of a property related token. That may not matter, but it is genuinely shocking how many people involved in such projects just assume that token ownership automatically equates to part ownership of the property. The other issue I see which is a cause for concern is that the contractual documentation tends to focus very much on the purchase of the tokens and very little on what rights the token purchaser has with respect to the property itself.
If you need any advice on the matters above or any other crypto / blockchain matter, please call James O'Connell.
If you want to know more about the momentum towards tokenisation of assets generally, just Google “Blackrock tokenization” (note American spelling).