The tokenization of real assets, driven by the adoption of blockchain technology in regulated finance, is gaining traction. Security tokens have become popular for fundraising and investment purposes, offering benefits such as increased liquidity, global trading opportunities, wider investor participation, reduced costs and time for issuing securities, and improved transparency through blockchain and smart contracts.
The World Bank may embrace blockchain technology in the future, as indicated by a recent report that explores the tokenization of infrastructural projects. The report emphasizes the advantages of using blockchain to digitize debt financing processes for global infrastructure and real estate projects. It acknowledges the potential of blockchain in democratizing funding and enhancing transparency in the World Bank’s operations.
However, challenges remain in the infrastructure and real estate tokenization. The absence of a universally recognized tokenized standard, varying anti-money laundering and know your customer processes, cybersecurity concerns, and ambiguity surrounding the legal status of smart contracts and digital tokens have been acknowledged by the World Bank report.
Furthermore, the report states that many of the existing real estate and infrastructure tokenization projects have only been accessible to accredited investors due to securities regulations. However, becoming an accredited investor is generally not feasible for retail investors, as the requirements vary across jurisdictions. This dilutes the intended impact of democratizing investments through tokenization.
While, the report highlights jurisdictions like the U.S., Luxembourg, Switzerland, and the European Union as having robust legal frameworks to support tokenization, it states that the UAE frameworks are among those that are still in the early stages of development and lack clarity.
The UAE is witnessing promising advancements in real estate tokenization, although it is still in the early stages. While there are no publicly documented instances of successful asset tokenization projects in the UAE, indications suggest that this situation may soon undergo a transformative shift.
Unlock Blockchain organized a virtual round table, gathering industry experts to delve into the current landscape of real asset tokenization in the UAE, focusing on the advantages, viability, regulatory hurdles, and future outlook of real estate tokenization.
Among the esteemed professionals participating in the round table were Manuel Karkour, Founder and CEO of The Convo, a European hospitality company; Hadi Kabalan, Cryptocurrency Essentials committee member at the CryptoCurrency Certification Consortium (C4); and Waqas Nakhwa, Co-founder and CEO of AqarChain, a blockchain-powered real estate investing platform.
Tokenization’s Significance Lies in Its Underlying Motivation
When discussing Dubai real estate, the proficiency of real estate professionals in Dubai is commendable. During upward market trends, properties are swiftly sold without the need for additional technological or legal expertise, thus avoiding the burdensome task of technology management. Likewise, during downturn, real estate professionals possess the expertise to navigate down markets effectively, selling properties without the need for constant price reminders. If the motivation is solely focused on selling real estate, tokenization is not always the most effective approach, agreed the panel.
Manuel emphasized that tokenization can be utilized to create a bridge between valuable real estate and retail investors who may not have significant funds to invest in individual properties. “By focusing on building relationships and bridging the gap between real estate value and retail investor capabilities, sustainable value is generated”, says Manuel.
For Hadi, if one wants to embark on a tokenization journey, he should have a software mindset to engage in a digital conversation with token holders. This perspective justifies the additional technology, security and legal costs associated with the tokenization process, as the issued tokens will not only represent ownership, financial or stakeholder rights but also serve as an interactive software. “And what software can do is only limited by imagination”.
Retail Investor Perspective and Regulatory Hurdles
While developers in UAE may not find significant advantages in tokenization purely for driving sales, retail investors can benefit from the potential problem-solving capacity, according to Waqas. Currently, the prevailing approach to tokenization primarily revolves around increasing sales, liquidity, and revenue streams. While these financial aspects hold merit, Waqas queries the potential problem-solving capacity of tokenization for investors, like its ability to address inheritance issues, legal complications, and simplify the buying process.
Additionally, Waqas acknowledges the diverse regulatory frameworks in different countries and the highly regulated nature of the real estate industry. He sees tokenization as a solution to investor challenges, especially enabling remote investment in global markets. However, regulatory complexities hinder the realization of this solution, as regulators often adopt a demographic-focused approach, considering multiple parameters such as financial implications, asset management, and trust concerns.
Waqas emphasizes the need for a secondary real estate market in Dubai to provide liquidity and enable retail investor participation in real estate tokenization. Although crowdfunding platforms address the fractionalization of real estate, property crowdfunding platforms in the DIFC are currently prohibited from facilitating secondary trading of these shares.
“The real essence of tokenization is not achieved when affluent individuals are simply asked to share their funds, as this practice already exists in the ecosystem”, says Waqas. Without enabling broader access to retail investors, real asset tokenization cannot fully deliver on its potential to democratize investments.
He further challenges the necessity of special purpose vehicles (SPVs) controlling assets. He questions why the real estate market, which operates on the basis of square footage or square meters, cannot utilize the same metric for fractionalization. In his view, current regulatory restrictions impede the establishment of a secondary market for real estate tokens, limiting substantial growth in this area.
Market Makers and Market Demand as Drivers for Regulatory Engagement
While Waqas sees regulation as a hurdle, Hadi argued that the challenge is not with regulation but with the legal validity of tokens being accepted as title deeds, something which is still not the case globally. He believes that regulatory mechanisms already exist for securities distribution and how investment choices are presented to retail investors, but the challenge is to have a digital mindset from first principles.
Meanwhile, if the goal is to use a private blockchain, it would be more cost-effective and efficient to employ a traditional database. Similarly, if one just wants to sell fractions, crowdfunding and fractionalization platforms can handle it without the added costs and risks that come with the benefits of using a public blockchain.
The panel noted that in Switzerland, shares of SME companies are legally valid when represented as a blockchain entry. They envision a future where title deeds can be validly accepted digitally in the UAE, similar to the approach taken in Switzerland, but stress that various factors need to align, including technology, law, regulation, and market mindset, for the regulators in the UAE to adopt it.
Manuel highlighted the importance of market makers and sufficient demand to drive active regulation. He suggests partnering with crowdfunding platforms to showcase aggregated properties to potential clients as an optimal strategy meanwhile. Manuel believes that the involvement of market makers and increased demand will spur regulatory involvement. Hadi noted that regulators are often prompted by public demand. He anticipates that once a large financial institution enters the tokenized asset market and provides liquidity and choice, market activity would drive greater regulatory engagement.
Real Estate Tokenization Ascending Beyond Fractionalization
Over the next decade, real estate tokenization will surpass fractionalization, Hadi believes. He suggested that this shift will be driven by a new generation that recognizes the importance of software and how it interacts with various industries. Blockchain technology enables a unique integration between real estate and finance, transforming a traditionally non-digital asset into software-driven functionality. Unlike fractionalization, which simply divides and shares existing assets, tokenization offers a more innovative approach. Hadi argued that he current attempts at fractionalization are limited and fail to tap into the full potential of software and blockchain capabilities.
The technology behind blockchain is relatively young and developers are only now starting to explore its potential. With time, they will discover novel applications that go beyond fractionalization.
In the UAE, Hadi predicts that we will see the emergence of existing stock exchanges adopting blockchain rails, enabling global access to lots of tokenized assets. However, he emphasizes the need to recognize that this transition will require several years to fully materialize and will not happen overnight.
Real estate tokenization is inevitable in the UAE, but the timing of its full implementation remains uncertain. Regulatory frameworks and market demand will play crucial roles in shaping the future of tokenized assets. As the landscape continues to evolve, addressing challenges and aligning technology, law, regulation, and market mindset will be key to unlocking the full potential of real estate tokenization in the UAE.