NFTs & Smart Contracts will optimize construction industry transactions

Posted by Ricardo J. Rodríguez - 05 May, 2022

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Blockchain-enabled Smart Contracts & NFTs

MBS_NFTs_01The construction industry represents more than 5% of the GDP in most Western economies1. It is a very prominent industry. Yet, there remain inefficiencies everywhere that smart contracts and blockchain technology can assist. The Blockchain is the technology behind bitcoin, a decentralized digital currency. But there are other applications for this technology in the construction industry that extend beyond financial transactions.

Behind the scenes, the world of construction is a complex one. The entire construction process entails collaborative relationships between many parties who work together to achieve the same goal: to construct a project on time and within budget. Contracts, subcontracts, supplies, and services make up most of these relationships. When it comes to payments, vendors play a crucial role in any construction project. They are responsible for providing supplies and equipment needed to complete the job on time, so they need to be paid on time. There might also be issues of non-performance by contractors or subcontractors, which could lead to delays and cost overruns that affect the project’s completion date.

When you consider that a large portion of those costs goes to lawyers and consultants, it becomes clear that the general contracting space is ripe for technological disruption. In addition, while the construction industry has been traditionally slow to adopt new technologies, it is now evolving to include them. Blockchain technology can address these challenges effectively and transform how things are done in the construction industry. This process will involve creating new systems, processes, and ways of doing business involving all stakeholders, from architects and engineers to surveyors and contractors.

The application of blockchain technology to the construction industry is already underway in several major markets. Many major companies have announced their intentions to integrate blockchain solutions into their construction projects. In the U.S., these include such high-profile names as Microsoft and IBM, with other companies like J.P Morgan Chase, Lehman Brothers, and the XRP Ledger already having completed proofs-of-concept or pilots2.

Currently, construction companies use paper documents to document every construction project step. These documents are then put into a system where everyone on a team can view them. However, this process is not secure and does not fully track payments for individuals or teams who did not physically handle the materials. As a result, paper-based documents are inefficient, costly to maintain, and prone to risk.

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What is blockchain technology?

Blockchain and crypto are becoming part of our lives more every day. However, there are still misconceptions about how blockchain technology will work and be integrated into existing systems. Many people think that blockchain technology is only helpful for cryptocurrencies, but it is much more than that. Blockchain technology allows for the creation of digital assets using Non-Fungible Tokens (NFTs) that can be transferred between parties peer-to-peer.

At its core, blockchain technology is a decentralized system where transaction details are stored on multiple computers worldwide instead of on one system owned by one entity. This framework creates an added level of security and reliability because it allows systems to continue functioning without any single point of failure. The concept behind blockchain technology is that data can be stored on a ledger. It doesn’t matter where that data came from — if it’s valid and unalterable, you can use it to build an immutable ledger.

For example, a blockchain could be used to create a contract that automatically pays suppliers and subcontractors based on verified time and material reports. Or it could be used to create a contract for design and construction services that automatically issues payments at set milestones or upon completion of critical tasks. By eliminating intermediaries and reducing the need for oversight, blockchain technology can help make project cost estimates more accurate, shorten project times by eliminating post-retrieval review, and increase transparency. Using smart contracts, users can make agreements and exchange money or assets without needing a third party involved to complete the transaction. Everything is verified automatically on the blockchain network by all participants simultaneously, saving time. You could then apply this same concept to track the progress of projects — which materials were used on which job? Where are they now? Who owns them? Etc.

It’s a significant industry with lots of moving parts and thus presents many opportunities for disruption. Focus on risk management and contract negotiation. Smart contracts are an essential part of blockchain technology and will revolutionize the way people do business. Everyone involved in a construction transaction will have full access to all documents, agreements, data, and other information stored on the Blockchain. The use of smart contracts will dramatically reduce risks and costs associated with delays, disputes, and fraud during the project’s life cycle. Blockchain technology presents a significant opportunity as a critical part of corruption mitigation efforts, particularly on government-sponsored projects.

 

MBS_NFTs_03Relevant blockchain use-cases for the construction industry

The construction industry will be significantly impacted by the implementation of blockchain technology due to its current inefficiencies concerning data collection, payment, and risk management. A recent McKinsey report states that blockchain technology could lead to a 10%-20% reduction in transaction costs for the construction industry3.

Blockchain will have a significant impact in four areas of construction: digital twins, project data, cost and risk management, and payments.

  • Digital Twins - The application of blockchain technology will allow for interoperable digital twins where supply chains can share accurate and real-time data across software platforms.

  • Project Data - Architecture, engineering, and construction (AEC) firms have a lot of documentation to manage throughout a project’s lifecycle, from bidding to design to construction. Blockchain can provide access to critical project information at every step of a project’s lifecycle. Instead of searching through manual documents or files, owners, contractors, and subcontractors can easily access a building plan’s schedule, budget, or design requirements.

  • Cost & Risk Management - Owners and developers could tailor their smart contracts to fulfill a myriad of project transactions with transparency and record them immutably on the Blockchain.

  • Payments - The Blockchain can also help provide a fast, transparent, and secure payment method. Payment to subcontractors would allow for real-time payments, or even performance bonuses, with automatic triggers based on the completion of agreed milestones.

 

MBS_NFTs_04Decentralization & trustless transactions

The application of blockchain technology will optimize construction industry transactions by being trustless and decentralized. Information silos that come with paper-based documentation can also contribute to delays in project delivery. If different stakeholders use different systems or clients use outdated software, it can be challenging to share information efficiently and accurately. Within Blockchain’s distributed ledger, multiple independent stakeholders can collaborate without trusting each other. In the same way that the internet has revolutionized the exchange of information, Blockchain can revolutionize the business of value. In this sense, trustless means that you do not have to trust the other party or an intermediary as a party to a contract. The nature of the smart contract has already authenticated and validated all immutable parameters through the distributed ledgers, so the interactions occur seamlessly.

Smart contracts are computer protocols that facilitate, verify, or enforce the negotiation or performance or make a contractual clause unnecessary. Smart contracts also have a user interface and often emulate the contract logic. The purpose of the smart contract is to act as a middleman, responsible for executing all parties’ obligations. Smart contracts allow businesses to cut out intermediaries and reduce transaction costs. They also provide an immediate agreement between buyer and seller, which can help reduce the risk of fraud.

An intelligent contract requires all parties to fulfill their contractual obligations promptly. If any party fails to fulfill their responsibilities, the agreement automatically executes, transfers funds, or assigns rights per the contract terms.

 

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What are Smart Contracts & Non-Fungible Tokens (NFTs)?

A smart contract is a computer program, or a transaction protocol intended to execute, automatically control, or document legally relevant events and actions according to a contract or an agreement. The objective of smart contracts is to provide security that is superior to traditional contract law and to reduce other transaction costs associated with contracting.

Many organizations are currently exploring a version of smart contracts through digital asset tokens such as non-fungible tokens (NFTs). Consider NFTs immutable digital representations of traditional contractual documents. NFTs may represent physical objects, asset rights, access, or contractual documents like real estate deeds or property titles. They allow multiple parties to come together and share information about their shared resources without relying exclusively on physical documentation.

NFTs can act as the digital representation of the asset that the transaction is tied. The usage of these tokens also serves to authenticate the integrity of the asset and stakeholders involved. For example, if a buyer and seller are to enter into a smart contract of purchase and sale, a trustless digital representation of the property (the NFT) in question could be used. Once all parties have agreed upon the terms, all data is stored indefinitely on the Blockchain. A trustless digital asset representation means that there would no longer be any need for third-party verification, streamlining the entire process. The process is further optimized by eliminating costly fees and adding a layer of security for both buyer and seller instead of utilizing third parties like escrow agents.

NFTs are protocols and standards that provide the framework for establishing digital representations of physical assets. These assets can then be ‘transferred,’ in a sense, and tracked on the Blockchain in real-time. An example would be the transfer of ownership rights to a building. The tokenization of this asset is then registered on each successive ‘block’ of transactions. So as you may begin to see, NFTs carry many potential use cases.


MBS_NFTs_06Tokenized assets for the built environment

Many construction companies could explore developing their non-fungible tokens (NFTs) or digital asset tokens. The concept of tokenized buildings or assets would bring much-needed transparency and agility to several industry transactions. NFTs and smart contracts will undoubtedly boost the efficiency of transactions in the construction industry and the products or services.

Customized NFTs will allow better quality control over products and more efficient inventory management. When it comes to real estate, the tokenization of a property can also accurately represent the structural data and quality control measures associated with a particular building or property, reducing instances of fraud and damage. Below we explore a list of some additional examples:

  • Attribution / Title transfers - A buyer could purchase a home through an NFT, and the owner would be transferred immediately, without the need for title agents, escrow, notaries, or other intermediaries. It would save time, but it would also reduce fraud potential and eliminate the need to rely on heaps of paperwork that are often misplaced along the way. Title transfers could apply to furniture, fixtures, equipment, materials, land, intellectual property, or whole projects.
  • Stakeholder Payments - Each payment could be programmed into a smart contract and processed transparently without delay or need for intermediaries. Furthermore, charges could be verified by third parties like local government oversight agencies to ensure that funds are being correctly used for the intended purposes.
  • Material ownership / Supply Chain Logistics. A smart contract is computer code that automatically executes when certain conditions are met — for instance, a buyer purchasing a piece of equipment from a seller. NFTs track unique digital items such as warranty documents, service agreements, bills of materials, and even buildings themselves, making them traceable and verifiable on the Blockchain. This quality makes them a popular tool for tracking supply chains and sharing ownership rights in digital form.
  • Legal Document / Asset Tracking - Another use could track assets about the project itself, such as insurance policies, bonds, liens, and warranties. With the token, the owner has a certificate of ownership of the digital asset and can sell, trade, or transfer it as they deem necessary. NFTs could automatically ensure that funds or rights release upon clause fulfillment.

 

MBS_NFTs_07NFTs & Sustainability

The construction industry is a prime target for applying blockchain technology because the industry consistently suffers from poor transparency and interoperability. Moreover, distributed ledger technology (DLT) will provide many benefits when considering sustainability, embodied carbon, and material safety opportunities.

However, one of the biggest problems with blockchain adoption is its high energy cost. Generating tokens on cryptocurrency platforms involves solving complex mathematical algorithms and verifying transactions using enormous electricity. Conscious of this challenge, the major crypto platforms are trying to change. Many crypto platforms now advertise their eco-consciousness and are working on innovations to mine coins, seeking a broader use of renewable energy sources4

While challenges to NFT’s impact on the environment continue to progress, their potential uses cases to accelerate the adoption of sustainable solutions within the construction industry cannot be ignored. Only a handful of free tools are available to track a building’s carbon footprint, and contractors may not have the resources to use them effectively. NFTs could be used to validate and transparently share validated metrics around a project’s true environmental impact.

The concept of tokenized buildings or assets would bring much-needed transparency and agility to several industry transactions, including environmental product declarations. An EPD is a document that verifies the environmental impact of construction materials, and it has been driven by the Architecture Engineering Construction Institute’s Sustainability Extension for Building Information Modeling (LEED). However, LEED is not a requirement, and many contractors aren’t aware of the potential value they can provide their clients with an EPD. Although there is a growing market for EPDs, many companies, due to resource limitations, may need to create EPDs or material provenance reports without third-party verification. With an NFT, all of this information could be stored without intermediaries that require additional fees and additional time for the process. Third parties would verify the data behind EPD and then tokenize it as an NFT. The EDP’s value and data are transparent to everyone involved in the building’s lifecycle — from product manufacturers to designers, contractors, owners, operators, and even building occupants.

 

Takeaways

Today’s construction industry is rife with ambiguity and bureaucracy, but legacy issues could become a thing of the past. Existing industries are seeing rapid disruption thanks to blockchain technology. As blockchain tech adoption rises within construction businesses, they can increasingly ensure broader security and trust between their stakeholders. We’re sure many in the construction industry can see the potential for blockchain technology to streamline processes and make information more transparent. Still, the question remains: will the industry respond favorably? It may take a while before we find out.

The most important consideration for the construction industry to remember is that this technology is still in its formative years. Much experimentation will be needed, and not all bets will likely pay off. After all, this is still largely unregulated, requires a particular staff/expertise level to deploy, and implementation is not user-friendly. But if one thing is sure, blockchain technology will continue to expand its reach into new industries. The benefits are too great for organizations to ignore.

Nevertheless, much like businesses replaced brochures with websites and hand-typed letters with emails, NFTs will substitute traditional paper-based transactions over the long term. That being said, we will see increasing adoption of these platforms within the construction space. The construction industry is one of the largest industries globally, and it’s going through significant changes that will result in greater automation. The application of smart contracts in the construction industry opens up even more possibilities by allowing sellers/contractors to be more in control concerning their assets and intellectual property.

Topics: managing risks, Construction Project Planning, Expert Insights, Efficiency/Productivity in Construction, Market Insights, Sustainability

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