PropTech in the United States – where we're heading

Part 1 - Blockchain-based smart contracts and transaction automation

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PropTech Insights

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The traditional real estate industry is being reshaped by the emergence of blockchain technologies, artificial intelligence, and the Internet of Things. These technologies help real estate "incumbents" execute transactions more efficiently and consistently. But this is only a small part of their impact. The more disruptive change created by PropTech technologies is the evolution of new business models that transform operations and create new revenue streams. Terms like the shared economy, smart buildings, smart cities, tokenization of real estate assets, and virtual reality are signposts of this vast change.

As these technologies continue to grow and become more widely applied, and as the regulatory framework continues to develop, PropTech will automate to its full potential.

In this article, the first in our series, we take a look at blockchain-based smart contracts and transaction automation.

Smart contracts and automation

The idea of the "smart contract" is nothing new. When Nick Szabto first introduced the concept in the mid-1990s, he conceived a smart contract as "a set of promises, specified in digital form, including protocols which the parties perform on these promises." More recently, the concept has taken on new relevancy in the real estate industry with the invention of blockchain, the technology underlying smart contracts.

Blockchain is a combination of technologies – including digital signatures, asymmetric key cryptography, distributed ledgers and peer-to-peer communication, among other things – which, collectively, support a decentralized network of information cryptographically stored on-chain.

A blockchain real estate platform can link to real-world external property data (such as grantor-grantee indexes, chain-of-title documents, zoning information and public utility data, for example) to generate a digital identity for a particular parcel of real property. Using blockchain-based digital identities, a prospective buyer and lender of that parcel can conduct due diligence and, at the time of contract negotiation, incorporate closing conditions that are tied to the status of this external data.

Real estate contracts themselves can also be generated on the blockchain, with the key terms programmed on-chain and the underlying documents stored off-chain. When certain predetermined conditions occur, the technology is self-executing. A blockchain-based smart contract, for instance, between a buyer and seller can determine whether certain closing conditions are met, initiate the payment of proceeds from the escrow account to the seller's account, and notify the title official to initiate the property transfer to the buyer. In the leasing context, a "smart" lease agreement can, among other things, initiate payment of a security deposit and rent when the lease is signed and, going forward during the lease term, facilitate automated payments. If the tenant occupies the space, then the smart lease can automatically release rent payments – secured in a digital wallet – to the landlord after netting out payment of operating expenses. All of this activity can be monitored – and authenticated – by the smart contract's link to the external data via the blockchain platform.

A challenge to the legal framework

Smart contracts facilitate automation, certainty, and efficiency. But they also present challenges to the existing legal framework. In this area, we can expect significant changes in coming years.

In this new environment, for example, contract law will need to address such subjective issues as "reasonableness" and "good faith" in the context of automated smart contracts. Another key concern – the consequence of human error. The coding associated with the data input and design components of smart contracts may, in some instances, become quite complex. But coders are only human. The consequences of coding mistakes or bugs can lead to financial or other losses by transaction counterparties, beneficiaries or third parties – the effects of which could easily reverberate even farther afield, posing risks to a company's broader reputation and triggering disputes that lead to costly litigation.

For these reasons, prudent counterparties to smart contracts might well demand additional layers of professional due diligence at the front end – by lawyers to provide comfort that the coding and related contractual documents and provisions are legally enforceable, and by tech experts to verify that the protocols are sufficient to maintain the coding for its intended functions. While smart contracts are designed to perform largely without such intermediaries, there will – at least for the foreseeable future – be a need for human oversight, intervention and interpretation to address legal disputes involving such contracts.

Finally, it is important to note that the wider real estate industry has traditionally relied on legislative guidance and innovation to address fundamental changes and novel issues within the industry. In the case of smart contracts, the United States government, to date, has not regulated smart contracts to the exclusion of states. As a result, smart contracts – and the surrounding technology – are mainly regulated (if at all) at the state level. For now, some of the most important legal developments for blockchain and smart contract regulation and implementation in the United States have probed whether the smart contract is enforceable or can be used as evidence in contractual disputes.

Summary – the future

PropTech will continue to unlock new and untapped opportunities for the real estate industry in the United States and beyond. Simply introducing superior technology into the traditional real estate context, however, does not guarantee such technology's adoption, much less its scalability or ultimate success.

Real estate companies must reconsider their existing systems and find ways – via emerging technologies such as the blockchain and smart contracts – to efficiently and reliably connect to a broader range of ecosystems.

Given the complexity and novelty of these issues, it is critical that players in the PropTech space work closely with experienced advisors to navigate potential minefields and manage emerging risks while pursuing the very real opportunities that these technologies present.

Learn more about these PropTech issues by contacting either of the authors.