By Pamela Morgan
In most jurisdictions, security deposits are intended to provide landlords with a financial guaranty against nonpayment of rent or excess damage to a rental property during tenancy. In the past the primary way to provide this guarantee has been for the tenant to deposit funds, in trust, with the landlord. The landlord takes custody, but not ownership of the funds. The obvious problem is that, aside from ethical and legal obligations, a landlord has no incentive to return a tenant’s security deposit - which is why almost everyone who has been a renter has a “they-didn’t-return-my-security-deposit” story.
Custodial security deposits present the same problems as most custodial accounts. Custodial accounts are easy to “borrow” from. In the case of security deposits, the penalties for misuse of funds are comparatively low to the reward of keeping the money and most tenants will not actually sue to recover a deposit. While some jurisdictions require that landlords hold security deposits in a separate account, some don’t. In the end it really doesn’t matter whether the funds are in a separate account or not because they’re controlled solely by the landlord with little, if any, oversight by tenants or anyone else.
Unfortunately, many landlords have a standard practice of not returning security deposits regardless of the condition of the premises. When the tenant receives a form notice that they’re not getting their deposit back, they’re faced with two choices: fight or walk away. Often the deposit amount simply isn’t enough to justify taking time away from work, traveling to a jurisdiction where they may no longer live, and presenting evidence before a court where success is never guaranteed. Undocumented residents and those hiding from domestic abusers cannot go to court to recover deposits. Regardless of the reason, many tenants simply walk away. Angry at the landlord. Angry at the system.
We can do better.
Using bitcoin’s multisignature address feature we can create a 2-of-3 address, where the tenant is a signer, the landlord is a signer, and a trusted disinterested third party holds the third key. In minutes, and from anywhere in the world, the tenant, landlord, and third party can combine public addresses to create a multi-signature address with a 2-of-3 signing configuration. Once the address is created, the tenant funds the address. All parties can verify on the public blockchain, within 10 minutes, that the funding has occurred and within about an hour the landlord can be confident that the funds will be there at the end of the term. Then nothing happens for a year. Or more. The landlord cannot misappropriate funds, as it takes two signers to move funds out of the account. At the end of the lease, the tenant creates a transaction transferring the entire deposit to another tenant-owned address. The tenant sends the transaction to the landlord for signing. If the property is damaged the landlord can send a counter transaction and ask the tenant to sign. The landlord and tenant can then negotiate among themselves. If they cannot reach agreement, they can get the third party signer involved.
Alternatively, a transaction can be structured to acknowledge the most common scenario - where there is no damage to the premises and the deposit should be returned in-full to the tenant at the end of the lease. To make the deposit refundable by default, at the beginning of the term, both the landlord and tenant sign a transaction refunding the deposit at a future date. Bitcoin’s nLockTime feature allows them to create a post-dated transaction that cannot be processed before a stated date. By signing an nLockTime transaction, dated for the length of the lease plus 30 days, the landlord will have 30 days to make a claim and get the third party to override the transaction. A time-locked refund transaction shifts the burden of proof to the landlord, who must make a claim and prove damages in order to obtain deposit money. If the landlord and tenant agree to extend the lease, the funds can be relocked with two simple transactions.
With or without nLockTime, bitcoin’s multisignature addresses are superior to traditional custodial landlord accounts because they ensure landlords do not unlawfully commingle, keep, or spend the tenant’s funds. It balances the power between the parties and provides public oversight through the network. Importantly, the third party is not involved if the landlord and tenant agree on the refund amount themselves. This keeps costs down and encourages communication. Finally, the parties are still protected by traditional landlord/tenant laws and the third party would be required to follow those laws. This is one example of ensuring due process through technology.
So often in fintech we see solutions in search of problems. In this case, technology can quickly, easily, and cheaply solve a real problem for millions of renters. While in the short-term price volatility and the lack of incentive for landlords to adopt this solution may make it less likely to gain widespread adoption, neither minimize its potential. Bitcoin’s built-in multisignature feature can simultaneously protect landlords and tenants while righting the grossly imbalanced power dynamic between the two. With multisig you could actually get your security deposit back in-full without going to court. Imagine that!