This past August, Vermont Governor Phil Scott signed into law bill S.269, creating legislation for the adoption of blockchain technology and regulation of blockchain-based companies. Blockchain has as much criticism as it does praise. So much of the technology’s success is predicated upon who, whether government agencies or private companies, is willing to lay the groundwork to ensure the technology offers a cost-effective alternative to current processes used by financial institutions and consumers… and if they are willing to risk losing that investment of time and money to a competitor who makes a better version of the technology a few years later.
Despite the obstacles to implementing a safe and standard blockchain system, it continues to garner a lot of buzz in the title and real estate industry.
Here are some aspects of the technology and applications of smart contracts, in particular, that could one day affect settlement agents.
The must-know elements of blockchain technology
Blockchain is basically a shared and secured ledger of economic transactions. Traditionally, a ledger is held by a private entity and those who want access must request it. In the case of real estate transactions, there are countless documents that must be gathered on a property and some of those documents are not easily available to the public. Settlement agents and ultimately, homebuyers, must rely on third parties like banks and municipalities to accurately keep records on properties and disseminate that information in a timely manner before closing in order to clear a title or pay off other unrecorded municipal debts. If that data existed on a blockchain, pre-closing title curative work could become obsolete.
The platform is where various types of digitized, decentralized, and public transactions take place. While Bitcoin may be the most well-known platform, in terms of enterprise applications of blockchain, it doesn’t perform nearly as well as other platforms. In fact, Bitcoin doesn’t make the top five or even the top 10 list for solving complex business problems. Platforms like Ethereum, Hyperledger Fabric, R3 Corda, Ripple, and Quorum offer far more promise for the financial, real estate, and insurance industries, mainly due to their smart contract functionality.
Most platforms, like Ethereum, are permissionless or public platforms and use a consensus algorithm, PoW (proof-of-work), to verify transactions. This means that while it is decentralized, it’s not the fastest platform. Other forms of digital ledger technology may use a private platform that has its own rules on verification and hand-selected nodes (or computers) that do the work.
Decentralized Applications (dApps)
Whether it will be a desktop software application or something you run on your mobile phone, dApps are how parties will access their preferred blockchain platform. These platforms and applications are in their infancy right now compared to other types of software platforms and developers often have to make tradeoffs between decentralization, scalability, and security.
For public platforms, there is currently no blockchain that could run an application the size of Facebook. This is because speed is traded for decentralization. Facebook is a completely centralized system where they have complete control over everything. This means they can process information quickly, but users have no control over what happens as we are all starting to realize.
Nodes are the computers within a digital ledger network. Nodes are responsible for solving complex algorithms to verify the authenticity of a transaction. Depending on the platform’s rules, the nodes are what come to a consensus for each transaction before a new block is written for a ledger.
This is essentially a page of the ledger. Each new transaction is recorded as a new block within the chain of previous transactions of the ledger. The data within a block is permanent once it’s verified by the network.
There are private and public keys in a blockchain. Both are large integer numbers. Public Keys are sent between parties that are part of the transaction. Private Keys are hidden from everyone else but you. You must have a Private Key to access the Public Key.
What are smart contracts and how do they function on blockchain platforms?
Smart contracts are pieces of code stored, executed, and replicated on a digital ledger and supervised by the network of computers that run the blockchain. In theory, if a smart contract is created on a decentralized system, it would cut out the middleman, intermediaries like lawyers, save time, and reduce conflict between parties who agree to a deal.
A smart contract can be used to deliver any sort of goods or services from one party to another. Smart contracts not only define the rules and penalties of the transfer but it also automatically enforces those obligations.
For the real estate industry, this means that smart contracts could be used in a plethora of ways. Lenders might use smart contracts to approve mortgage applications, title insurance companies could use it to search a property’s title and instantly issue policies, and closing officers might set up automatic escrow accounts after a deal is completed.
Impact of smart contracts on real estate transactions:
Benefits for consumers
Title insurance was created as a way to safeguard an investment in real property. As fraudulent deeds became more common in the United States, an industry was created to reduce the risk associated with purchasing property. The breakdown of trust between two parties negotiating a real estate deal was a boon for title professionals. Clearly, title insurance is needed in a world where forged deeds are still recorded by county clerks.
Despite the value of title insurance, in today’s economic climate, many consumers have become cynical and even suspicious of middlemen involved in many transactions like banks and attorneys. For those who are willing and even eager to adopt the technology, blockchain smart contracts provide a so-called “trustless” and decentralized alternative to the traditional process of transferring assets from one party to another.
Another major issue within the title industry is communicating the importance of title insurance to homeowners. Many don’t realize that their homeowner’s policy is separate from their lenders. Ideally, blockchain technology would mean that a property’s records are more transparent and accurate and any attempts to record a fraudulent deed within the system would be rejected.
Unlike municipalities that will file a forgery in the public record, a blockchain system would never record one, to begin with, making one of the most common causes of title defects no longer a concern for title underwriters, real estate investors, and homeowners.
This is a new technology that many people still find risky. Suspicions are high and reasonably so. Anyone who has been following the drastic rise and fall of bitcoin currency’s value would be skeptical of trusting such a young and unregulated technology with their most private information and the most expensive transaction of their life.
It’s unlikely that we will see countless real estate transactions via blockchain anytime soon as a result, but the necessary groundwork to make it happen in the coming decades is being laid by states like Vermont and countries like Sweden. Right now, we’ll have to wait and see how these pilot programs pan out and how they deal with unforeseen problems before we see any mass adoption by homebuyers and real estate investors.
The impact of blockchain and smart contracts on lenders:
The spirit of blockchain is decentralization and democratization of data, but that won’t stop banks from developing their own private versions of the technology. For larger institutions, this will help connect all parties involved in a real estate transaction within one system they can control. This will mean that much of the time-consuming and expensive due diligence – the cost of which is offset by charging borrowers processing fees – will be minimized.
Having instant and accurate transaction history as well as details of outstanding bills and credit ratings will lead to better lending decisions. Smart contracts could be used to speed up the mortgage approval and settlement process by codifying instructions and automating current manual workflows. Overall efficiency would be improved when managed by a blockchain.
The same principles guiding business decisions lenders make on borrowers could be implemented by underwriters and their title agents via smart contracts.
Impact of smart contracts on settlement agents:
There’s been some anxiety over the idea that blockchain will make title insurance and title agents obsolete. This really depends on what type of the technology becomes the norm for financial institutions and consumers. A completely decentralized and public blockchain for nationwide land record keeping in the United States seems highly unlikely. Because there is so much variation in land recordkeeping standards and title insurance regulation from state to state, we’re more likely to see some sort of hybrid between public and private.
Property and financial data will most likely not exist on the same platforms. Title agents and real estate attorneys will still act as intermediaries while utilizing a proprietary blockchain application to execute smart contracts in a real estate deal. Title insurance will still offer important value to lenders and homebuyers to guarantee clear title and bridge the gap between financial institutions and government records.
What’s needed to make blockchain less buzz and more bite in the title industry?
- Government oversight and support
- Standardization & Safeguards
- Industry implementation
Government Oversight and Support
The Federal Trade Commission Safeguards Rule requires financial institutions under their jurisdiction to have measures in place to keep customer information secure. In addition to developing their own safeguards, companies covered by the rule are responsible for taking steps to ensure that their affiliates and service providers safeguard customer information in their care.
Right now, there are no standardized federal rules surrounding title transfers on a blockchain.
Seven states have passed laws that reference blockchain. They include Arizona, Delaware, Illinois, Nevada, Tennessee, Vermont, and Wyoming. Additionally, eight states have amended their money transmitter laws to address cryptocurrencies as of March 1, 2018.
While the details of each state’s bill vary, they all were created with the intention to make the creation of blockchain companies easier and bring more businesses (and high-paying jobs) to their states. There is still a lot of ambiguity in the language of the bills that will need to be hammered out.
Standardization & Safeguards
As of now, it’s the proverbial wild west among blockchain platforms. While the purest form of blockchain is one that is completely decentralized and public, some companies may see a lucrative opportunity to build their own private version of a digital ledger technology to execute smart contracts. Companies in the insurance and financial industries may see implementing this kind of technology as a way to give them an edge against the competition.
The question is how many people feel comfortable enough utilizing these platforms when there is little standardization and safeguards in place. So far, Vermont has passed a bill to enable the creation and regulation of personal information protection companies (PIPCs) and blockchain-based limited liability companies (BBLLCs) as well as create studies for expanding the use and adoption of blockchain, but it doesn’t really address how smaller municipalities might transfer over a digital process for recordkeeping.
While the bill is an important first step in making the technology a tangible reality, it’s still yet to be seen if local governments will invest the time and money to lay the groundwork for creating and maintaining a digital land records system. Should a private company decide to work with municipalities to make this change, it begs the question of ownership and control of that data.
What are the ramifications of having once public information held with a private company? What rights will consumers have in regard to the storage and sharing of that data with other entities?
The title industry is often slow to adopt new technological changes. Typically, the final push comes from the financial and consumer sector after state and federal laws allow for the change. Once lenders and buyers have started to feel more comfortable with a process, title agents will need to be ready to meet their expectations and needs. Electronic and remote notarization is a perfect example of this.
We all know that being first to market with new technology doesn’t spell instant success for a company. In 1984, only 8.2% of U.S. households had a computer. Now the vast majority of Americans – 95%- own a cell phone of some kind. 77% of Americans have a smartphone, essentially tiny computers in our pockets with more power than supercomputers of the 1960s. Because of these rapid changes, it’s impossible to predict which blockchain company and platform will come out on top for land recordkeeping and which will go bust.
While we are years or even decades away from smart contracts being a commonplace aspect of the real estate transaction, now is the time to think about how these technological changes will impact your role as a settlement agent and the title insurance industry as a whole. It remains to be seen exactly how this technology will be used in the United States, but the advantages to consumers, lenders, and other influencers in the industry means that we will see some sort of implementation and process changes around blockchain record-keeping and smart contracts in the future. Undoubtedly, the technology will go through several major iterations before the average settlement agent will start to engage with it in any meaningful way.
In the meantime, we’ll all be keeping an eye on Vermont, Sweden, and others as they wade through the successes and failures of adopting a distributed ledger system for their land records.