Monday, August 21, 2017

Bitcoin Versus Real Estate

When people start building condos in cornfields, the market is overheated.

Within my lifetime there have been two major real estate bubbles, the latter being far more serious than the former.  What happened was that people started buying houses and thinking they were made of gold.  Pretty soon people start to think that any house was worth a lot of money regardless of how well it was built or where it was located.  As a result, builders started building in places where no one really wanted to own a home, such as in the middle of a cornfield, two hours from major city.

A friend of mine bought such a place in 1988.  It was a long, long way from work, but on the weekend when he went out to look at it, it seemed like a short drive in the light weekend traffic.  Besides, everyone was getting in on this Real Estate deal, so why not him?   When the market collapsed in 1989, he had to cash in $10,000 from his 401(k) to bring to the closing to unload the condo, which no one wanted to buy at that point.

Housing bubbles collapse.  I experienced this first in 1989 and then again in 2009, neatly 20 years apart.  People never learn from experience, as their economic memory is only about 18 months old as I have noted time and time again.  I was fortunate in that the free-standing house we bought in 1988, within commuting distance of the city, largely held its value during those lean years.   The entire Real Estate market went down from 1989 to about 1994, but some properties fared better than others, and the condos-in-cornfields did the worst.

Many prognosticators have noted that there appears to be a similar bubble taking place in cryptocurrencies.  It is not that Bitcoin has heated up to an unsustainable level necessarily, but that there are so many other cryptocurrencies hitting the market at once, as everyone wants to get in on this "cryptocurrency" deal.

In terms of a real estate analogy, perhaps Bitcoin represents the prime condominium development located near the center of the city, which was sold out early on and which is still highly desirable, if not overpriced.  Many of these newer Johnny-come-lately cryptocurrencies represent the condominiums built in the cornfields hours away from the center of the city.  People think these later developments are worth as much as the former, but they are mere shadows of the original idea.

In the Real Estate venue, when the market collapsed, the condo-in-a-cornfield depreciated in value very quickly, while the more desirable properties fared better.  However, the entire market was affected as the result of the crash.  Similarly, when stock markets decline, even premier equities decrease in value, as we saw in the stock market crash of early 2009.  The real gems recover quickly, but the real stinkers go bankrupt.

If you apply this analogy to cryptocurrencies - at it is a valid analogy, I think - you can see a similar thing may take place.  A lot of these Johnny-come-lately cryptocurrencies will be like those condos-in-a-cornfield.  They will depreciate rapidly and end up going bankrupt.  But the major players the market will also be affected, and their value will decrease accordingly.  Bitcoin, being the premier cryptocurrency, will be severely affected by the ultimate crash of these other "crap-to currencies" but may recover where others fail.  People will still lose money, however.

There can be too much of a good thing in any Market.  And the market cannot support an infinite number of cryptocurrencies, or condos in cornfields.