Why Bitcoin keeps going up? the world’s most powerful innovation explained through ‘Tales of Tinytopia’.

Learn about the world’s most powerful innovation explained through ‘Tales of Tinytopia’.

The rise of Bitcoin has been unprecedented and has beaten every other asset over the last 10 years. Compared to the S&P 500, the world’s premier investment option, Bitcoin has seen some huge gains. It’s safe to say Bitcoin has left S&P in the dust.

This incredible growth is even more impressive considering the fact that the S&P 500 is a widely understood, well-researched, and highly integrated financial instrument in human history. In contrast, Bitcoin is fundamentally just a bunch of computer code, a shared ledger, and is supported by a few die-hard fans. Investment access to Bitcoin is available to less than 1% of the world’s population, with the rest of the world often ignoring it, ridiculing it, or the media constantly declaring it dead.

The invention of Bitcoin is indeed a pivotal moment in the history of finance. Never before has humanity been given the ability to hold or transfer money without relying on trusted intermediaries like banks. This has significant implications for the world in the coming decades, as money is one of the most important commodities in the economy. We work hard throughout our lives so that we can earn money and save it for the future. This collective effort pushes economies to reach new heights.

Bitcoin is indeed a remarkable feat of engineering once you look under the hood. Bitcoin solves the so-called ‘Byzantine Generals’ problem, eliminating the double-spending problem in a decentralised manner. Banks, on the other hand, solve this double-spending problem using a simple centralised ledger. For example, let’s say you have $100 in your bank account and I have $50. When you transfer $20 to my account, the new balances on your bank account and mine should be $80 and $70 respectively. It’s trivially easy to solve this problem using simple Excel sheets or SQL databases, which is what banks do in the backend. However, it was incredibly difficult (until Bitcoin came along) to achieve this with no central party in control, as every party would want to tweak their ledger to spend as much as possible and still end up with the original or a higher account balance.

The ability to ‘transfer value digitally’ without a central party in control is at the centre of Bitcoin’s value proposition and the reason for both the incredible opportunity and controversy surrounding Bitcoin.

The key concepts here are ‘value transfer’ and ‘digital’. While we can easily transfer digital information (through email/WhatsApp), it has no inherent value as it can be infinitely copied. We can transfer valuable physical items like gold or art, but we can’t transfer value digitally without a trusted middleman, also known as banks.

Enter Tinytopia

The country ‘Tinytopia,’ as the name suggests, is tiny, with just 40 families on a tiny island. Despite its size, the residents of Tinytopia are pretty happy.

The President of Tinytopia, known as Mr Tiny, decided to introduce a form of currency to facilitate more efficient trading among citizens, replacing the inefficient barter system that was originally in place. The president issued 400 ‘tiny tokens’ and distributed them among the 40 families, with each family receiving 10 tokens.

Following the issuance of tokens, the citizens of Tinytopia were happier as they no longer had to rely on inefficient bartering. Instead, items could now have prices attached to them, listed in ‘tiny tokens’.

As a result of this change, houses in Tinytopia also had prices listed for the first time, with each house costing roughly 5 tinies.

Since both the supply of houses (40 houses) and money (400 tinies) were fixed, the price of houses rarely moved beyond 5 tinies.

This frustrated President Tiny, as citizens were not considering real estate as an investment compared to countries like the US, UK, India, and China, where governments could collect taxes based on the value of real estate holdings.

After much contemplation, President Tiny realised that the easiest way to increase the price of real estate and encourage people to treat it as an investment rather than just a utility was to increase the money supply. So, he began issuing 10% more tinies annually and hired a group of economists to promote the idea that printing new money is beneficial for the economy as it creates more jobs.

This plan worked. With an increased money supply, prices of everyday goods started to rise, and eventually, even house prices began to increase. As house prices rose, people started to view real estate as an investment and a store of value. This further drove up prices, and banks began offering loans to people to buy houses with 40-year mortgages, further inflating the prices.

Some young entrepreneurs saw this as an incredible opportunity — the significant gap between the costs to build houses and the actual prices they were sold for — and began building houses, making them incredibly wealthy. Of course, the President, local governments, and real estate developers were careful not to create more houses than the new money supply could support, ensuring that house prices did not fall with increasing supply and perpetuating the illusion of real estate as an investment.

This story of Tinytopia mirrors the situation in many countries in the modern world. Most world currencies experience annual inflation (or money printing) ranging from 5–500%, resulting in the prices of everyday goods and services increasing over time, like clockwork. This unfortunate reality can be observed across the globe.

Between 50–80% of the world’s wealth is currently stored in real estate across various countries. Whenever house prices begin to correct due to constant new supply, central bankers often panic and resort to printing new money, perpetuating the myth of real estate as an investment.

Why is Real Estate a Trap in the 21st Century?

Real estate is considered the ultimate investment class worldwide because everyone needs a roof. You can touch it, feel it, and even use it to attract the opposite sex by displaying your holdings. This is precisely why 50% to 70% of the world’s wealth is locked in real estate.

Let’s take a look at why house prices keep increasing despite more houses being built every year.

On average, Western governments have printed money in the range of 7% to 10% per year. This, combined with fractional reserve banking, is why we see prices of things going up.

While the cost of milk and meat often rises faster than houses, they are not considered ‘investment’ class assets as they are perishable (thankfully).

Even cars are not seen as ‘investments’ as newer models keep being introduced constantly.

Investing in stocks is obviously complicated and risky.

Real estate hits the sweet spot of investing. It’s tangible, widely popular, has substantial backing from banks, and most importantly, house prices over the long term seem to keep rising. Although a 7% new money printing per annum may seem tame, compounding has a significant effect. Over 11 years, the money supply effectively doubles, and it quadruples over 22 years. So, unless a country’s housing stock increases by 400% over 22 years, house prices will keep rising (nominal prices, not adjusted for real inflation). Of course, houses in most countries do not appreciate four times in 22 years.

This, dear friend, is the secret behind house prices rising — all that price rise is simply due to governments printing more and more money.

The average home in a country cannot constantly appreciate, even if the population doubles due to immigration, as long as the money supply remains constant. This is the hard mathematical reality.

Why is real estate not as reliable in the 21st century?

Technology

Technology is the biggest risk for real estate costs over the next few decades. Living in a posh zip code is no longer a determinant of success.

Remote working

With the rise of the internet and mass remote working, workers are no longer tethered to a ‘location’. The physical networking that is so important to grow a new business or job is slowly being replaced by online platforms like LinkedIn and YouTube. This trend will only improve over time; the proof is in the pudding. Business travel is falling to an all-time low, while the number of online meetings held through Zoom and Teams is going through the roof. The rise of remote working started as a big trend only after the COVID pandemic in 2020 and is yet to realise its full potential.

Self-driving

Self-driving cars are another huge factor. Over the next 10 years, self-driving cars have the potential to offer accident-free, high-speed driving options to commuters, significantly reducing travel costs compared to public transport and dramatically improving connectivity. The rise of self-driving vehicles will further reduce the need to live and stay in a city centre.

Offshoring

More and more jobs are being offshored, and this trend is irreversible. Over the last 10 years, even the high-paying jobs have been offshored and this will accelerate thanks to the rise of remote working.

The combination of remote working and self-driving means that the need to stay within a super expensive city like New York or San Francisco no longer makes sense for the vast majority of workers.

Remote living

Remote living is also on the rise. As more people live out of RVs, the need to stay tethered to one location and pay expensive mortgages/rents is mitigated, decreasing the demand for real estate further.

Ubiquitous internet, thanks to Starlink and other satellite internet providers, allows you to surf the internet from any part of the world. Imagine living and working on a luxury cruise ship and visiting a new country every weekend. This becomes a possibility thanks to satellite internet. Moreover, you can legally avoid paying income tax and other taxes by adopting this nomadic lifestyle.

Taxes

Taxes on real estate holdings are constantly increasing, both in absolute numbers and as percentages, due to ballooning debts and never-ending social spending. More and more municipalities are raising their property taxes/council taxes year on year to fund unsustainable pensions of public sector employees and other social care obligations.

Interest rates

Interest rates have been relatively low for the last 20 years or so, keeping mortgage rates low. However, we have come to the end of this low-interest rate regime, and interest rates now reflect historic levels. This has a long-term impact on cutting down real estate prices as mortgages become increasingly affordable.

Bitcoin.

The unprecedented rise of Bitcoin poses a significant threat to real estate investing. Never before has the world seen an investable asset class with a total fixed supply. This inelastic supply means that as the price of Bitcoin increases, it creates further price jumps owing to FOMO (Fear of Missing Out), pushing more people into Bitcoin away from real estate investing.

The rise of Bitcoin will allow people to treat their fiat currencies like hot potatoes. As more and more people view fiat currencies as depreciating assets and start investing in Bitcoin, the demand for bank deposits decreases, resulting in higher interest rates (as there are no takers for bank deposits). This forces central banks to print more currency to offer higher interest rates, pushing inflation further and driving more people into Bitcoin.

A whole generation of 20 and 30-year-olds, ten years from now, would end up investing in Bitcoin and seeing huge gains compared to investing in real estate. Over the next decade, this fundamentally reduces their appetite for investing in real estate, unlike their parents.

‘Real estate’ investing has many unavoidable risks, including companies relocating to different locations, politicians increasing property taxes, young people moving to better neighbourhoods, communal riots, strikes, business shutdowns, better innovation in foreign countries, repairs, finding tenants, rent controls, mandatory upgrades, new tenant protection regulations, increasing maintenance fees, natural events like floods, traffic congestion, garbage issues, and much more.

The biggest appeal of real estate, its tangibility, can become a curse when times are bad. Imagine living in your posh Beverly Hills mansion, only to cross paths with drug addicts regularly. You can’t simply divest without incurring significant losses.

There are many cities in the world that are in a state of decay due to job losses, etc., yet house prices, when measured in local currencies, continue to rise. This doesn’t make sense, and yet it keeps happening. This happens because local currencies keep losing value due to excessive money printing by their central banks.

Many other negative externalities affect real estate over the long term, which have become increasingly visible over the last few years.

How to Value Your House? ( which your Realtor Never Talks About )?

Have you ever wondered what a fair value for a house is? When you walk into an open house for a viewing, your realtor often highlights all the positive aspects like the gym, the swimming pool, nearby train stations, etc. However, when it comes to price negotiations, they typically reference the prices of nearby properties. But how do you know if that’s a correct valuation? What’s the fair price?

The unfortunate reality is that even bank assessors simply base their valuation on nearby properties.

In all fairness, the value of real estate is highly dependent on its location and the local market conditions. However, that doesn’t mean one can entirely trust that number.

What if everyone in that area ends up paying more or less? How does one arrive at the right valuation?

Discounted Cash Flow (DCF) is the gold standard for measuring the value of any cash-flow-producing asset like stocks, bonds, etc.

DCF calculates the value of any given asset as the sum of all the present values of future cash flows for as long as that asset produces cash flows.

So, let’s say a stock is expected to provide dividends for the next 15 years (anything beyond that is difficult to predict and should be ignored), you would create a model for the cash flows and discount them based on interest rates.

In the case of real estate, monthly rent after taxes and repairs are considered cash flows.

Warren Buffett and other value investors use this modeling technique.

The alternate model is the price per earnings or P/E, which is like a silver standard. In this model, you compare the price of an asset and its earnings, divide the price by the earnings of similar assets, and obtain this ratio. You then compare the P/E ratios with other similar stocks to determine if the price is higher or lower.

Most stock analysts these days use P/E for stock valuation instead of the gold standard–DCF, due to the high inflationary world we live in.

The comparables model: This is the bronze standard of valuation, where you simply compare similar assets and derive valuations. This method is used for valuing startups that do not yet produce any profits. The reasoning for using this method for valuing startups is simple: startups in their early growth phase run on losses, so using P/E would result in negative numbers, which doesn’t make sense; therefore a simple comparables model makes sense. As you can guess, this method is highly speculative and risks creating bubbles within a given industry.

Unfortunately, the entire real estate market operates on a ‘comparables model,’ which is obviously not ideal as the entire local area could be in a bubble.

What happens if we use the gold standard of valuation or DCF model for valuing real estate prices?

If one were to use the DCF model for valuing houses, the end result would be a bit scary ( after accounting for moderate rent inflation, maintenance fees, taxes, etc.). Most houses in developed markets like the US and UK would be overvalued by 50%, whereas those in developing markets like China and India would need a massive 75% correction.

The reason for this massive bubble in real estate can be attributed to a few factors:

1. Massive inflation in fiat currencies, which makes investing in anything seem like a winning strategy provided its supply is a bit less than currency inflation.

2. Massive lending by banks to mortgages instead of lending to innovative businesses.

3. Central banks’ support for this reckless behavior of banks through constant bailouts of failed banks.

4. Lack of a strong store-of-value type investment like Bitcoin up until now.