Blockchain: taking the digital plunge

The blockchain technology which underpins cryptocurrency, non-fungible tokens and other digital assets has been around for some time. However, more recently there seems to have been a shift from this being seen as something fundamentally outside mainstream economic and commercial activity, to playing an increasing (and often high-profile) role in modern commerce.  The growth of more speculative digital assets is one part of this. But blockchain technology has far-reaching applications as a decentralised method of recording transactional data – with obvious implications for real estate. A 2019 HM Land Registry trial concluded that blockchain technology could enable speedier property deals, more trust in the transaction, higher levels of security, and increased transparency for participants.  A logical further extension is the recent announcement that a large UK asset manager, Abrdn, is actively considering ways in which it can enable individual investors and institutions to buy digital tokens relating to real estate assets. One of the driving forces behind this development is the “democratisation” of real estate investment, making it easier for individuals to access while allowing for investments in a wider class of assets. So to what extent does this represent the future of real estate investment?  What would these digital tokens be? If we view “tokens” as representing a genuine share of beneficial ownership of a property asset, this is essentially another way of allowing beneficial ownership of an asset to be sub-divided and held separately from legal title. It is fundamentally the same principle as when someone who wants to invest £100 in a start-up business can do so relatively cost-efficiently through a crowd-funding platform like Seedrs or Crowdcube where paper share certificates (or statements of beneficial ownership) are never issued.  A pivot towards blockchain-based tokens could “just” be a more streamlined way of recording and processing transactions.  But if the “tokens” do not represent a share of beneficial ownership of an asset or units in a fund, what rights do they represent? The rapid rise in the prominence of digital assets has left law and regulation struggling to catch up. What does it mean to “own” a digital work of art which you have bought for $69m (£52.3m) – what rights have you actually acquired? How many holders of cryptocurrency understand the tax implications of their holdings, including swapping currencies?  Recent Financial Conduct Authority research suggests ownership of cryptoassets has risen, but the underlying level of understanding appears to be falling. It can be inferred that some holders may not fully understand the risks involved. Digital assets may well grab headlines as they are adopted for high-profile purposes by celebrities, musicians and sporting organisations, but is it realistic for those who are not already experienced real estate investors to make investment decisions based on these assets? Legal and regulatory environment There is no doubt there can be barriers to entry for smaller investors. But this is no accident. The FCA is well aware of the potential for exploitation in the real estate market. While it remains to be seen how this will play out, at first glance it seems hard to imagine that any structures based on digital assets would escape the ambit of applicable rules on financial promotions, collective investment schemes and alternative investment funds simply because they are facilitating the issuance and trading of tokens recorded on a blockchain, rather than more conventional interests. Indeed, the current indications are that government and the FCA will take a reasonably robust line. On 18 January, HM Treasury announced proposals to bring certain cryptoasset promotions within the scope of the Financial Promotion Order.  The legal, regulatory and compliance infrastructure needed to navigate these existing rules, as well as more general requirements of company or partnership law, is significant. And for those structures open to external investors who fall outside the ambit of those rules, similar considerations apply. Retail investors can already invest in a REIT if they wish to do so – but as a public listed company a REIT is subject to its own legal and regulatory demands.  All of this comes at a financial cost. Possible blockchain issues There are also broader concerns around blockchain technology in this context. While records based on registers held by external registrars or central government registries can potentially look outdated and inefficient, they do have a crucial advantage. There is a specific party legally responsible for maintaining accurate records. If an error arises, and this will often be inadvertently, there will be potential legal sanctions against the party in breach, and/or an established route to rectification for the wronged party. There is an inherent level of accountability and transparency, and also knowledge within the broader public (or at least knowledge which is easily accessible). Arguably, that does not currently exist with blockchain.  Overview The comments above might seem pessimistic. That is not necessarily the case. Anything that leads to an improvement in the way in which real estate transactions can be carried out is to be welcomed. But the concern is that, in focusing too heavily on potential advantages of greater digitisation, certain fundamental principles get left behind.  Two keys to unlocking the potential benefits of greater digitisation, particularly in the context of making real estate investment more accessible to those who do not currently participate, are:       The FCA and government attitude, and in particular what, if any, additional regulatory burdens will be imposed. Recent experience in the cryptocurrency sector suggests that – perhaps understandably – the FCA will not move quickly. This in turn creates a danger that early adopters of these types of arrangements may find that what initially seemed like a viable business model becomes more difficult to maintain and potentially unsustainable.  Will the use of blockchain technology in practice achieve sufficient cost savings and operate in a sufficiently reliable and user-friendly way that it is both attractive and cost-effective in driving the more fundamental change in real estate investment which is contemplated? Afterword This piece is written on the basis that any developments relate to real-world assets. According to reports, the market for digital land is booming. Around three-quarters of all sales take place on The Sandbox, which recently saw a plot of virtual land change hands for $4.3m. That is a brave new world all of its own. David Webster is a partner at Russell-Cooke  Image © WestEnd61/Rex/Shutterstock