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Bettering Mortgage Link by Link

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Editor’s note: this feature originally appeared in the March issue of DS News, out now.

You have to look no further than the front page of the Wall Street Journal to learn about Bitcoin these days. Its exponential rise in price has captured the attention of both Wall Street and Main Street alike, but because of its price volatility, its questionable source of value, and the security breaches resulting in theft from exchanges, many people continue to view Bitcoin as a house of cards built on thin air headed for an inevitable collapse. If you dismiss Bitcoin as just noise, you’re overlooking the most important thing about Bitcoin—it utilizes blockchain technology, the most revolutionary technology that has entered the marketplace in decades.

To stay relevant in the fintech sector, it’s important to at least have a basic understanding of blockchain technology, and the use cases being explored today that could have an impact on mortgage markets.

Blockchain in Plain English

Blockchain, at a basic level, is a new way of keeping track of information between parties who need to share and trust that information. Many of the blockchain pilots underway today are simply trying to store and share data in a more efficient, secure, and transparent manner.

“All blockchains or similar ‘distributed ledger technologies’ have a common set of characteristics,” said Ashley Lannquist in a “Blockchain at Berkeley” blog. Lannquist explains that blockchains are “digital ledgers or logs that record electronic transactions that occur between two parties. The two parties do not know each other and directly engage in a peer-to-peer network of connected computers. Rather than relying on a third-party middleman (ex. PayPal, a bank, etc.), the network collectively reaches agreement (‘consensus’) on which transactions are legitimate using a consensus mechanism. By ‘legitimate’, we mean that, for example, Alice sends money to Bob and does not spend the same digital currency twice (called a ‘double spend’) or do anything else malicious.”

Each type of blockchain platform can have a different set of rules for how a consensus must be reached to determine the legitimacy of a block, but all mechanisms entail a system where the validators, often referred to as miners, are incented through rewards and/or transaction fees to only approve blocks that contain legitimate transactions, and then others in the network must agree with the determination (reaching a consensus). Once a block of data is validated as legitimate, it becomes a permanent record and is then linked to the next block to form a chain. Blockchain technology could be used to keep track of any store of value including, but not limited to, account balances, arbitrary pieces of data, or asset ownership.

There are certain blockchain platforms that were developed in a way that allows for more sophisticated applications to be built on top of them, such as the Ethereum smart contract platform. Many of the applications being developed in the banking industry revolve around “smart contracts,” which really aren’t contracts, but can be better described as self-executing software protocols that allow for certain actions to automatically happen when a dependent event takes place. There isn’t room for any gray areas, but if a company could define “if this, then that” scenarios, the application could administer the transaction without an intermediary. For example, if a master servicer wanted to sell servicing rights to a specialty servicer, but only when a certain portfolio reaches a delinquency percentage of x, a smart contract could theoretically be programmed to automatically administer that transaction when the preset qualifications are met. In this way, a blockchain with a smart contract application guarantees that the contract is carried out as intended without anyone managing it.

Additionally, if the parties making the transactions know and trust each other, they can create a private and permission-based blockchain, allowing for the enterprise use to skyrocket. For example, a private permission-based blockchain can be limited to a group of financial institutions that want to share information and transact with each other regularly. The members can all be participants in the blockchain but could limit the visibility of any single transaction to only certain members who need the information, such as the two banks exchanging funds and their regulator. There are already consortiums of banks across the globe working on blockchain solutions to replace archaic systems that plague the banking industry.

Putting Theory to the Test

REAL ESTATE | One notable pilot program for blockchain technology came out of Cook County, Illinois. The Cook County Recorder of Deeds partnered with a California-based real estate tech start-up to explore how land records could be recorded utilizing blockchain technology with the goal of figuring out how to complete a real estate transaction without the need for paper. Although the pilot fell short of that goal, it did prove that the conveyance itself could be documented with all of the necessary information needed for the public land records index, and also that cryptographic signatures rather than wet signatures could be used. The primary roadblock that could not be overcome were the legal requirements for providing paper legal notice of that transaction, and so the pilot’s proposed workflow was required to utilize a Confirmation Deed that would be traditionally recorded to evidence the transaction.4 Only Arizona and Vermont have passed laws officially recognizing the legitimacy of information stored on a blockchain.5 However, the Cook County pilot was successful insofar as it demonstrated what could easily be done in the future in the United States if there is a better understanding and adoption of this technology by both the mainstream public and lawmakers. The Republic of Georgia, for example, is the first government to register land titles and track real estate ownership with a blockchain.

BANKING | Because blockchains are a great store of value and can securely house data, it makes sense that the leading industry in blockchain technology development is the finance industry. The banking industry, so far, has been focused on capital market applications like the clearing and settlement of trades, global payment processing between institutions, and other more potentially relevant uses to the mortgage industry, like identity verification and loan syndication.7 Even Jamie Dimon, CEO of JPMorgan Chase, who is one of the loudest critics of Bitcoin, is a huge advocate for blockchain technology. Chase has been developing Quorum, a permissions-based private enterprise focused blockchain built on top of Ethereum’s smart contract platform. The company also is a member of IBM’s Hyperledger, which includes other member companies like R3, builder of a new distributed ledger operating system for financial markets, which it hopes to make available in 2018.

Other notable financial focused blockchains include the private consortium blockchain called Ripple. Ripple allows participating banks “to process cross-border payments in real time with end-to-end tracking and certainty.” It has attracted at least 75 banks, including Bank of America and Santander. Chain, another notable technology company, has partnered with institutions like Citi, Capital One, Fidelity, and NASDAQ, and is focused on facilitating transactions between entities directly, aiming to decrease costs and increase throughput.

All of this demonstrates that the effort to utilize this new technology in banking is underway, and will modernize the operating infrastructure that we know today.

MORTGAGE SERVICING | Dovetailing the real estate and banking use cases, it is not hard to imagine blockchain applications being successfully deployed in the mortgage industry, and especially the mortgage servicing space. Servicers oftentimes rely on largely obsolete operating systems but must comply with the most stringent regulatory requirements of any industry, demanding quick and accurate production of data for audits. They also must make data-driven decisions based on the current value of real property collateral and loan status, requiring the need to pull from many different sources to take any single action. Blockchain could be utilized to bring all of this information together to make it more readily accessible. Possibilities include the storage of loan origination and property information, payment processing, and self-executing smart contracts that can automatically determine a change in loan status. In the future, many of the servicing functions done today could be disintermediated by this technology. Even entire business functions, like work performed by third-party closing attorneys and escrow companies, could theoretically be replaced by a peer-to-peer blockchain solution. There are already companies that have created enterprise-level blockchain solutions specific to the mortgage industry, which aim to accomplish these very things, including one announced in  March 2017 called Factom Harmony.

Change Is Coming 

Blockchain technology is new, and, like any emerging technology, continues to evolve. What we all know to be true is that technology doesn’t wait for you to catch up with it. It may be years before the technology becomes mainstream, but with its revolutionary potential in sight, and when taking into consideration the amount of money already invested and the visible progress made to date, there is no doubt that blockchain will continue to gain a broader acceptance.

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