Cryptocurrencies, Blockchain and Canadian Mortgages

In the summer of 2021, Spain passed a bill that allows borrowers to pay their mortgages using digital assets (ie. cryptocurrencies).

The proposed legislation, aimed at deepening the acceptance, use, and regulation of digital currencies, would also allow the real estate industry to invest in mortgage pools using crypto and encourage banks to use blockchain technology to keep track of mortgages and insurance.

Wow – that was a mouthful…

So where is Canada with regards to Crypto and Blockchain?

In this article, we will explore a few haphazard topics in a fun way…

What is the Blockchain

Blockchain is a new type of secure database system that maintains and records data in a way that allows multiple stakeholders to confidently and securely share access to the same data and information. 

Transactions, or data, are stored in a “ledger” (registry, record, or log) that is distributed among interested parties that are participating within an established network of computers. A record of consensus is provided, using a cryptographic (secure communication) trail, which is maintained and validated by several individual users, called nodes, that independently check the data blocks. 

Only stakeholders that need to see the data will have access. And if anyone tries to tamper with, duplicate, or alter any part of the record, all stakeholders will know.

Decentralized Finance (DeFi)

Decentralized finance, or DeFi, is a system by which financial products become available on a public decentralized blockchain network. That makes them open to anyone to use, rather than going through middlemen like banks or brokerages. 

DeFi refers to a system by which software written on blockchains makes it possible for buyers, sellers, lenders, and borrowers to interact together or with a strictly software-based middleman rather than a company or institution facilitating a transaction.

Woah, ANOTHER mouthful!

Basically, DeFi allows for two or more parties to proceed through a transaction without needing someone to police the transaction to make sure everyone abides by their responsibilities. 

Multiple technologies and protocols are used to achieve the goal of decentralization. 

For example, a decentralized system can consist of a mix of open-source technologies, blockchain, and proprietary software. Smart contracts that automate agreement terms between buyers and sellers or lenders and borrowers make these financial products possible. Regardless of the technology or platform used, DeFi systems are designed to remove intermediaries between transacting parties.

What is a Cryptocurrency?

A cryptocurrency is a digital (virtual) currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology (do you like how I’m wrapping everything together?).

A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.

It’s believed that cryptocurrencies, blockchain, and related technology will disrupt almost all industries, most notably finance and law.

As an aside: Cryptocurrencies face criticism for a number of reasons, including their use for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them. However, they also have been praised for their portability, divisibility, inflation resistance, and transparency.

Bitcoin was created in 2009 and is the earliest cryptocurrency to meet widespread popularity and success. It is, by far, the largest cryptocurrency by way of market capitalization (total value).

“The Bitcoin system is a collection of computers (also referred to as “nodes” or “miners”) that all run Bitcoin’s code and store its blockchain. Figuratively speaking, a blockchain can be thought of as a collection of blocks. In each block is a collection of transactions. Because all of the computers running the blockchain have the same list of blocks and transactions and can transparently see these new blocks as they’re filled with new Bitcoin transactions, no one can cheat the system.

“Anyone—whether they run a Bitcoin “node” or not—can see these transactions occurring in real time. To achieve a nefarious act, a bad actor would need to operate 51% of the computing power that makes up Bitcoin. Bitcoin has around 13,768 full nodes, as of mid-November 2021, and this number is growing, making such an attack quite unlikely.”¹

Investopedia

Canada, Blockchain, and Mortgages

Interestingly, Canada Mortgage and Housing Corporation (CMHC) has created a Blockchain Whitepaper (in-depth report or informational document). 

CMHC sees three avenues for blockchain in mortgages: 

1. Origination (the act of getting a single mortgage)

2. Securitization (funding big blocks of mortgages, or mortgage backed securities)

3. Servicing (dealing with borrowers and their mortgage payments).

CMHC thinks that the best way to use blockchain is through mortgage backed securities (MBS).

The reasoning for this is:

a) CMHC is the owner of the national housing association (NHA) mortgage backed security (MBS) program, which will allow them to impose specific methods and rules.  

Basically, CMHC can just *tell* everyone that *this is how we’re doing it now*.

b) The Blockchain will allow CMHC and investors to bypass intermediaries, making it cheaper for CMHC and the investor.

This is exactly what the blockchain was created for..: fewer hands in each transaction.

c) the Blockchain will allow for much more efficient processes and transfers of information from CMHC to lenders and to investors.

d) all information will be immediately reconcilable, validated and there will be an audit trail, tracked by multiple parties. 

There is a proof of concept developed to prove the value of the blockchain for mortgage securitization. So far, 2 financial institutions have helped CMHC in their research. CMHC’s goal is to get 8-12 banks on board to create a “beta” or test environment. 

There is no word on blockchain being used down the line for borrowers… i.e., everything that CMHC intends to do is way above our pay grades and it will not affect the everyday broker, banker, or borrower.

The Current Lay of the Land

Cryptocurrencies and Down Payment

We cannot currently use any crypto account for a down payment. This is not allowed as all down payment must be in a Canadian institution and, so far, no Canadian institution has cryptocurrency accounts.

Quick Down Payment Info: Lenders typically want to see a 90 day transaction history of your down payment. This is not a bank rule, but a government of Canada Anti-money laundering regulatory rule.

OK, so what about moving money from your crypto account (also called Wallet) to your Canadian account in order to use those funds for your down payment? Well, most lenders will gloss over and say: “NEXT.” Lenders are just not set up to accept cryptocurrencies … rather, they don’t even want to see online statements from crypto accounts; there’s just no training at the lender side for this type of asset.

In some cases, the lender *may* accept the history of your crypto money by way of account transaction statements. The transaction statements are a historic proof of where money has been to satisfy your down payment requirements, but it’s an “exception” from the lender to do this. 

Generally, we have gotten exceptions from a few lenders if the transaction statements show a borrower’s name, account number, amount of bitcoin or crypto currency, and dated transactions (dates are mandatory). The lender would then want to see this money deposited into a Canadian bank account, and that money to be in your account for at least 30 days prior to purchase of your property. 

The problem here is that we (and I mean most Canadians) don’t know what a normal account statement looks like when it comes to cryptocurrencies. I’ve personally seen a few; some look like normal bank statements and some look like excel files. Suffice it to say, the crypto statements that look like a normal bank statement will have a better chance of getting “approved” by a lender than something that looks very different. Again, there’s just no training at the banks when it comes to cryptocurrencies.

Paying your mortgage off with Crypto Currencies

This is not going to happen for a while… a long long while.

The reason why it won’t happen is because banks and other institutions lend to borrowers in Canadian dollars because the money they have on hand is in… Canadian dollars. They don’t want to be paid back in a cryptocurrency because they would then have to transfer the crypto back to Canadian dollars in order to give to investors. Think of it like you trying to pay your Canadian mortgage in Turkish Lira… ya, not gonna happen.

Further, exchanging crypto for dollars in order to make a mortgage payment provides at least three problems: 

1. Crypto is a volatile asset; the bitcoin someone exchanged for $1,000 CAD may only be worth $900 tomorrow (or $1,100). This means that planning for payments is out the window because each $1,000 may be a different amount of bitcoin on a daily basis.

2. Crypto currencies have high transaction fees. Fees to transfer bitcoin from one person to another can be costly and it would not make sense to cash out crypto on monthly transactions.

3. TAXES: yup, cryptocurrencies are considered a real asset, meaning that if they increase in value and you sell, you have to pay capital gains. 

Further, there are just not enough people who have cryptocurrencies for it to become a mainstay in the banking industry. There’s very little demand to use cryptocurrencies as a mode of payment at the moment; the majority of people who hold crypto are holding for the long term and for the asset’s appreciation, rather than as a day-to-day transaction vehicle.

For Bitcoin mortgage payments to become mainstream, lenders would have to set up the appropriate technology to easily receive crypto payments from consumers.

As an aside, the more-innovative United States hasn’t even accepted crypto as payments. United Wholesale Mortgage, the US’ 2nd largest mortgage lender, announced and then quickly shut down accepting crypto payments in August. We’re just not there yet…

Cryptocurrency as a form of Security

A crypto-backed loan is a type of loan that allows you to access the value of the cryptocurrency without having to sell it. Traditional secured loans backed by collateral, also known as mortgages when it comes to housing, require borrowers to provide an asset of value (a house) to back up a loan in order to obtain funds.

With a crypto-backed loan, you don’t have to sell your cryptocurrency to get the money you need. And, rather than using your home or business as collateral, you can collateralize your crypto assets instead.

Benefits of a Crypto-Backed Loan

The biggest advantage of a crypto-backed loan is that there is no need to sell your cryptocurrency to receive funds. Rather than using your home, car, or business assets, you would collateralize your crypto assets instead. This is important because you won’t lose out should your crypto assets increase in value over time. Rather than cashing them out, you can still hang on to them and benefit from their appreciation over time. 

Negatives of Crypto-Backed Loans

Paying for things – including mortgages – with cryptocurrency is a bad idea full of unnecessary risks. For starters, the price you pay for something today may not be the price you pay for it in the future. If you have a 5% interest bitcoin loan when bitcoin is at $1,000 per coin, and bitcoin increases in value by 20% to $1,200, is your 5% on the original $1,000, or is it on $1,200? Are you paying interest of $50, or are you paying interest of $60?

The only way this *might* work that I see, for now, is that everything would have to be pegged at the dollar. So, if you have a bitcoin loan for $1,000, it would be $1,000 of dollars, and not $1,000 worth of bitcoin. Basically, every transaction would have to be boiled down to its root fiat (government issued) currency.

That said, it is possible to have a cryptocurrency-backed loan. Ledn is a new Canadian lender that will use crypto as security.

So, you can see that there are a lot of irons in the fire when it comes to blockchain and crypto currency. Canadian banks are simply not prepared to handle the hot potatoes just yet.

Cited Sources

1. Frankenfield, Jake, “Bitcoin Definition.” Investopedia, November 30, 2021.  Accessed December 19, 2021. 

https://www.investopedia.com/terms/b/bitcoin.asp.