It’s time to revisit Bitcoin. What is it? What are its flaws? What can it do for real estate?

Explaining Bitcoin to your mom

A New York realtor recently accepted $18,000 worth of bitcoins as payment for rent, making it the first U.S. real estate transaction to be brokered with the digital currency.

Since the funny money seems to be gaining legitimacy, we thought we’d better review Bitcoin’s fundamental flaws and assess its viability as a means of exchanging real estate.

Bitcoins have gained international recognition, but many still find it difficult to grasp how the so-called currency works. The New York Times recently published a comic strip called, “How to Explain Bitcoin to Your Mom.”

The silly cartoon succinctly distills the story to the four essential questions surrounding any currency:

  • How do I earn it? You can “earn” bitcoins by “mining” for them, which basically consists of buying software and working with your computer to create the currency; or you can buy bitcoins with dollars on any of the Bitcoin exchanges.
  • Where do I keep it? Traditional banks won’t store bitcoins — they must be kept in a digital wallet.
  • What can I buy with it? Theoretically, you can buy anything with bitcoins, as long as the seller accepts them.
  • Is it safe? This is the 64,000 bitcoin question. The quick answer is “no”.

Well-established flaws

In all the excitement surrounding Bitcoin, the skeptics far outshout the early-adopters — and for good reason. Once the reality of Bitcoin is separated from the theory, many problems emerge.

Bitcoin’s fatal flaw is that it is built on a deflationary model. Here’s why this is a problem, described in terms of the dollar. 

If, for whatever reason, the U.S. dollar takes a nosedive and becomes worthless, it is backed by the full faith and credit of the U.S. government. Thus, there is a floor on the dollar and anyone storing their wealth in dollars enjoys this explicit government guarantee. In terms of safety, it doesn’t get any better than that.

Bitcoin, on the other hand, has placed a ceiling on its currency in order to build in scarcity and thus produce the illusion of value. Production of bitcoins is set to halt once 21 million bitcoins are “minted.” This structure is what has led to bitcoin’s incredible volatility. Due to their self-imposed, eventual scarcity, bitcoins can be nothing but a speculative gambling chip, bought and immediately traded for dollars — or worse, hoarded in hopes of a big payday.

This hardly seems the recipe for a successful emerging currency.

Friending the futurists

We have much greater enthusiasm for what Bitcoin represents for the future of real estate transactions.

Let’s agree on two things:

  • the status quo of exchanging real estate could be vastly improved; and
  • thus far, technology has done very little to move the real estate industry forward.

The real estate industry’s greatest failing has to do with the sheer number of middlemen involved in the process. Currently, in order for the average person to buy a single family residence (SFR) they must pay the:

  • lender;
  • seller;
  • agent;
  • appraiser;
  • title company and escrow services; and
  • mortgage insurance premiums,

just to name the most obvious.

The core philosophy behind Bitcoin is its peer-to-peer (P2P) structure. Imagine being able to buy a home, actually finance a home, without using a traditional lender! Some P2P lending sites have already popped up, like Prosper Marketplace and Lending Club.

These sites put people with extra cash in touch with others who need loans — it’s really that simple. Often the interest rates are much lower with P2P loans, but the fringe benefits can be substantial.

Consider the list of payees above — the lender is at the top of this food chain for a reason. All the others on the list are paid via the lender. Yes we have scores of regulations to make sure this is done fairly, but this problem runs deeper.

Under the current status quo of lender control, the buyer must pay for an appraisal that the lender orders, using an “independent” appraisal management company (AMC). We all know the debacle that AMC regulation has turned out to be. With P2P lending, buyers could shop for their own appraiser (with the help of their experienced agent) and it would be portable, allowing them to shop for multiple P2P lenders.

The same rings true with the entire escrow process. The Real Estate Settlement Procedures Act (RESPA) had to be created because of the deep corruption between lenders and escrow companies. Dodd-Frank has added more regulation to the process, including mandating the revised HUD-1 for greater transparency, but lenders are still able to sneak in hidden fees at closing.

One can imagine how the escrow process might change if the traditional lender were removed from the picture. Escrow truly is a holdover from old technology. In the era of digital currency, the terms and conditions of a real estate transaction could be written into the currency code itself, resulting in the disbursement of funds only after certain conditions are met (such as the transfer of title, which is also done digitally).

The astute reader will say, dollars are already digital, why do we need Bitcoin to improve the real estate transaction process?

The simple answer is, we don’t. But futurist movements like Bitcoin at least recognize the need for changing the status quo. Even if (or when) Bitcoin crumbles like the Zimbabwean dollar, it has revealed the possibility of different way of doing business — a difference the real estate industry desperately needs.