Wary of real estate token investments

Real estate tokens lead in potential

In today's digital economy, the concept of tokenization is no longer strange. In July 2014, the first token project using the US currency (USD) was launched. There have been several tokenization initiatives employing USD in various ways since then. From MakerDAO's effort in December 2017 to mint tokens to confirm the USDC, Pax Dollar (USDP), Ethereum (ETH), and Wrapped Bitcoin (WBTC) portfolios, to the prominent projects of Iron Finance and Terra Project in March 2021 and September 2020, respectively, that tokenized the USD stablecoin through algorithms using Iron and UST Tokens.

Although numerous initiatives have tokenized assets such as gold, bonds, funds, companies, vehicles, yachts, wine, oil, carbon credits, and even stocks, nothing jumps out in terms of potential market scale as much as real estate.

According to Savills analysis, the total value of global real estate in 2020 will be $326.5 trillion. In comparison, the global fixed income market is expected to stay at $126.9 trillion in 2021, while the global stock market is expected to be worth $124.4 trillion and the entire value of circulating US dollars is $40.8 trillion.

Real estate has a potential market value that is 1.1 times greater than the combined market value of the world fixed income market, global stock market, and US currency, making it the "holy grail" of all token initiatives.

Elevated Returns' tokenization of the St. Regis Aspen Resort in 2018 drew international attention to real estate tokens. Through Aspen Coins, the tokenization successfully generated $18 million for 18.9% ownership of the resort hotel, drawing substantial market interest and enthusiasm.

In 2019, a similar real estate token initiative called RealT was launched, tokenizing real estate assets worth more than $50 million in cities like as Detroit, Cleveland, Chicago, Toledo, and Florida.

CitaDAO, a real estate token initiative, using the decentralized finance (DeFi) paradigm in 2022 to tokenize a Singaporean asset at a greater price than its true worth. This revealed that encoded real estate might be worth more than its actual value.

The geographical location, types of real estate, legal frameworks, liquidity, technology, collaboration methods, and investment capital of these projects differ, but they all have similar qualities such as easy participation, diversity, efficiency, and transparency.

The advantages of real estate tokenization are becoming more widely recognized. In essence, real estate is a low-liquidity asset. As a result, the primary benefit of tokenization is the possibility to boost liquidity in this market.

Five main risks

Nonetheless, Savills analysts note that, while real estate tokenization has numerous advantages, certain unsuccessful initiatives, such as Terra UST, expose inherent hazards.

The first risk is de-tokenization, which refers to the conversion of tokens to their real-world worth. To put it simply, token holders must be able to trade their tokens for real-world assets like real estate, debt, or equity capital, as long as they adhere to Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements. They should be able to do so anytime they wish, without seeking permission from anybody to authorize the asset swap.

This ensures that the token price does not fall drastically below the asset's original worth. If that were to happen, some astute investors would take advantage of the situation by acquiring tokens at a discount and repurchasing real estate at a cheaper rate.

Second, there is counterparty risk, which refers to the chance or probability that one or more parties in a transaction would fail to meet their contractual commitments. Recent platform failures like as FTX, Celsius, Babel Finance, Voyager Finance, BlockFi, Hodlnaut, 3 Arrow Capital, and many more serve as continual reminders of the counterparty risk when dealing with centralized financial platforms (CeFi).

Third, there is the liquidity risk. The idea of liquidity refers to banks running out of funds when clients withdraw huge sums of money. Recent Silvergate Bank and Silicon Valley Bank instances emphasize this concern. Real estate assets have lesser liquidity than lending portfolios and take longer to sell.

Fourth, there is the issue of legal liability. Regulatory authorities have become more interested in digital assets in recent years as a result of multiple platform failures that resulted in billions of dollars in damages. This has resulted in increased regulatory scrutiny as well as large-scale exchanges involving this asset type.

The majority of regulatory concerns are around the use of digital assets for illegal purposes such as money laundering. Every cryptocurrency project must comply with anti-money laundering (AML) regulations and the Financial Action Task Force (FATF). Regulatory organizations are also investing heavily in this field to guarantee that it does not endanger the existing banking system, causing massive damage to financial firms.

Fifth, there is infrastructure risk, which relates to the probability of problems occurring in the infrastructure of the platforms. This frequently involves concerns related to the technology around which the platforms are created.

Unless fully vetted and confirmed by the market, most token initiatives pose infrastructural concerns.

According to Savills experts, while the benefits of tokenized real estate have been demonstrated in recent years, investors must be aware of the dangers to avoid being caught off guard by weaknesses that can lead to the collapse of projects such as the Terra Project by Do Kwon or FTX.