The crypto conundrum
Chava Gourarie
A growing crop of blockchain and crypto startups promise a golden age of transparency, security and access in real estate, but is the hype legit?
The Real Deal
At Consensus 2018 — a conference where cryptocurrency die-hards convened to plot the future of blockchain — two pioneers in the budding industry battled over whether the encrypted database technology had a future at all.

Bitcoin enthusiast and entrepreneur Jimmy Song faced off onstage against Joe Lubin, the soft-spoken co-founder of Ethereum, one of the more popular platforms for creating blockchain services.

“Blockchain is not going to solve all your problems for you. That’s the snake oil we’re being sold,” Song said, dismissing the hoopla of the crypto scene and larger blockchain ecosystem as unchecked hype. He predicted that in five years, the only real use for blockchain would be a more stabilized Bitcoin.

“I’ll bet you any amount of Bitcoin that you’re wrong,” Lubin shot back, prompting whoops and claps from the crowd.

He’s not the only one willing to bet on that future. The conference, which took place during New York’s inaugural “Blockchain Week,” attracted a mix of besuited finance and real estate players, radical libertarians and data junkies.

In real estate, hundreds of startups have launched in recent years offering blockchain and crypto services — and there are many more in the works. The shared goal is to revolutionize every branch of the industry, from investment and finance to research and record keeping. And many of the companies sprouting up promise an end to fraud and the beginning of a golden age of transparency, security and access, with fewer intermediaries.

The nascent crypto sector has already started to evolve since its heady days, just last year, when the bubble of initial coin offerings (ICOs) grew explosively and virtually everyone wanted to know how quickly Bitcoin would make them rich.

Now the bubble has popped, insiders say, and the dilettantes have gone home. What’s left is the work of creating viable companies that bring value to the centuries-old real estate industry. Blockchain — a growing list of decentralized and incorruptible public records — provides a foundation for those companies to build on. And several longstanding real estate firms, including JLL, Newmark Knight Frank and Rose Associates, have tapped into that in the past year.

Even the Real Estate Board of New York, the industry’s leading trade group, has shown support for the crypto sector through its year-and-a-half-old tech committee.

“Hype helps us get the first meeting,” said Thomas Klocanas, a strategist at the Brooklyn-based blockchain incubator ConsenSys, which Lubin founded in 2014. “But then it’s our job to demonstrate the value proposition in the real world.”

But while blockchain and crypto pioneers are scoring big wins in real estate, some of their projects and services can become fertile ground for inflated asset values, false marketing and fraud, according to multiple sources.

That, combined with limited legal and financial guidelines and growing confusion — even among federal regulators — about how digital currencies should be classified, means blockchain and crypto enthusiasts may be in for a rude awakening.

“It’s a jungle out there,” said Jeff Holzmann, managing director of iintoo, a New York-based social network for real estate investment. “There are very few rules and a lot of questions about who’s going to eat who.”

Token change

One potentially innovative use of blockchain in real estate would be the tokenization of physical properties, allowing sponsorship to be broken into smaller and easily tradable fractions.

Just as shares represent ownership in a company, digital tokens would represent stakes in a property or building portfolio, with the tokens’ values pegged to that of the assets. The tokens could then be bought and sold on secondary markets — disrupting real estate investment as we know it.

A legal framework for that could dramatically open up property markets, sources say, bringing liquidity to historically nonliquid assets and providing access to millions of investors who have been locked out by the high barriers to entry.

“It would change everything,” Holzmann noted.

Increased competition from millions of small-time investors would mean lower returns, but for a lot more people, he added. “It means the returns you’re used to are going to get so competitive, you’re not going to make 20 percent a year on your investments,” Holzmann said. “It’s all going to erode back to an efficient market. But a lot more people will have access.”

Of course, the slightly older crowdfunding industry promised the same universal access to real estate investment and never quite took off as expected. But crowdfunding also never saw the same level of mass appeal as blockchain.

Now, a growing number of startups are experimenting with the tokenization model, including several based in New York City, and the stakes are rising.

One of the many services looking to “democratize real estate” is Meridio, a year-old startup that operates out of ConsenSys’ Bushwick headquarters. On a recent Tuesday, during a torrential rainstorm, a stream of entrepreneurs in T-shirts arrived at the graffitied warehouse carrying fresh copies of the book “Radical Markets” — a favorite among blockchain acolytes.

The group included Meridio’s founders, Mo Shaikh and Corbin Page, who are putting tokenization to the test at a five-unit rental building in Bushwick. Meridio worked with the private equity firm Cayuga Capital Management, which owned the property at 304 Troutman Street, to try out a model of fractional ownership.

The building now belongs to a group of 15 investors whose stakes are represented by digital tokens. All of the transactions were conducted through smart contracts — coded instructions triggered by specific conditions — on the three-year-old, public Ethereum blockchain. Once the building’s rental income is deposited, in theory, the money could be automatically divided proportionally among the investors.

But there is no way to tokenize an asset under existing laws, so Meridio divvied up ownership in the LLC that controls the property rather than the actual building. “Because of these financial and legal systems, we’re confined to that,” Shaikh told The Real Deal. “Until those evolve, we’re operating within the existing framework.”

Meridio’s founders are hoping to run a similar experiment on a commercial property next to show the viability and value of tokenized real estate. They also plan to develop a limited secondary trading service — for token owners and other “whitelisted investors” — until more robust token exchanges come about.

“This is where a lot of the exciting development happens for us in the next five years,” said Page. “Over time, as more assets come onto the platform and as more investors get used to this idea, it will likely evolve into a marketplace.”

The London-based Leaseum Partners is another company looking to tokenize New York real estate. The firm is partnering with Michael Chetrit of the Chetrit Group and launching a $250 million blockchain-based investment fund. The 10-year fund will be structured as a real estate investment trust, with digital tokens representing traditional shares, and will pay out quarterly dividends.

Leaseum’s founder, Steve Sillam, said that in order to accommodate cryptocurrency skeptics, people can also invest directly in the fund, rather than buy tokens, and choose to get their quarterly payouts in fiat currency.

Leaseum worked with multiple law firms and compliance teams in order to meet all the regulatory requirements in the U.S. and the U.K., its founder noted. Initially, only accredited investors can participate, but the hope is that the laws will change to accommodate secondary markets in digital assets, Sillam said.

But even if they didn’t, it’s still a game changer, Holzmann argued.

“There are 15 million accredited investors in this country,” he said. “Even if each of them invested $50,000, we’re talking about running Blackstone out of business.”

Regulatory blur

That is part of a much larger reality, since the only way for a liquid market of tokenized properties to evolve is with the right legal infrastructure.

In order for blockchain and crypto to become sustainable, sources say, there will need to be more clarity over how the new financial instruments should be regulated and which agencies and laws should cover them.

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One sticking point on the crypto scene has been the question of how to classify digital tokens: as commodities, currencies, securities or something entirely new?

And not all tokens are created equal. Some digital coins, like Bitcoin, Ether and Ripple, were designed to function as currencies, though they’re more often used as investments. Asset-backed tokens, which are the newest iteration, are most closely linked to securities.

One example is the recently launched Aspen Coin, backed by the St. Regis Aspen Resort in Colorado. Manhattan-based Templum Markets is issuing the coins in what it’s calling a “tokenized asset offering.” Templum is registered with the U.S. Securities and Exchange Commission, and the Aspen tokens will be registered as traditional securities.

But many of the crypto coins launched by startups itching to raise cash have existed in the twilight zone between securities and currencies. A large chunk of them are similar to arcade tokens, which are needed to make the machines work but useless once you exit the arcade. These coins, often referred to as utility tokens, give the holder access to a specific platform or application and can also be traded on the open market.

Initially, most crypto startups wanted to avoid the definition of their tokens as securities, so that they could launch ICOs without having to register with SEC. But as mainstream interest and regulatory scrutiny have both increased, it’s become much harder for these companies and their backers to fly under the radar.

A ruling from a federal judge last month that ICO fraud could be prosecuted under securities law has provided more clarity on the SEC’s role in crypto regulation. The case involved Maksim Zaslavskiy, a Brooklyn businessman who was arrested last November for allegedly defrauding investors in two cryptocurrencies: REcoin and Diamond Reserve Club. Zaslavskiy claimed the tokens were backed by real estate and diamonds, respectively, and raised $300,000 from nearly 1,000 investors, the SEC said.

But prosecutors alleged that the properties and diamonds didn’t exist, and Zaslavskiy is now facing criminal and civil charges. The civil case is awaiting the outcome of the criminal proceedings, and the two companies have been dissolved.

Zaslavskiy’s defense argued that he could not be prosecuted under securities law because the digital coins were currencies. However, U.S. District Judge Raymond Dearie denied the motion — without affirming whether the coins are securities or currencies — allowing the case to move forward.

“The label Zaslavskiy chooses to attach to the alleged scheme does not control our analysis,” Dearie wrote in his Sept. 11 ruling. “Stripped of the 21st century jargon,” he said, Zaslavskiy’s scheme was “a straightforward scam.”

“Giant holes”

While Dearie’s ruling provides a much-needed legal precedent, Jason Gottlieb, a securities lawyer at Morrison Cohen, said it’s not a representative case for legitimate companies looking to create new business models using blockchain.

“The SEC guidance relating to tokens has been somewhat [thinner] than most market participants would like,” Gottlieb said. “I think from the SEC’s point of view, there are too many open questions, and the agency so far has been trying to force tokens into the same boxes as securities.”

Much as in the Zaslavskiy case, the SEC has increasingly started to go after crypto players that engage in false marketing or outright fraud. However, the federal agency has not clearly stated its position on asset-backed tokens like the Aspen Coin and Leaseum fund.

Several moves on the agency’s part have shown its “skittishness” on certain crypto matters, Gottlieb said.

In July, for example, the SEC denied a bid from Cameron and Tyler Winklevoss, founders of the crypto exchange Gemini, to create a Bitcoin-based exchange-traded fund. The agency has yet to approve any such funds, though several companies are developing similar financial instruments.

In the meantime, the consensus among the legal community is to treat tokens as securities when possible, and many have taken to the phrase “security token offerings” — rather than initial coin offerings — when referring to new crypto financial products.

But the gray area with enforcement can have direct business costs.

“Many companies are going to be hampered by the uncertainty of the regulations,” Gottlieb said. “Even if you’re trying to do everything very responsibly and in a very compliant manner, there are still giant holes.”

Since blockchain technology and cryptocurrencies are decentralized, sources say, they can be used for scams and even money laundering — despite claims to the contrary. Aaron Wright, a professor at Cardozo Law School and co-author of a new book called “Blockchain and the Law,” said blockchain technology won’t protect against fraud.

“Blockchains are just data structures, so if bad information goes in to the data structure, it’s still bad information,” he said.

Seeking opportunity

New York real estate — which is no stranger to fraud, money laundering or bad information — is looking for ways to make blockchain technology work in its favor.

REBNY’s tech committee launched its second PropTech Challenge in August and included blockchain as one of four categories that hackathon participants could compete in for a $50,000 prize.

“This is an industry that is ripe for blockchain and that ultimately will be transformed by it,” said Sandy Jacolow, one of the committee’s 34 members. The real estate tech veteran got his start at Clarion Partners in the late 1980s and recently joined commercial mortgage brokerage Meridian Capital Group as its chief information officer after spending seven years in the same role at Silverstein Properties.

The city’s Economic Development Corporation is also betting on crypto. The nonprofit partnered with the crypto news site CoinDesk to launch its first Blockchain Week in May and recently set up a resource center for blockchain startups.

As crypto incubators and co-working spaces have cropped up across the boroughs, New York City saw an 800 percent increase in blockchain job listings between 2015 and 2017, according to numbers provided by the EDC. And blockchain jobs in Brooklyn alone skyrocketed from 93 in 2015 to 745 this year.

While that growth is encouraging, there will need to be guidelines to protect investors as the market expands, Jacolow said.

One concern is that crypto coins are often lumped together, making it hard to gauge what each one is really worth. For example, two blockchain-focused real estate companies that launched in September 2017 have seen their values cut in half, fluctuating in line with the overall cryptocurrency market.

Propy, a blockchain-based “global real estate store,” lost 60 percent of its value and close to half its market cap in the past year, according to CoinMarketCap, which tracks cryptocurrency exchanges. And the REX coin from Imbrex, a data marketplace that launched with 2,200 listings from Toll Brothers, lost 75 percent of its value and nearly 75 percent of its market cap in the same period.

Propy CEO Natalia Karayaneva said she understands the negative response to cryptocurrencies. “A lot of companies exploited the hype,” and since many people conflate Bitcoin with blockchain, “if they hear about anything bad in the space, they think it’s blockchain’s fault,” she added.

Propy, which closed its first blockchain-based real estate transaction in Vermont last year, is looking to streamline the process of buying and selling homes. It eliminates the problem of sending documents by email, which is notoriously insecure. But Karayaneva said she has bigger plans: to allow Propy’s users to transact on properties the way cryptocurrencies are bought and sold.

“Blockchain is not a pill for everything,” she said, “but for our case it’s very suitable.”

Amol Sarva, CEO of the flexible office space provider Knotel, is another big proponent of using the encrypted database technology in real estate — despite the naysayers — and is launching a blockchain-based data platform for commercial properties called Baya.

Knotel recently bought the San Francisco-based commercial real estate data firm 42Floors, which will serve as the starting point for that. Sarva told TechCrunch in July that the idea behind the deal is to get “access to data and technology on over 10 billion square feet of office space.”

During a recent interview with TRD, he compared blockchain’s early years to the birth of the internet, calling blockchain a “truth machine” due to its protections against data tampering.

“Blockchain could be our first opportunity to refocus on truth rather than just information,” Sarva said. “In the real estate business that means better decisions, less friction on transactions and more transparency. That didn’t exist in the internet era.”