An iPhone for On-Chain Real Estate

CitaDAO Is Building an OS for the Future of Property Investing

Article by Teeleroo Cover Art by Chameleon

BanklessDAO (bDAO) had the opportunity to host CitaDAO representative Joel Lin’s presentation about their nascent protocol, which will bring real estate financing onto the blockchain. His description of taking the unbanked route to collateralizing property found an enthusiastic audience in bDAO members, whose collective mission is to steward people to a bankless world.

Using decentralized finance (DeFi) to unlock more assets creates real utility for property owners, and it hints at a world where new entrants have innovative ways to enter the real estate market. The current players in the traditional real estate space are beneficiaries of a system that gates the space.

While enabling access to real estate investment through tokenization is a worthy goal, the capability to leverage this new type of asset introduces risks. It has the potential to disrupt the concept of ownership, or result in financial harm to unprepared participants. Mechanisms that mitigate risk should be built into any product of this nature.

Tokens 1.0

Tokenizing real estate is not a novel concept; the ICO craze of 2017 tested the limits of what could be brought to market. As an example of how crazy things got (and what to avoid), Bananacoin raised money to fund the expansion of a banana plantation in Laos to tap into Chinese demand for Lady Finger bananas.

Needless to say, the project fell apart. From inception, token holders’ right to redeem Bananacoins was not contractually guaranteed, and a robust market to trade the coins was not sustained. People wanted to buy the farm, but instead Bananacoin sold the farm.

Tokens 2.0 Featuring CitaDAO

Modern DeFi is a step above 2017; the same market frictions still exist but there are new tools to solve the problems. Enter CitaDAO, and its fixes for Bananacoin-era problems:

  • Tangible Asset — The Proof-of-Concept (POC) for CitaDAO featured a commercial building in downtown Cardiff, Wales. It is owned by a private family-owned corporation and currently leased to blue-chip tenants.

  • Transparency — The on-chain nature of information tied to the Real Estate Tokens (RETs) makes it more difficult for projects to defraud or mislead investors. Each property has its own set of RETs.

  • Redeemability — Holders of the RETs can redeem the tokens for full ownership of the underlying asset. The mechanism of redeemability ensures that on-chain value is linked to off-chain value; if a token holder tries to purchase the property outright, those holding the rest of the RETs can accept the offer if the value reflects market value. If not, the holders can counterclaim to capture the original buyer’s tokens at a discount.

  • Legally Sound — A legal opinion from a reputable Singapore law firm underpins the project, which CitaDAO feels puts them in compliance with security laws in Commonwealth countries.

  • Defined Yield Strategy — Project incentives exist to hold both RET tokens (representing real properties) and KNIGHT tokens (with governance properties). In this way it is possible to grow wealth outside of property value increase and rents.

  • Integration With Larger Ecosystem — CitaDAO likens itself to the iPhone: an operating platform serving as the base level for applications.

CitaDAO Use Case

The POC featured a commercial building in Wales; currently, only commercial properties in Commonwealth countries are eligible. The process, which failed to gather enough support in the first round, involves tokenizing the property. This is achieved via Introducing Real Estate On-chain (IRO), amounting to the transfer of title to a Special Purpose Vehicle (SPV). Those committing to the IRO receive the RETs which can be traded on the market.

CitaDAO Compared With Traditional Finance (TradFi)

Property Ownership

The tokenized manner of buying property follows the TradFi equivalent of purchasing, i.e. it involves the transfer of value to secure ownership. However, TradFi transactions require considerably more time and energy as the process involves complex steps and delays. While buying tokens takes seconds or minutes, buying property takes weeks or months.

Ownership of investment property entails the collection of rents to offset financing and management costs, with the excess cash representing the profit. Another way to make a return on the investment is to borrow against the principal paid down on the property or the appreciated value of the property. This financing is available through the lending institution.

Real Estate Investment Trusts (REITs)

For investors interested in a safer version of real estate exposure, TradFi offers REITs which allow ownership in pools of real estate assets. Holders of REITs are rewarded with dividends and in favorable market conditions, the REITs increase in value. They trade on stock exchanges, with investors choosing between an array of property classes such as malls, apartment buildings, and commercial buildings.

REITs address the problems of liquidity and volatility, but issues remain for the investors. They don’t have control over the exact basket of holdings, they get stuck with the management fees, and they are still tied to the TradFi system and its frictions.

CitaDAO Option

CitaDAO introduces an alternative vehicle for real estate investors. There will always be parties that purchase properties as an investment and REITs will continue to maintain market share on their public exchanges. Where CitaDAO succeeds is in putting Web3 ideas into practice.

It takes very little effort to transfer USDC to the CitaDAO protocol, much less effort than it does to incorporate a company for the purpose of investing in real estate, or to open a brokerage account and fund it to purchase REITs. In true DeFi spirit, CitaDAO affords an opportunity for property investment to anyone who can connect a funded wallet to its protocol.

Leveraging in Real Estate

CitaDAO’s work in shaping real estate’s packaging to decrease friction in the transaction and rewrite ownership terms changes the nature of the asset. As with many innovations in Web3, there is no clear guidance to help us judge whether tokenization is good or bad.

Critics of the existing system look at this new paradigm favorably and applaud the removal of banks (and the governments backing them) from the purchase process. They believe that smart contracts successfully eliminate the need for vetting intermediaries.

Another benefit is that fractionalization via tokens reduces the barrier to entry; ownership of the $20 million Wales property is not limited to millionaires. Leveraging RETs is yet another way to expand the purchasing power of a small sum of money.

On the opposite side, conservative investors may be against real estate tokenization and cite the U.S. housing crisis of 2008 as proof of how a financial advancement turned sour. The crisis was precipitated by lenders accepting higher risk mortgages which unlocked residential property ownership for a new category of buyers. For those who contracted into the mortgages and couldn’t meet the terms, bankruptcies ensued and a cascade effect spread to the greater economy.

Such bankruptcies are perhaps not exclusively the fault of borrowers, but in fairness to the lenders, the terms were laid out in the contract, albeit in legal language. There is an argument to be made that the state can only protect us so much, and once we decide to leverage an asset, be it real estate or blue-chip stocks, the risk should be borne by the investor.

Watch out below!

Protect Me From Myself: State Intervention

The state intervenes to protect the basic rights of citizens, such as the safety of an individual, even when contractual obligations demand otherwise. For example, the fine print on a lift ticket may say that the ski resort is not liable for any harm suffered on the ski hill, but that doesn’t mean the court will shield the resort from legal actions. The physical safety of the skier trumps the contract signed with the resort.

We see the same protections when it comes to housing: the court ensures that the basic needs of citizens are met, notwithstanding their contractual obligations. During the Covid-19 pandemic, U.S. landlords’ right to evict tenants was suspended. This meant that falling behind on payments, whatever the reason, didn’t result in the loss of housing. The state’s argument that housing is an enshrined right justifies its protection.

It is debatable whether the state should elevate individual rights above a legal contract. It looks a lot like the state imposing on our freedoms but the counter argument is that we need intervention to stop bad actors.

We can imagine a situation where, thanks to tokenization, an apartment complex is flipped numerous times in a short period, and somewhere along the chain of transactions a bad actor evicts a tenant or otherwise acts contrary to reasonable expectations. In this instance, public concern would be justified in questioning the tokenization of the building.

Metaverse: Polished Web3 Property

The metaverse is home to property systems that operate outside of state laws. If you transact in The Sandbox, you don’t have to worry about the state nullifying an agreement because the terms are unfair. It’s not as though the virtual space is irrelevant; the dollar amounts in consideration are large enough that the space warrants examination. The property next to Snoop Dogg’s sold for half a million dollars in the Snoopverse and there is no end in sight for property appreciation.

The lesson from the metaverse is that it can be a testing ground for off-chain cases. Those buying virtual property next to Snoop Dogg believe they are getting value. Maybe they hope to sell the land or maybe they’ve got a streetfront billboard in the works. The bet is that the NFT remains attractive in years to come. If enough people believe this, it’s not the state’s place to step in and declare otherwise.

Using this comparison, CitaDAO’s proposition makes sense. The property use is novel and the risks are many but enough people are convinced of the value proposition being made, and the expectations of revenue from a stable asset are reasonable. Property on platforms such as The Sandbox is not an on-chain corollary of physical property, but it should be on the radar as the two realms inform each other.

CitaDAO’S Challenges

As with all contracts on the blockchain, there is the risk of hacks or unforeseeable losses. The recent Solana hack of $322 million stands out as an example. In this case, the protocol covered the loss, but it wouldn’t be safe to assume that CitaDAO would be responsible for compensating a similar loss.

Whale transactions are another risk as liquid chunks of money can manipulate tokens and markets. CitaDAO’s buyback program allows RET holders to force other holders to up their stake; it’s easy to imagine how a holder with an inordinate amount of cash could game the system.

These two challenges, contract risks and whale manipulations, are not specific to CitaDAO and therefore carry little weight as critiques of the project.

Another challenge in tokenizing property is that most land has restrictions on it, like easements or covenants. This limits the pool of property available as land can only be transferred to an SPV and tokenized if title is clear.

Moreover, even property with clear title is never without encumbrances. State laws allow for the appropriation of land in rare circumstances where the public good overrides property laws. Acts of nature further cloud things. It’s foreseeable that RETs inadequately gauge the risk in this novel property ownership situation.

From iPhones to iDeeds

CitaDAO’s answer to all these worries is that it doesn’t claim to solve all problems at the retail level. The project wishes to emulate the iPhone, meaning that developers build apps on top of its platform, and the retail level problems get solved as the ecosystem evolves. It’s reasonable to assume that as CitaDAO builds a marketplace around its protocol, it will attract solutions to the existing problems and new ones that arise.

The appetite for tokenized real estate is so great that it’s likely to become ubiquitous. As with the limited adoption of the first iPhone, it will take some time to build the foundation. Once it’s there, the promise of blue sky for developers of code and property is real.

Innovations and developers can take the protocol in multiple directions, including consumer protection and inviting limited state regulation to accomplish the same.

Author Bio

TeeLEROO is applying pruning shears and pen to the world around him.

BanklessDAO is an education and media engine dedicated to helping individuals achieve financial independence.

More About This Topic

How Property On Chain May Disrupt Real Estate Markets by Florian Strauf

CitaDAO Delivers Real Estate OnChain, DeFi Style by Florian Strauf

Disclaimer: this isn’t investment advice. This article has been written for informational and educational purposes only and it reflects my personal experience and current views, which are subject to change.

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