Beyond Bitcoins: The Future of Real Assets Tokenisation

By Jacques Bughin

The recent past has been turbulent for digital assets, including many Web 3.0 bankruptcies, a variety of scams and attacks, and new regulations. But while some media have proclaimed its death, recent news, – such as the recent rise of bitcoins flirting with the USD 100,000 by the end of November 2024, – may have built a unique “Mark Twain” moment that reports of the death of Web 3.0 are greatly exaggerated.

In fact, many companies in industries such as financial services, retail, media, or real estate, have continued their foray into  Web 3.0, possibly outside of the crypto labelling, such as tokenized loyalty programs, or luxury goods (see Table 1). Furthermore, more and more companies are becoming ambassadors of the potential of « tokenization, » that is, the process of converting assets into digital tokens that represent ownership through the blockchain. Finally, although highly uncertain and subject to frequent revision in recent years, tokenisation has been computed to grow into a $10 trillion global market by the end of the decade. For example, Citibank had recently estimated that tokenised real estate could pass the $1.5 trillion mark by 2030, while equity and venture capital could be close to $1 trillion, for $4 trillion to $5 trillion of tokenised digital securities such as mutual funds, debt and equity securities.

The above then leaves no choice for executive and managers, but to actively reconsider their strategy for Web 3.0. While a lot is said about tokenisation of financial assets, this article focuses on real assets, in particular, the category of real estate—as many companies own/lease some, and is potentially one of largest vertical opportunities in real asset tokenisation.

Show me the money

The real estate industry is one of the most important and oldest asset classes in the world, valued at close to 300USD trillion. But it should be much bigger. The actual worldwide asset allocation is currently 10%, while given its risk/return profile, as much of 30-60% should be allocated to real estate in an optimal institutional portfolio,

Why this is so is the result of three sins:

• accessibility: Marketability should have definitely increased as many countries have been passing laws for the applicability of REIT (real estate investment trust)  since 50 years,  as a means by which the investing public can gain exposure to real estate.In thirty years, a real change has come from that vehicle, from 120 listed REITs in two countries to 940 listed REITs in 42 countries and regions. Yet today, still 80-90% of the value of the overall underlying real estate market is not listed.
• Regarding liquidity, the typical holding period for real estate debt seems to be 4-7 years, while private equity real estate funds have lock-up periods of up to seven years. Public and private REITs, as an improvement, deliver a better liquid channel for both retail and institutional investors but virtually all markets have struggled to build more  recognized REITs markets and still face regulatory and tax-code hurdles to gain access to the international investment community.
• In terms of costs and inefficiency, real estate deals require several parties and significant amounts of manually generated paperwork. The process of structuring an offering, arranging financing, and gathering necessary due diligence items often takes weeks or months.

God Bless Real Estate Tokenisation

On top of its sins, the real estate industry has been rather immune to technologies. But the  development of Blockchain technologies (plus AI) may be the set of technologies that will revolutionize everything. The blockchain is a powerful technology that safely stores transaction records on a distributed peer-to-peer computer network. Among (many) use cases, blockchain can specify a link to Real estate administration and title registration systems, ensuring transparent and immutable records of ownership; can facilitate secure and efficient transactions; can offer new ways to manage estate assets, with proposals for concepts such as rental platforms, real estate data storage solutions, and multiple listing services; or finally can build a system of real estate as blockchain-based tokens. All those effects can further be turbocharged by AI.

In particular, blockchain tokenisation offers specific advantage to counter the three sins. Among those:

1. Accessibility: Tokenization lowers the entry barrier for real estate investment, allowing smaller investors to participate in high-value real estate projects. This democratizes access to real estate investment opportunities. Blockchain technology ensures that all transactions are recorded on an immutable ledger, as smart contract, enhancing transparency and reducing the risk of fraud for participants, enhancing accessibility to more secured returns
2. Enhanced Liquidity: Traditional real estate investments are typically illiquid.

Tokenization allows for fractional ownership, making it easier to buy and sell small portions of a property without the need for a full property sale.

3. Fast and Lean Transactions: Blockchain eliminates intermediaries, streamlining the real estate transaction process through efficient peer-to-peer (P2P) transactions, automation, and smart contracts.

The excitment beyond Real Estate tokenization emerged about a decade ago. The St. Regis Aspen Resort in Colorado was tokenized, allowing investors to buy shares in the luxury hotel. Similarly, the luxury Manhattan condo, 436 & 442 East 13th Street, was tokenized by the real estate firm Propellr and the tokenization platform Fluidity. In Europe, the AnnA Villa in Paris became the first property to be sold fully through a blockchain transaction. The luxury building, located in the city’s Boulogne-Billancourt district, was valued at €6.5 million and sold to French real estate companies Sapeb Immobilier and Valorcim. The procedure began with the transfer of ownership of the building to a joint-stock company (SAPEB AnnA), followed by the division of the firm into 100 tokens powered on Ethereum and each subdivided into 100,000 units, with each share traded for €6.50.

Since then tens of tokenization projects have seen the light in many cities around the worlds. Furthermore, platforms like RealT and Polymath offer tokenized real estate investment opportunities, attracting new investors.

Back (or Crash?) To Earth

But behind those attempts to initialize the market, market remains tiny- In effect, by 2022, the market size for real estate tokenization was $2.7 billion. A few elements also appear as headwinds.

1. The first is regulation: despite progress, regulatory environments for tokenized real estate vary widely across jurisdictions. Navigating these regulations can be complex and costly.  Regulatory bodies are however beginning to recognize and approve tokenized real estate securities. For example, in the United States, the Securities and Exchange Commission (SEC) has approved several tokenized real estate projects, providing a legal framework for their operation.
2. Another issue is that while tokenization aims to increase liquidity, the market for real estate tokens is still developing, and actual liquidity might not match expectations initially. Arguments heard are:

“Crowdfunding did not work”. Tokensiation may face the crowdfunding liquidity issue. The later was supposed to  add liquidity to the commercial real estate space, but it never took off.  In fact, while user experience and manual processes were cited as flaws within most crowdfunding platforms, akey issue was  that investments can only be traded on one specific platform. Tokenization on more widely adopted networks would be a solution by introducing a much more global audience that is not confined to a single platform. Tokenization could also reduce the number of third parties involved (i.e. brokers, escrow agents, etc.) in the typical investment process. Reduction of third parties involvement naturally adds fluidity to the real estate investment process

-“Goodbye ISPX”. Liquidity is challenging nevertheless even for blockchain. The most famous case is ISPX which went listed in the UK market, as a market maker of listings on the blockchain. In the end, there were only three listings – all of which were linked to one of the founding IPSX shareholders, M7 Real Estate. These were also wholesale listings, i.e. not open to retail investors. Perhaps IPSX was unlucky with its timing: Brexit was unfolding and Covid lay ahead.

Proving the asset class tokenisation value and differentatiors to traditional REITs.

Swinkels (2023) considers a sample of 58 real estate tokens in the USA. He finds that a token has on average 254 owners, which shows that tokenization can improve risk sharing across households. Kreppmeier et al. (2023) provide first empirical evidence on real estate tokenization by analyzing a data set on 173 real estate tokens in the USA with more than 200,000 blockchain transactions. They found that the ownership of properties is not concentrated on a small number of small investors, which confirms that tokenization can provide broad access to real estate for many small investors.

Liquidity yes, but does it go against the profitability? On RealT, where Investments are available through the Ethereum blockchain, the answer seems yes: in fact, various studies have demonstrated that tokenization generated returns of 15%, compared to a -15% return on traditional Real Estate Investment Trusts (REITs) in 2022.

But there as well, there might be catch: in the 1990s and early 2000s, participants in the property investment market became fascinated by the potential for the securitisation or unitisation of real estate. REITs became popular, and it also became easier to raise – and offload – debt. The result was a financial crash and the insolvency of many banks, driven by downside volatility in real estate prices.

Arguably, therefore, illiquidity is a necessary evil in justifying the defensive role of real estate. As theory suggests that the illiquidity of property means that its required – and expected – return is higher than it would otherwise be, introducing liquidity to property may damage returns, as the illiquidity premium may be eroded. Nevertheless, Real estate market participants has this curious belief in the superiority of an ‘offmarket’ transaction. In fact, it is strongly believed that a wider secondary market will also increase effective demand in the primary market and improve the perceived quality of the asset.

An executive journey to real estate tokenisation success

Given the above, the optionality of playing in tokenisation can not be dismissed—let alone the risk of disruption by competitors and entrants. A strategy roadmap that is highly valuable, in our experience is based on the following five steps:

Prospection

Step 1: Define segments to play. For example, larger assets already held in fund structures may eventually be tokenized successfully; there may also be an alternative market for tokenized residential, social impact, or community assets where investment regulation and risk/return are not the main drivers of behavior. The mass market for the tokenization of single commercial real estate assets, however, may be some way down the road.

Step 2: Define the conditions for market take off.  A few developments are necessary for the digital tokenization of single real estate assets: (a) an expressed demand for the fractionalization of single real estate assets, b) )market participants need to be comfortable with blockchain, the digital underpinning of tokenization, b) Further, in many land markets fractionalization requires an intermediate structure to be established because the direct ownership of land cannot be shared amongst many, increasing the cost of tokenization.

Those two steps provide a view of marketability of tokenization, which coupled with competitive intelligence of attackers and peers launching their projects, gives a guidance for early mover or fast follower strategy in active tokenization

Capability building

Independently of sensing the market readiness, executives may not take time in investing in capabilities to quickly pilot and, especially scale opportunities. They must

Step 3: Pilot. Given large uncertainty, but also ecosystem play in tokenization, it is imperative that executives get resources ready to pilot and better crystallize the use cases for their business plan. In particular, the following needs to be assessed:

1. Tokenization type. Not all tokens are equal. The perspective on token already is shifting from cryptocurrency towards more comprehensive token standards to set the basis for much large enterprises use. The so called International Token Standardization Association (ITSA) has been establishing a taxonomy along the four dimensions of: purpose, industry, technological setup and legal claim.
2. Token interoperability. Interoperability is known to be critical to scale market, but it also induces a common, and possibly more competitive play. Institutions such as InterWorkAlliance drives standards for interoperability.
3. Token compliance. Different countries have developed various infrastructures. In the US, while real estate tokens often trade as securities and have to beregistered in an exemption like Regulation D or Regulation Aþ, tokenization platforms  must also comply with SEC regulations, Europe, has also a recent MICA policy and  real estate tokens are considered as securities
4. Token technology platform. In particular, blockchain is not enough – it must be integrated with advanced technologies, such as AI and IoT, is set to further streamline property management and investment decisions
5. Token economics. It is really important to test the assumption of the underlying economics, and the competition reactions. Who are the main entities involved in the value chain of the asset? How competitive is the market for the asset and what is the interest of existing Real estate players to play coopetition and coordinate with a model of tokenization? What is the appetite of end customers and willingness to pay?

Take off

Step 4: Commercial launch and scale.  A typical mistake in digital projects, of which tokenisation is one, is to scale slowly instead of intending to ‘hyperscale’. Hyperscaling is a must in tokenisation, as most business models have a platform architecture component – with a possible winner-take-all structure. It is also time to explore DeFi integration for broader utility of tokens.

Phase 5: Evolve. Remember that tokenisation remains uncertain. You must remain agile to pivot if necessary. In the meantime, you need to build the foundations for brand recognition. In particular, at this stage, it’s more than time to leverage AI and other cutting-edge technologies to enhance the value proposition (e.g., real-time property monitoring) and position the company as a leader in Web 3.0-driven asset management.

Ready to go?

Table 1: Case examples of tokenization projects

About the Author

Jacques Bughin is the CEO of MachaonAdvisory and a former professor of Management. He retired from McKinsey as a senior partner and director of the McKinsey Global Institute. He advises Antler and Fortino Capital, two major VC /PE firms, and serves on the board of several companies.

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