This article is written by Atchaya J, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. The article has been edited by Anahita Arya (Senior Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).
Table of Contents
Introduction
What if I told you there is a technology that can handle all the critical functions of storing, verifying, transferring ownership and money could be streamlined in real-time through a single mechanism that is transparent, secure and fast. That’s blockchain for you, and let us see how it is set to shift the paradigm in the real estate business.
What are blockchains and smart contracts
Blockchain in simple language is a distributed ledger technology that functions in a peer-to-peer network. Thus, the information is neither collected nor regulated through centralization by a single entity. The process starts with recording information with a timestamp as a block of data. That block is then verified by the nodes of the peer-to-peer network. After verification, hashing technology is used to add the block to a chain of blocks. The reason why Blockchain is said to be virtually impossible to hack is that, to alter or modify a specific entry/information, you will be required to alter the entire blockchain which is then subjected to speed limits.
Blockchain technology is set to speed up the slow and tedious real estate transaction process by eliminating all the middlemen keeping in mind the government regulation.
The smart contract simply takes care of all the aforementioned issues and smoothly runs the transaction autonomously. Technically it is an electronic protocol according to the specific instructions input in the respective code of the contract. The terms coded in the contract thus remain fixed and leaves no room for contractual interpretation. These terms are automatically accepted by the parties as soon as they execute the transaction and the money is instantly transferred which is in the form of cryptocurrency.
Smart Contracts in India
Firstly, the Indian Contract Act of 1872 deals with all kinds of contracts. As long as a smart contract incorporates all the essential elements of a valid contract under Section 10, it stands valid. Two questions arise in such case:
1. Is crypto-currency acceptable as a consideration under Indian Law?
2. In absence of a separate regulatory framework, how will aggrieved parties be compensated? (The Indian Government is in fact bringing a regulatory framework for the cryptocurrency transactions soon).
Secondly, the Indian Information Technology Act 200, Section 5 and 10 deals with acceptable and valid digital signatures to enforce a contract digitally. Rule 5 lays down some guidelines regarding the verification of digital signature for the execution of the e-Contract. The execution can be done through:
a. Digital signature- You can obtain a secure digital signature with a digital signature certificate issued by a licensing authority; or
b. E-sign based on Aadhaar (12-digit identification number issued by the Unique Identification Authority of India) e-KYC services (Aadhaar e-sign). Aadhaar e-sign will allow you to render signatures electronically through third-party applications. Such third-party application maintains an audit trail of every alteration to the e-Contract to which the Aadhaar e-sign has been affixed to.
But, since there is no legal authority to sanction electronic signature which is generated through hashing technology in Blockchain, admissibility of Smart Contract before Indian Courts become largely questionable under Section 88A of the Indian Evidence Act.
Under Section 25 of the Indian Contract Act, 1872, mutual consideration is essential for the validity of the contract. On the other hand, a smart contract can be executed through code even without mutual consideration. In such a scenario, Indian courts will not provide protection to the aggrieved party on incurring damages.
Thus, despite Indian Law allowing the functioning of electronic contracts, the legality of Smart Contracts remain in the grey area. It means that though you may successfully execute a smart contract in India, you may not be able to file a suit or recover damage through Indian Courts. One solution can be coding the smart contract to automatically penalise the party from the cryptocurrency wallet in case of a breach.
What is the situation of the traditional real estate industry
Traditional real estate market is in itself a high risk, high reward and high conditions industry. There are few barriers such as:
Irresolute nature: As simple as it could be said, the seller is cautious and doubtful about transferring the property to the buyer before getting confirmation of the payment. Similarly, buyers are also cautious about sending payment before actually receiving the said property. As a solution to this problem parties hire a third party in real life most of the time such as notaries to get the transaction done with backup and security. But as you can calculate, this process increases the cost and also causes delay for the whole transaction to complete.
Transparency issue: Real estate transactions deal with huge amounts on a daily basis. It requires the involvement of a lot of parties from the parties contracting to brokers to notary etc. Thus, the market is also subjected to corruption, money laundering, tax evasion and related concerns.
Fees: As discussed earlier, real estate transactions involve many parties. On the same ground, it also attracts many fees ranging from exchange to transfer fees, broker to investment fees, lawyer to accountant fees and so on.
Lack of liquidity: The supply of buyers is the main factor deciding the liquidity of a real estate asset. As far as real estate transactions are concerned, there is a long waiting period to get hold of the right buyer or third party for completing the transaction.
Blockchain and smart contracts in Real Estate sector
Propertyclub is one such real estate platform that enables transactions through cryptocurrency or its own PropertyClub Coin (PCC) through smart contracts. Managego, Realblocks, Meridio, Smartrealty, Reasy are some of the blockchain-based real estate companies that have taken the early mover advantage. The Bee Token is an interesting company, similar to blockchain modified Airbnb, where the homeowners rent out spaces in exchange for cryptocurrency.
Tokenization and Real Estate
Blockchain technology enables the tokenization of real-world assets. A token essentially is a representation of a real-world asset, value or function in digital format. To understand how this would be effective, let’s take a look into Fractional Ownership:
Fractional ownership, defined as the scenario where several unrelated parties can share in the risk and ownership of high-value tangible things, is a concept that is resurfacing in new and interesting ways- Forbes.
It basically means, when a property is co-owned by multiple persons through buying tokens of the property. It gives an opportunity to a buyer to micro-invest in order to own a property. Such a transaction can take place hassle-free through a multi-signature smart contract, where the investors are assured that all future decisions shall be undertaken upon agreement of all.
Tokenization of real estate property exists in real life without blockchain. BrickX, Australia is one such example where fractional investing in real estate takes place starting from $100. Blockchain can enhance this process, increasing transparency, security and speed.
Five use case of blockchain in real estate
1. Payments and Leasing
Smart contract’s application on distributed ledger technology enables agreements to be signed and paid on the chain. Every payment ranging from lease to license, rent to security deposits, fees to maintenance can be automated through a secure system which depends on the secure code coded in the contract.
For example, Airfox is a decentralized platform that lets those in underbanked parts of the world make payments, receive small loans and send money all over the globe.
2. Accounting and Financing
Accounting will be shifted to an absolute real-time process as the records are embedded on the chain in real-time. It also means the preparation of various auditing documents such as balance sheets, cash flow statements, income statements etc will not take enormous time, unlike the traditional way.
For example, Westpac, one of Australia’s largest banks, partnered with Ripple, an enterprise blockchain solution for global payments, to implement a low-cost cross-border payment system based on blockchain technology.
3. Registries and Sales
Land titles are vulnerable to mismanagement and lengthy and costly legal procedure for recovery of the same. By maintaining track changes in an immutable ledger which is a secure shared source, blockchain replaces all the tedious paperwork needs, risk of fraud and loss.
4. Loan and Mortgage
Blockchain basically allows transaction of loan or mortgage through verified information, secure data sharing, strict transaction monitoring and real-time payment in a single program. Also, Smart Contracts can be made use of to boost the confidence of investors by providing proof of asset performance through real-time reporting to regulators.
For example, The Synechron Blockchain Accelerator for Mortgage Lending.
5. Identity
Decentralized identities secured among necessary parties through mutualized blockchain-based KYC procedure can enable background checks, high security and low costs.
For example, The public “KYC Smart Contract” and the private “KYC Admin Smart Contract” deployed on the Alastria Network through the Quorum Maker Utility.
Five advantages of adopting smart contracts in real estate
No delays: Commonly, money is transferred to the seller only after the new owner is registered or the notary informs the buyer of the mortgage completed by the previous owner. All these processes result in delay which is automatically eliminated by the smart contracts, where the code is designed to transfer money as soon as new registration is detected in the database. No tricks to delay the transaction can be used by either party contracting.
Transparency: Given the fact that the whole smart contract is based on blockchain technology running in a peer-to-peer network, no transaction is hidden or vulnerable to corruption. All the real estate transactions, usually involving huge values are only executed after verification by all the node computers making it completely transparent.
Secure: Altering or hacking the data in blocks of blockchain is nearly impossible as discussed earlier. Proof of Work and Proof of Stake are two algorithms used to confirm transactions while adding a new block. These mechanisms ensure that the transaction is secure between the parties directly without the involvement of middlemen.
Distributed ledger: Real estate transactions are multi-fold involving many parties and processes. When all the transaction is cleanly recorded and easily traceable back to a distributed ledger with no centralized authority controlling it, it is a great deal to let go of.
Elimination of intermediaries: Blockchain effectively streamlines a non-redundant easy transaction process rendering many intermediaries including brokers, escrow companies obsolete. It brings into function a single mechanism for all the processes from storing, verifying to transferring or digital records.
Future prospect of smart contract
Smart contract is not void of any limitation. Taking a deeper look, it has many serious concerns which requires much more expertise and continuous development to overcome the same. As of now the applicability of smart contracts is limited to only simpler transactions. The reason being software’s inefficiency to process very complex contractual conditions as of now. For instance, think about how complicated construction contracts are on a usual basis. There are sophisticated clauses involving quality assurance of materials and physical verification. When it comes to such physical verification, the smart contract automatically loses its practical validity. Also, how is it possible to rely on smart contracts for the evaluation of construction works? Or how will a smart contract verify if the tenant has moved out of the property as mentioned in its clause?
Trust is still in question, for real estate professionals to adopt the nascent technology. Given the fact that these smart contracts are only understandable by the software developers, resistance is inevitably high.
Conclusion
In a nutshell, the limitations of smart contracts are high due to their immature stage. This is the very reason that such technology will not be a topic for elimination, rather will have room for continuous evolution. We are bound to see a gradual adoption of blockchain and smart contracts in the very near future. Improvisation and development are the core for any technology, and the same will apply to smart contracts continuously removing its limitations.
References
- https://youteam.io/blog/10-use-cases-of-blockchain-technology-in-banking/
- https://builtin.com/blockchain/blockchain-payments
- https://www.synechron.com/finlabs/mortgage-lending
- https://consensys.net/blockchain-use-cases/real-estate/
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