Can Smart Contracts on Blockchain save Toronto real estate ?

Smart contract creates more problems than it solves for such transactions

If the real estate transactions were conducted on blockchain using smart contracts, the sales would have gone through and buyers wouldn’t be walking away from his deposit — A Disappointed Realtor

Background

People have been writing about the Canadian real estate “bubble” for ages. I know that as I have been one of them, most notably For Canadian GTA and GVA residents, the American Dream is dead and Predicting Minsky moment for Canadian housing. However, knowing the track record of forecasters, I shied away from calling it a bubble.

“The (stock) market has predicted nine of the last five recessions” — Paul Samuelson [Nobel Laureate]

The Canadian press highlighted the rising prices in Greater Toronto Area (GTA) and Greater Vancouver Area (GVA) yet it always ready with the justifications for the price increase to be sustainable: Greenbelt regulations (see Is “Places To Grow” Act to be blamed for GTA Housing unaffordability?), rising number of new immigrant families making GTA their homes, low availability of ready housing etc.

South Of The Border

Then Ben Carlson at Bloomberg got whiff of what is going on in Canadian real estate and wrote a piece for Bloomberg View on June 21, 2017. (Well Zerohedge has been writing about it for years but no one takes Zerohedge seriously except for gold bugs).

https://www.bloomberg.com/view/articles/2017-06-21/canada-s-housing-bubble-will-burst

The money quote from the above article is given below. More scaremongering if you ask me.

No one knows when insanity like this will come to an end. Bubbles are like an avalanche. The longer they build up, the worse they will be when they eventually destabilize.

Then two days ago, Noah Smith of Bloomberg View retweeted the same article with this scary chart from the article. Nothing new.

https://twitter.com/BV/status/896783702788890625

The Tide Turns

What is new is that over the weekend, the tide seemed to have turned as Canadian press published a number of articles which hinted that there is a correction coming in the market.

https://www.bloomberg.com/view/articles/2017-06-21/canada-s-housing-bubble-will-burst

Between 2011 and 2016, the number of households in Toronto rose to 2.14 million, an addition of about 146,200, according to the census data, the latest round of which came out Wednesday. That compares to 175,825 new homes built over that period. In other words, supply of new houses exceeded real household demand by almost 30,000 over those five years.

That throws cold water on the argument — voiced particularly by the industry — that the city’s affordability crisis won’t be resolved unless the government introduces measures to help increase supply.

“Every step of the way everything that could be a headache has been a headache,”

Toronto Star carried a very detailed story about how buyers are having difficulty closing the transactions as lender approved appraisals are coming at lower prices and buyers are contemplating walking away from deposits.

https://www.bloomberg.com/view/articles/2017-06-21/canada-s-housing-bubble-will-burst

Lawyers, realtors and mortgage brokers report a surge in calls from distressed sellers whose buyers purchased in the heat of the market, only to find that the subsequent drop in the home’s value is more than the cost of walking away from a deposit.

Others, who bought unconditionally, have discovered they can’t get the financing to meet their purchase obligation. In some cases, the bank appraisal has come in at a value below what a purchaser agreed to pay, leaving the buyer scrambling to make up the difference.

https://www.bloomberg.com/view/articles/2017-06-21/canada-s-housing-bubble-will-burst

Innisfil RE/Max Chay real estate agent Heather Jones is dealing with the heartbreak of home buyers having to walk away from a deal right now.

And Jones is not alone, as buyers have to come up with extra cash now that the market has levelled out again.

“What’s happening is people purchased these properties (to fight) multiple offers with no conditions, and basically they believe it’s a done deal,” Jones said.

But when an appraisal says the home is worth less than what was offered, the buyer is on the hook.

Jones encouraged her homebuyer to walk away from her deposit, and for the home seller not to pursue legal action.

From The Front Lines

But no one knows the lay of the land like realtors and they give their minute by minute analysis on social media mainly Facebook, Instagram, LinkedIn and Twitter etc. Below is the sampling from yesterday.

By @remaxcondoplus on twitter

https://twitter.com/BenRabidoux/status/897115771259826177

By @choosemj on Instagram

https://twitter.com/dima_nomad/status/897287624351723524

Blockchain and Smart Contract

So you might be wondering, and rightly so, where does blockchain and smart contract comes into all of this. This was prompted by a statement by a disappointed realtor friend of mine yesterday who probably heard it from his fintech enthusiast friend saying

If the real estate transactions were conducted on blockchain using smart contracts, the sales would have gone through and buyers wouldn’t be walking away from his deposit — A Disappointed Realtor

Definitions

But first, a few words (read tweets) from chief evangelist of Blockchains

Then, a customary definition of blockchain

A blockchain is a ledger of records arranged in data batches called blocks that use cryptographic validation to link themselves together. Put simply, each block references and identifies the previous block by a hashing function, forming an unbroken chain, hence the name.

Put like this, a blockchain just sounds like a kind of database with built-in validation — which it is. However, the clever bit is that the ledger is not stored in a master location or managed by any particular body. Instead, it is said to be distributed, existing on multiple computers at the same time in such a way that anybody with an interest can maintain a copy of it.

Better still, the block validation system ensures that nobody can tamper with the records. Rather, old transactions are preserved forever and new transactions are added to the ledger irreversibly. Anyone on the network can check the ledger and see the same transaction history as everyone else.

Followed by, definition of smart contracts

The idea of smart contracts goes way back to 1994, nearly the dawn of the World Wide Web itself. That’s when Nick Szabo, a cryptographer widely credited with laying the groundwork for bitcoin, first coined the term “smart contract.” At core, these automated contracts work like any other computer program’s if-then statements. They just happen to be doing it in a way that interacts with real-world assets. When a pre-programmed condition is triggered, the smart contract executes the corresponding contractual clause. [It does not require any human / external intervention].

Smart Contract and Canadian Real Estate

How does my friend think the blockchain and smart contract system works? To him it was simple. Smart contracts cannot be backed-out of. Once the buyer signs the smart contract to purchase a house, the transaction will go through as smart contract will ensure that buyer will complete the transaction.

Hence yours truly felt responsible to explain to him that despite all the hype, smart contract is just a computer code on a blockchain network. And the problems encounters in executing transactions through smart contracts are bigger than challenges faced by him currently. For example:

1. Oracle Problem

In computing, oracle is used as a mechanism for determining whether a test has passed or failed. Someone needs to tell the smart contract running software that buyer has not completed the transaction. That defeats the whole purpose of smart contract as it is supposed to be automatic. Once you introduce a human element, the transaction will not go through. For example, let’s say the realtor was to act as oracle. The buyer could have the realtor arrested or kidnapped and the smart contract will not be executed.

2. Assets On The Blockchain

You might argue that why would one need an oracle. Once the closing date approaches, the contract should automatically execute i.e., having the all the assets of the buyer on blockchain.

Firstly, the buyer was arranging a loan from the bank so obviously he didn’t have enough assets in place to complete the transaction.

Secondly, even if he had assets, they should be on the blockchain in the form of cryptocurrencies. This opens a whole new Pandora’s box of buyer being tech savvy enough to not only own cryptocurrencies but also having them stored in a hot wallet or in a cryptocurrency exchange where cryptocurrency exchange agrees to act as an escrow account. But to provide smart access to your hot wallet, you will have to give surrender your keys to the smart contract and you might as well kiss your cryptocurrency goodbye now. If the cryptocurrency exchange agrees to act as your escrow agent, the question arises why this transaction can’t be completed safely, securely and conveniently in the real world with a bank and a law firm. But if the buyer keeps the cryptocurrency in cold wallet, smart contract cannot touch it. [Apologies if this paragraph was too wonkish. Suffice to say cryptocurrency presents its own myriad challenges. For a sample, you can Google about securing cryptocurrency through hot wallets or cold wallets to realize the needlessly cumbersome challenge it is].

Thirdly, you might argue that it need not be cryptocurrency. Once blockchain takes over the world, the registry of such assets as buyer’s car registration or house registration will be maintained on blockchain and smart contract as part of its execution/enforcement transfer the ownership from the buyer to seller of these assets. But then the car or the house exists in the real world and smart contract cannot help you to take possession of it. Matt Levine highlighted this in Bloomberg like this:

My immutable unforgeable cryptographically secure blockchain record proving that I have 10,000 pounds of aluminum in a warehouse is not much use to a bank if I then smuggle the aluminum out of the warehouse through the back door.

3. In Computer Code

Whereas real world contracts are in English (or any other comprehensible) language, smart contracts are in computer code. True that code is open for all and everyone to see but if anyone who has worked in software engineering will tell you, it is very hard to write a bug free code. You may argue that a standard code can be used for standard sales and purchase. But if anyone has ever signed a purchase agreement, they know that there are always some amendments and additional conditions added to account for the idiosyncratic aspects of each transaction. Who is to ensure that while making such amendments in a smart contract, a software programmer does not enter malicious code?

4. Immutability

In the real world, and as those people who work in contract law know that, nothing is simple. The agreements exists not to define what happens when everything goes smoothly rather how to proceed when things do not move according to plan. Even after agreements are signed, there are addendums, amendments etc. and even negotiations post executions and if material adverse information becomes available, contract can be cancelled. Smart contract on a blockchain means that once the contract has been entered into the system, it cannot be changed.

5. Medium of Exchange

Smart contracts and blockchains at the moment deal in cryptocurrencies. Eventually they may move into fiat currency but if that is the case, the whole movement to move towards blockchain is a moot point. It should be remembered that blockchain existed to facilitate bitcoin transactions. If the enforcement of smart contract is in the form of transfer of cryptocurrencies, the house will need to be quoted in cryptocurrency value. With the very volatile nature of cryptocurrency values, both the buyer and seller don’t what they are getting in the real world value. Below is the bitcoin currency chart with respect to US Dollars. Depending on the day rather depending on the minute/second smart contract is executed, the value transferred in real world terms can be significantly different.

6. Confederacy of Coders / Miners

Last but not least, the legislative system in Canada is fairly stable and having precedence of decades of case law guiding how the legal system will behave. There is no such precedence in blockchain. In blockchain world, it is a confederacy of developers and miners who decide how the blockchain will evolve. This is the case with the recent forking of bitcoin into Bitcoin and Bitcoin. It needs to be mentioned that forking decision was not taken by votes from investors in bitoin. It was taken by group of coders and miners of the currency. From philosophical point of view, the investor is moving from tyranny of government to tyranny of coders/miners. Earlier after the DAO hack, there was a rollback of Ethereum blockchain again decided by developers/miners. So what will happen to your smart contract when it executes, there has been a forking of the blockchain? Whereas right now if the buyer reneges on sales and forfeits his deposit, the seller can pursue him in the court of law for making up the difference. However, in case of smart contract, it is anybody’s guess how the smart contract will be executed. Once executed, neither the seller nor the buyer will have recourse to court of law because in smart contract world, CODE IS LAW.

Conclusion

Replacing standard language contracts with smart contracts sales and purchase transactions make realtors yearn for the days when they used to worry about was buyer walking away from his deposits.

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