Will blockchain spell the end for secured real estate financing?

Traditional Real Estate Finance

Most real estate professionals understand that real property is an illiquid asset. Meaning that the equity locked up in real estate isn’t easily converted into cash; and the only way one can convert equity into cash is by borrowing against it. This is done by way of a mortgage. 

For decades property owners who have needed cash for one reason or another have agreed to pledge their property as collateral in order to obtain a loan secured by a mortgage or deed of trust. Typically, this is achieved through a bank or mortgage company. In certain instances, a property owner will seek to obtain a loan from a private lender. In either case, in order for an owner to access the liquidity from the equity stored in his property he must incur various fees and charges, including pledging his interest to a third party, who will then file a lien against it to secure repayment of the obligation owed. 

Assuming an owner qualifies and is approved for a mortgage loan, a lender will then negotiate the terms, i.e. the loan to value, APR, interest rate, monthly payment amount, length of loan, etc. and ultimately draw up the note and mortgage for the borrower’s approval and signature. Once the transaction closes and the lender funds the loan and records their lien against borrower’s property, the borrower is now under an obligation to comply with the terms of the loan or face a foreclosure and possible deficiency judgement. 

The consequences for a borrower not fulfilling his or her obligations under a note and mortgage are incredibly severe and can result in a complete divestment of their ownership and possessory rights, as well as derogatory item being placed against your credit report.

Considering what could happen if one is unable to meet their obligations under the terms of a mortgage loan, why would anybody want to endure the long and arduous mortgage loan process? The answer is simple. Because it fulfills a need in the marketplace. Property owners need to be able to access the equity in their property and convert it to cash to pay for things they want and need. 

The concept of pledging one’s property to another in exchange for money has existed for centuries. And banks, credit unions and finance companies have played an important role in allowing property owners the ability to tap into their equity by offering cash in exchange for a lien against a borrower’s property.   Seems like a win-win situation, right? The owner/borrower gets cash from the lender, and a lender gets a lien against borrower’s real estate. Unfortunately, if the borrower fails to make the required monthly payment as promised under the loan agreement, the lender has a legal right to sell the property at auction in order to recover the outstanding balance of the loan.  

While the mortgage lending system has worked well for many years, as a result of the advent of blockchain and cryptocurrency technology, a property owner no longer requires the services of a bank, finance company or lender in order to access the liquidity in his property. Further, a borrower no longer needs to make monthly payments to a lender or fear the prospect of a foreclosure if they are unable to pay as agreed. 

New paradigm in Real Estate Finance

How does utilization of blockchain and cryptocurrency technology remove the need for a mortgage lender, as well as all the costs associated with a conventional mortgage or loan product?  Likewise, how does this technology, eliminate the need for monthly payments, short-sales, threats of foreclosures, and predatory lending practices?

Turbadium, a blockchain start up based in San Francisco, California believes they have figured it out. In order to better understand Turbadium’s concept of unlocking equity and creation of what they term as “sound money” a brief explanation of how cryptocurrency works within a blockchain environment is in order. 

What is Cryptocurrency, and How does it work?

Without getting too technical, a cryptocurrency, like Bitcoin, is essentially a digital asset that is secured utilizing public and private key cryptography. Bitcoin can be transferred peer to peer without the need for an intermediary like a bank or financial institution. It cannot be double spent, and its ownership can be tracked on an immutable, and global, public ledger system which is kept secured by participants in the network called nodes utilizing an algorithm to achieve mutual consensus.  

Each node in the Bitcoin blockchain runs a copy of the entire ledger on its computer. The nodes, also called “miners”, undertake work to solve a complex computer puzzle. The winner that solves the puzzle then broadcasts the solution to the other nodes as proof they solved the puzzle correctly. Once a consensus is reached, the node gets to place the block onto the blockchain and gets rewarded in new bitcoins. While this is an overly simplistic description of the inner workings of bitcoin, including proof of work, the gist is there for purposes of this article.

Cryptocurrency classification

Since its inception in 2009, Bitcoin, like other cryptocurrencies, has acted as a store of value. But its unique qualities also allow it to function as a medium of exchange as well as a unit of account. 

Understanding the classification of cryptocurrencies has been a bit tricky over the years as there really is no clear precedence for this type of asset. For years regulators have struggled to understand the technology and thus uniformly classifying cryptocurrencies like Bitcoin one way or another has proved challenging for regulators, not only here in the U.S. but also abroad.

While there is still very little case law on the books, recently the SEC has spoken out and given some guidance on the matter by specifically eliminating true decentralized cryptocurrencies like Bitcoin as falling outside the regulatory purview of the SEC.  

At present, most regulators, like CFTC and IRS here in the U.S. classify bitcoin as a property right, like a commodity. While FinCEN by way of the U.S. Treasury, classifies cryptocurrencies such as Bitcoin as currency.

Why classification is important

Classification is important in this context because what Turbadium is attempting to do is develop a true cryptocurrency. One that is stable and, can be used not only as a store of value but also as a medium of exchange as well as a unit of account. A cryptocurrency that is tied to a hard asset like real estate. 

The cryptocurrency proposed by Turbadium will, in theory, be one similar to that described by SEC chairman Jay Clayton in an interview he did with CNBC, i.e. one “like bitcoin, that replaces sovereign currencies like the yen and the euro.” 

In addition to the above, Turbadium’s ultimate goal is to create what they term as “sound money”. Money that is backed by an asset, like real estate, and is not subject to the control of a central bank or government. The creators of the Turbadium model are staunch libertarians and share similar ideological beliefs to that of the famed Satoshi Nakamota, the anonymous creator of Bitcoin. Creation of a true free market digital currency that cannot be manipulated or controlled by centralized intermediary, while at the same time offering security and anonymity are all important features to have when developing a commodity coin like the one proposed by Turbadium.

Turbadium’s founders believe in Austrian economic theory in that the free market should dictate the price of goods and services, and that money creation and policy should not be controlled and manipulated by a select few at the top.  Due to the advent of Blockchain technology, companies like Turbadium can now experiment with different types of economic ecosystems that utilize free market, Austrian economic based theory that can serve as an alternative to our existing keynesian system.

Releasing trapped equity

With all that being said, how does Turbadium allow owners to release the liquidity trapped inside the equity in their property? They accomplish this through the process of tokenization and cryptocurrency generation. 

What is tokenization?

Tokenization is the process of converting rights to an asset, like real property, and creating a digital representation of it, by way of a token, which gets placed onto a blockchain.

The Turbadium Virtual Machine, Tokenization and Cryptocurrency Generation on a Decentralized Blockchain Environment

Turbaidum has created a virtual vending machine that exists on its own blockchain called the Turbadium Unified Blockchain Lattice (UBL), which intends to be scalable, flexible, immutable, and decentralized containing its own consensus algorithm. The UBL will include some Proof of Work-mostly to prevent spamming. The master nodes will primarily run Proof of Stake for the governing chain consensus & cross-chain validation. 

According to Turbadium, delegation is possible but not required with its blockchain. Delegation at launch will be used more for the rolling vote periods – meaning the currency users, for example, can delegate their governance shadow tokens to a predefined party. Then there is a reputation system they are baking in utilizing Semada's reputation algorithm which will eventually replace (or mostly automate) the delegation which will be based on reputation score.

With the introduction of a governing blockchain, a Turbadium Asset Blockchain (TAB) can interact with other chains to form private asset exchanges, pooled or index chains, or deposited to generate asset-backed cryptocurrency units. A governing blockchain will allow future asset classes to transparently interact with other chains in the UBL and even for the creation of entirely new classes of cryptocurrencies. 

Turbadium’s vending machine has been created for the express purpose of accepting and holding on deposit (by way of a smart contract), a digitally created asset token generated from a specified parcel of land, which then dispenses a cryptocurrency called Turba to the owner and holder of the asset token.

The concept is similar to that of a pawn shop collateral loan but different in that Turbadium is not loaning money the money to the asset token owner. 

In this case the property owner who has tokenized an interest in his property will then deposit the asset token into Turbadium’s virtual vending machine, which will hold the asset token on deposit for the benefit of not only the asset owner, but also the future owners of the cryptocurrency holders who make up the Turbadium blockchain ecosystem.

The token, once deposited within the Turbadium virtual vending machine, will then start the process of dispensing to the asset token owner a cryptocurrency called Turba into the asset token owner’s crypto wallet. Turba will then be sold and traded, peer to peer, on the secondary market exchange for fiat currency if so desired as the exchange rate for Turba should be 1 to 1 with the US dollar.

Turbadium’s smart contract virtual vending machine will hold the owner’s digital asset token on deposit, similar to a contract bailment, and can only be re-aquired by the asset owner upon re-deposit of the equivalent amount of Turba that was originally dispensed to the asset owner. Otherwise, the toke will continue to remain on deposit functioning as the asset which is backing the cryptocurrency and being traded and exchanged out in the marketplace.

How does a parcel of land get tokenized?

Tokenization isn’t just about creating a digital representation of particular asset. There is more to it than that. Ownership, property value, taxes, liens and encumbrances that affect title to the underlying real property asset must still be confirmed and verified before the asset becomes “tokenized”.  

While blockchain technology is a revolutionary breakthrough, the old principal of Garbage in, Garbage Out (GIGO) still applies. Documentation and information about the property and the property’s owners will still need to be collected, reviewed, authenticated and packaged in order to create an accurate digitized representation of the particular asset, meeting a specific rule set that the Turbadium virtual machine will accept. Think of it similar to the underwriting guidelines a lender uses to qualify a borrower and property in determining if it will extend a mortgage loan. Legacy technologies and systems will still be needed in order to accomplish Turbadiums vision, thus ushering in new business opportunities to help facilitate this new paradigm in real estate finance. 

Tokenization Agents

Tokenization agents will play an important role in supporting Turbadium’s future blockchain ecosystem. This is accomplished through the creation of the digital tokens which will feed Turbadium’s virtual vending machine in order to build out the network.

A tokenization agent will function similar to a loan officer in that these individuals, or entities will directly engage with property owners to assist them with tokenizing their real property interests. These individuals or entities will follow a checklist of underwriting requirements built into the coded rule set of Turbadium’s virtual vending machine. These items will include, but not be limited to, ordering a title report, appraisal, tax certification, confirming insurance, in addition to utilization of an escrow to confirm transfer of the property into a specialized land trust. Tokenization agents will work with an attorney who specializes in preparing these land trust which will be used specifically for real property tokenization.

Tokenization agents will likely employ blockchain developers, either on staff or outsourced, which will be utilized to create the digital asset token that is based on the culmination of all the documentation that represents the true owner’s interest in the real property.  

Ancillary Service Providers

In addition to Tokenization Agents, ancillary service providers such as title, escrow, appraisers, attorneys, insurance agents, and the like will all be necessary to support this new shift in crypto finance. 

Instead of dismissing blockchain technology as a passing fad, these services providers should all be gearing up to take advantage of this alternative revenue source that will surely transform the real estate finance industry for years to come. 

If you would like to learn more about Turbadium, visit their website at  www.turbadium.com, or if you would like to partner with the company to learn how you can take part in this new paradigm shift in real estate finance, you can contact the company via email at info@turbadium.com, or by phone at +1.415.349.5001.