The 2008 financial crisis was a devastating time for many, as the collapse of the United States real estate market caused ripple effects impacting the
The 2008 financial crisis was a devastating time for many, as the collapse of the United States real estate market caused ripple effects impacting the employment and livelihoods of millions of people.
According to TheStreet, one of the chief causes of the crisis was the opaqueness of the mortgage industry. Mortgages were bundled into packages called “mortgage-backed securities (MBS)” that could be bought and sold by banks and other investors who relied on rating agencies to determine how risky the securities were.
The banks sometimes “packaged AAA-rated securities with lower-quality ones, and these bundles were passed off as top-rated securities when they were sold to investors.” These investors didn’t necessarily understand that they were buying low-quality securities, which were likely to be defaulted on, leading to massive losses once the crisis revealed the truth.
According to Ralf Kubli, a board member of the Casper Association, this fundamental problem that sparked the crisis still exists, but it can be fixed through blockchain technology.
Kubli hails from both the traditional finance sector and the crypto industry. He has previously worked in various mergers and acquisitions, sales and executive management positions at Sika, Starmind International, BCM Europe, and other companies. In 2021, he joined the Casper Association board, a nonprofit promoting the Casper blockchain network.
He told Cointelegraph that tokenization of mortgages could allow them to become “observable, verifiable and enforceable” on a public blockchain, making the mortgage industry more transparent and helping to avoid the kind of surprises that arose during the 2008 crisis.
Interpreting paper agreements in a digital world
When financial agreements are written, they are put on “pages and pages of paper,” Kubli explained. Afterward, they are given to analysts and programmers who interpret these written documents as machine-readable code.
However, these analysts often have disagreements, he noted. Under normal circumstances, disagreements are small and can be resolved through negotiations. However, situations like the 2008 financial crisis show that disagreements can sometimes be considerable, causing catastrophic results. As Kubli explained:
“You have a written contract that then gets translated into computer code that then runs in these core banking systems, and after about 40 years when these core banking systems are still running, no one really remembers exactly what they programmed and how they programmed it […] and that gives us the world that you saw in the Big Short [film about the financial crisis].”
Kubli agreed that tokenization can help revolutionize the economy, saying “everything will be tokenized in the future.” However, he claimed that developers need to be careful with how they tokenize mortgages in particular. One way to tokenize mortgages would be to create a PDF file of a term sheet, then put a hash of that file into a token contract. But this would be a “dumb token” that isn’t any better than what we already have in traditional finance.
In his view, for tokenization to succeed, the tokens have to be “smart,” meaning the financial agreement has to be machine-readable and the various parties involved must agree to the code itself. Otherwise, differences in interpretation and analysis will continue, causing future disruption in financial markets.
DeFi doesn’t solve the problem
Lenders and borrowers already accept machine-readable contracts through decentralized finance (DeFi) apps today. When a borrower takes a loan from a DeFi app like Compound, for example, they never sign any legal agreement to repay the loan. Instead, by using the smart contract associated with the app, the borrower is understood to have agreed to the code running within the contract.
However, most DeFi apps require the borrower to put up cryptocurrency as collateral to secure the loan, and the value of the collateral has to be greater than the loan amount. Kubli argued that this limitation prevents DeFi from competing with traditional finance. “In DeFi, you’re not having cash flows over time, in DeFi you’re having collateralized or overcollateralized loans only” but “The world runs on credit, and credit is payment over time” he said.
Some industry experts have argued that “Soulbound” tokens — digital identity tokens representing the characteristics or reputation of a person or company — can extend DeFi into under-collateralized and overcollateralized loans.
However, Kubli emphasized that this only solves the problem of “underwriting the creditworthiness of a counterparty.” It doesn’t allow a stream of cash flows over time to be tokenized.
Digital term sheets
To ensure that the terms of a mortgage are transparent, Kubli believes that a “machine-readable, machine-executable and machine-auditable…
cointelegraph.com