Real estate, one of the world's oldest and most significant asset classes, is undergoing a remarkable transformation. The year 2023 marks a pivotal point in this evolution. At a high level, the year was shaped by market shifts, technological innovations, evolving investor preferences, and the collective learnings of the broader community about the nuances, challenges, and benefits of tokenized real estate.
This post dives into six of the most interesting trends in tokenized real estate that we have been following and tapping into at Upside.
1. Tokenized real estate is beginning to look remarkably… similar
For all the hype that typically follows blockchain, there are remarkable similarities between the tokenized flavor of real estate and traditional real estate. This is a benefit for the industry.
Innovative new projects often have a tendency to alienate users of their old incumbent equivalents when there is no resemblance to the predecessor. This concept, from a design standpoint, is known as skeuomorphism. And for years, Apple has done a good job building skeumorphs into innovative products like the iPhone that were fundamentally different from previous versions of the cell phone.
Unlike the majority of the crypto industry, tokenized real estate projects (for the most part) are not attempting to reinvent a well-established domain with decentralization. Instead, many are focusing on improving access to deals and the relatively outdated process of issuing, trading, and managing securities.
The skeuomorphism within real estate is evident when considering listings on yieldstreet...
...and this example of tokenized listings on Republic.
It could take up an entire post just writing on this concept.
Investors experience these similarities visually with the way the projects are listed, including the investment details, security issuance type, investor qualifications, project location, etc.
These similarities continue in investor onboarding, where anyone seeking to participate in a deal goes through AML/KYC, verification of accredited investor status, creation of an investor profile, etc.
For the Issuers, these visual similarities between traditional real estate investing and tokenized real estate investing continue on the backend, throughout due diligence processes, project administration, during private sales, and even through secondary trading. Keep your eyes peeled in 2024 and notice how these processes continue to grow in similarity from the beginning of the sales funnel all the way through to the way these interests are traded.
2. Wall Street Has Entered The Chat
Looking back to 2022, BCG predicted the trend toward asset tokenization would continue at a rate that would grow to $16 trillion in illiquid asset tokenization by 2030. So it should not come as a surprise that investment into the tokenization of illiquid assets grew following this assertion.
And perhaps this is evidence of the previous trend, but in 2023 tokenized real estate investments were increasingly in the spotlight for major investment groups including Blackrock. Larry Fink, the founder of Blackrock, said tokens are “The Next Generation For Markets” and put his money where his mouth is with their spot Bitcoin ETF.
Other institutions followed this trend: 2023 saw continued investment by JP Morgan in their platform for tokenized securities – Onyx – and Goldman Sachs likewise invested in their own Digital Asset Platform (GS DAPTM) to simplify the complexities associated with asset lifecycles within a unified environment rooted in tokenization.
Additionally, other players who made entrances in 2023 include: London Stock Exchange, UBS, Wisdom Tree, and Depository Trust & Clearing Corporation. As market dynamics continue to improve, it will be exciting to see who is next to join the evolution of securities.
3. Better Terms, Better Deals
One of the critical questions we asked ourselves throughout 2023 is: how can tokenized real estate products be positioned to make it a no-brainer for real estate developers, funds, and others to choose tokenization? This happens in two key ways.
At a fundamental level, removing illiquidity is the strongest case for tokenized real estate.
And yet, the biggest area for opportunity in tokenized real estate is offering deals with better terms. As much as crypto natives, degens, and others who have been in Web3 for a long time want to talk about the efficiency of transaction costs, the benefits of decentralization, and the transformative power of blockchain, those advantages do not matter without more favorable deal terms that cost out.
Throughout the real estate industry, liquidity is hamstrung by lockup periods. Some lockup periods, such as those under Reg D and Reg CF are legally mandated. However, other times lockup periods are used to stabilize asset performance, improve incentive alignment in long term deals, and as a hedge against market volatility.
Often, this stability negatively impacts sophisticated investors and culminates in an illiquidity discount of up to more than 25% for the valuation over 5 years.
Combined with tokenization, these favorable terms are able to be optimized in a way that traditional real estate investments cannot. The lack of standardization around shares in traditional real estate investing and the use of token standards such as ERC-1404 in tokenization means it is possible to programmatically enforce different rules and restrictions around the trading of securities on exchanges that can verify transfer rules are being upheld.
4. Secondary trading, the killer app
In addition to the creation of better terms for tokenized real estate products, another area where there are considerable advantages for tokenization over incumbents is with regard to secondary trading.
This secondary trading differentiation is made possible through the use of the ERC-1404 token standard.
To explore how these advantages manifest, consider the two following scenarios:
While the traditional mechanisms (Scenario A) for compliance remain functionally similar to the types of programmatic compliance enabled by tokenization (Scenario B), the notable gap in the ability to generate liquidity and trade security interests with reduced lockup periods is resulting in money being left on the table.
To demonstrate exactly the power of secondary trading, consider the Republic NOTE. The NOTEis a digital asset, backed by an evergreen private equity portfolio. The Note has been issued under Reg D, Reg S, and Reg CF.
As a result of this, different tokens have different transfer restrictions, but by using the features available on INX, this token is able to be traded while enforcing transfer restrictions without any issue. At Upside, we worked closely on the NOTE and helped to ensure it was optimized for secondary trading alongside Republic and INX. Now, investors may have direct access to a portfolio of private securities in a way that previously was not feasible.
5. Winter -> Spring?
Zooming out a bit more, this year we have seen increasingly positive sentiment as the year passed, hopefully a sign of things to come.
The early months of 2023 (and the latter months of 2022) were marked with distrust of the crypto market and widespread skepticism of the regulatory oversight. Additionally, the rise in interest rates saw more people keeping their capital on the sidelines – this was in both traditional fundraising, as well as in real estate fundraising. Things appear to be turning around.
Chair of the SEC, Gary Gensler, has spent a lot of time over the past couple years talking about the problematic nature of cryptocurrencies, the need for regulatory oversight, and the fate of the capital markets. When public sentiment was low, especially around the time SBF was convicted in 2022 alongside the algorithmic stablecoin crashes, his calls resonated with many.
Now, however, there is a different tune playing. In November, Sam Bankman Fried was convicted on all counts. Gensler has taken up the yoke against platforms that involve staking, claiming they are mostly unregistered securities. The SEC has taken a number of different types of losses in court, losing their case against Coinbase, getting warned over false and misleading requests against Debt Box after lying in order to freeze the company's assets, being brought back into court by Coinbase for requested rulemaking, and losing many of the important aspects of the long awaited case against Ripple to summary judgment.
On top of this, there are rumors about the approval of Bitcoin ETFs.
Outside of the regulatory landscape, another macro trend we are following is the Bitcoin halvening. If you are not familiar with the importance of the halvening, it reflects a point in time where the mining rewards for verifying a new block in the Bitcoin blockchain are reduced by 50% (they are halved). So far this date has preceded spikes in Bitcoin, typically because the reduced supply in Bitcoin (now that mining rewards are lower) means there is reduced supply with the same demand.
6. Improved Segmentation for "RWAs" (Real World Assets)
At the beginning of 2023, in conversations with colleagues and friends, we found many were using tokenized real estate and RWA relatively interchangeably. As the year went on, it was clear that a distinction was needed.
People looking to trade assets like gold and gemstones are going to need to be treated differently from a tokenization perspective than people looking to trade tokenized government bonds or treasury bills and these are going to be treated different from people looking to trade tokenized fund interests, interest in individual properties, and these are all going to be treated differently than tokenized debt offerings for real estate properties.
What 2023 showed us was that there are distinctions emerging. These distinctions are emerging along specific product lines and in line with the extant regulatory landscape.
The segmentation of tokenized real world assets is additionally being driven by the areas that are best poised for investment. This type of segmentation is driven along the lines of cache, community, and product market fit.
When you take a step back and think about the areas that could be ripe for investment, you would probably first think about projects that get people excited. These are the types of projects I am describing when I say cache projects are ripe for investment.
Constitution DAO is a great example of a cache project – you could chip in with other investors to buy a fractional interest in owning one of the copies of the United States Constitution. In real estate, cache investments usually include either hospitality projects in exotic locations, projects to renovate or restore historic buildings, or anything else that seems revolutionary and gets people excited.
Thinking back on which projects might be poised for a successful investment, its likely you would consider projects that have communities or that can draw from communities quite easily. An illustrative example for this type of community-centric project is LinksDAO. LinksDAO has a mechanism that provides any of the 66 million people around the world who are interested in golf with an opportunity to invest in owning part of a golf course.
Finally, when considering projects that are easily investible, you would look to the areas where professional investors, institutional investors, private equity groups, family offices, etc. are focused on investing. In each of these instances, there is already a proven product market fit. In the tokenization of real world assets, funds, and other real estate projects, the evidence suggests it is the same. RedSwan recently announced they would be tokenizing a $4b real estate portfolio fund in the Middle East.
Additionally, as individuals continually need to refinance real estate projects in order to get out of high interest rate loans, there is going to be even more demand for tokenized debt products and other alternatives to traditional finance.
While the 2023 might be coming to a close, the vectors for advancement and adoption for tokenized real estate, RWAs, and tokenization are only beginning to crystallize. The expectation for 2024 is that these trends continue to accelerate: there will be more institutional players entering the space, there will be better regulatory oversight, macroeconomic conditions will improve, and we will continue to see experimentation with new types of financial products that are more blended are more innovative than the ones of the past.
The only question that remains is whether you want to let the future happen to you, or whether you would like the future to happen with you?