Ah, Bitcoin: the increasingly large elephant in the room. As alternative cryptocurrencies like XRP face regulatory compliance issues and delisting, and as public enthusiasm about crypto in general increases, the price has skyrocketed past almost anyone’s near-term expectations.
Bitcoin is, at the time of writing, up nearly 500% from last year, and attention from institutional investors has led some to speculate that — fluctuations notwithstanding — it will continue to rise.
That possibility may hold lessons and implications for traditional investment spaces. Let’s explore how cryptocurrency relates to real estate.
The State of Play
Cryptocurrencies’ value proposition is complex and multifaceted. They can serve as stores of value and means of exchange (hence the second half of the name), but they’re unlike traditional currencies in important ways.
What is cryptocurrency, anyway?
Crypto’s central innovation is blockchain technology. In order for a means of exchange to be truly decentralized, it cannot rely on traditional transaction authentication regimes. Bitcoin elegantly solves the authentication problem via the ‘mining’ process. Users’ machines can perform the computationally-intensive task of verifying transactions to a comprehensive, authoritative record (the blockchain), a copy of which is held by every node and encrypted in every transaction. Miners’ verification service is rewarded with fractional bitcoins, which proceed to enter the money supply.
In theory, bitcoins can be spent as currency — and some on- and off-line businesses have begun this process, including Microsoft, AT&T, and Kentucky Fried Chicken. But, just as traditional currencies generate exchange markets, Bitcoin, too, has become a tradable asset that investors look to for returns. As a speculative investment, Bitcoin’s value is not clearly proportional to its buying power, insofar as relatively few legitimate purchases can be made with Bitcoin at this point.
Instead, Bitcoin’s trade value is subject to some considerations not usually relevant for traditional currencies. Appeal as a resilient, decentralized store of value inclines some enthusiasts to “hodl ,” effectively stuffing their digital wallets into mattresses and waiting for the day when Bitcoin replaces traditional currency and they can use it to pay for a Big Mac. Dissidents living under authoritarian regimes may appreciate Bitcoin because its purported anonymity can protect them. Meanwhile, some governments are concerned that Bitcoin could just as easily be used by criminals who rely on anonymity as a shield for narcotics, trafficking, or money laundering operations.
Regulatory issues and technical complexities increase Bitcoin’s volatility. On January 21st, Bitcoin fell 11% after Biden nominee Janet Yellen made remarks about its use by money launderers, or for other illicit financial activities, and some investors misinterpreted a normal process called chain reorganization, spiking Google searches for “Bitcoin double spend.” Because Bitcoin is decentralized, no single authoritative entity can unilaterally adjust its value in response to fluctuations. The Fed cannot expand or contract the supply.
These considerations prompt one theoretical and one practical question. First, are cryptocurrencies money, technology, financial instruments, insurance policies, all of the above, or something else entirely? Second, to what extent is it even meaningful to talk about ‘cryptocurrency’ as a category? Crypto isn’t a monolithic bucket; BTC and Dogecoin offer very different value, and likely face very different future prospects.
Crypto and Real Estate: Corollaries
Real estate investors may note some similarities between cryptocurrencies and real estate.
The theoretical cap on real estate supply is the total land area of Earth, but in practice, real estate investors accrue earnings by acquiring and developing land that meets a given set of criteria, such as location. The relatively limited availability of desirable real estate creates and protects its value as an investment class, and the resources and effort implicated in development drive “buy, improve, flip” strategies. Bitcoin contains a hard-coded cap on the total number of Bitcoins — 21 million, of which about 18.5 million have been mined. The mining limit is an effort to artificially emulate the scarcities that define the value of physical assets; no one would buy gold for $1,800/ounce if it were infinitely plentiful. Anything of value suffers from the possibility of shortages, and for both real estate and Bitcoin they are more-or-less neatly delineated.
Land Development and Bitcoin Mining
Land development could be interpreted as an analog to the mining process for Bitcoin: adding value on the expectation that it will be worth something in the future. But the analogy is imperfect. Bitcoin miners furnish proof-of-work in exchange for an asset that will be indefinitely tradable into the future (or so they hope). Land developers, on the other hand, face continuing upkeep and maintenance costs, and the intermittent cost of redevelopment. A shopping complex today could be a brewery in 20 years; it could also be rebuilt as a newer, shinier shopping complex. These recurring costs aren’t relevant to those holding a digital currency that does not degrade with use and time.
Similarly, the payout structure for Bitcoin and real estate are very different. As a speculative investment, Bitcoin’s endgame for many investors is selling at a higher price. Properly-managed investment real estate, on the other hand, is a revenue stream for as long as you hold the asset, in addition to being a long-term store of value.
Correlation to Traditional Investments
Cryptocurrency and real estate do both tend to be less correlated to traditional investments. Real estate demand, especially for housing at the lower end of the cost spectrum, is relatively resilient during recessions because housing is a human need. Bitcoin isn’t exactly countercyclical, but its value does sometimes correlate with uncertainties about the viability of traditional assets and stores of value. One primary reason for this is that Bitcoin has relatively few ties to established financial forces, like federal banks or the stock market. On the other hand, Bitcoin is unlike, say, gold in that it lacks established value as a commodity; being non-physical, it isn’t conductive, corrosion-resistant, et cetera. Still, a weak connection to traditional market forces could insulate Bitcoin from recessionary risks.
The bottom line here is that Bitcoin, like real estate investment, appeals to outside-the-box thinkers. Recession resilience, unique demand structures, and clear scarcity could motivate investors searching for the next financial frontier to purchase both. (If that’s why you’re reading this blog article, welcome!).
But There Are Some Differences
Use Value vs. Exchange Value
Real estate has a clear use value because it meets a basic human need. Use values drive up durable demand. Bitcoin, on the other hand, has very little use value (for now). Most people can’t use Bitcoin to purchase most things. Instead, Bitcoin has exchange value; crypto is still a relative luxury, and its price is primarily contingent on the expectation of future use value.
Old vs. New
Real estate is plausibly the oldest item of human value. Wars have been fought over land since the beginning of recorded history, and locales proximate to natural resources or urban centers have always held value. Cryptocurrency, on the other hand, is the bleeding edge, and significant uncertainty about what it will look like in a decade — or a century — is both a value driver and a source of volatility. Crypto is a far less certain bet than land.
Volatility and Liquidity
From investors’ perspective, real estate is relatively stable and illiquid. Because real estate ownership involves physical assets, losing all your money overnight is uncommon. Relatedly, as far as we know, no one day-trades houses. (If you do, please reach out to us -- we’d love to discuss.) Cryptocurrencies are highly volatile, but also highly liquid.
Every Bitcoin is, to appropriate the language of an econ professor, equally serviceable. Demand is a function of the fact that there are only 21 million of them. Not all real estate is equally serviceable; the practical cap on the real estate supply is that a relatively small portion of Earth’s land area is currently attractive for real estate purposes — only about 3% of the land area of the United States, and 1% worldwide, is developed. (And, about 29% of Earth’s land area is relatively unusable glaciers, deserts, and salt flats).
What About the Future?
Some crypto thinkers assume that there are, broadly, two possible futures for Bitcoin. First, the idea works, and Bitcoin is the first of a number of cryptocurrencies that see wide adoption and use as decentralized alternatives to fiat money. Second, the project crashes and burns.
What Happens to Real Estate in the First Scenario?
In the short term, not much. Bitcoin and other cryptocurrencies could see increased viability as alternative investments, but diversified portfolios that include alternatives such as real estate will retain their importance. Real Estate meets a basic human need, and demand isn't going away anytime soon.
In the mid-term, cryptocurrencies would gain traction as actual currencies. This could have a few noteworthy effects. First, landowners might change the way payments are made and processed to reflect the new norm. Second, as currency comes untethered from traditional sources of authority like central banks, investors under this scenario would anticipate a reduced role from those authorities. Alternative currencies are an alternate money supply that won't be subject to inflation — at least, not at the hands of federal bankers. If cryptocurrencies go truly mainstream, that could hold implications for asset price stability and the time value of money (read: loan affordability).
In the long term, the widespread adoption of cryptocurrency could decentralize financial markets in general, but the impact of this effect is hard to guess. Power may change hands and become less centralized, and new blockchain-based technology may open the arenas of finance and banking to many more of the world’s people, but in the long term, institutions like banking, exchanges, and loans are unlikely to go away — whether they operate in BTC or greenbacks.
What Happens to Real Estate in the Second Scenario?
In the short term, if crypto crashes permanently, real estate probably rises a bit. If an event occurs that furnishes dispositive proof against Bitcoin's viability, investors’ confidence in emerging or alternative investments may waver, fueling a small bump in more traditional spaces like real estate.
In the mid-to-long term, the indicators are harder to decipher, but the answer is definitely not: “we keep the status quo indefinitely.” Cryptocurrency isn't the first, and won't be the last, innovation by which the tech sphere impinges on the financial sphere. We're reluctant to aim our crystal ball solely at technological innovation, but the collapse of Bitcoin would likely generate some kind of influence vacuum waiting to be filled by the next emerging technology. What would that technology look like, and how would it impact real estate investors? Only time will tell.