How to Stabilize (Pun Intended) A Crypto Portfolio: Digital Real Estate!

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The back half of 2020 has been a huge period for crypto adoption. Unprecedented central bank money printing to support economies during the coronavirus pandemic and slashing of benchmark interest rates to near zero have caused many to question the long-term value and stability of fiat currency. In response, for the first time, many institutions, financial and otherwise, have looked to cryptocurrencies as a viable long-term store of value and/or payment method. A recent high-profile case is the publicly traded software company Microstrategy (ticker: MSTR) deciding, in the 3rd quarter of this year, to allocate almost all its excess cash — over $400mil — to Bitcoin. As of this writing, they are sitting on almost $300mil of paper gains. Just yesterday, the press reported that 169 year old life insurance company Mass Mutual purchased $100mil of Bitcoin for its general assets account. Moreover, PayPal, the popular P2P wallet and e-commerce payments provider announced in October that account holders will be able to buy crypto within its wallet and use it as a form of tender when making online purchases. Finally, the price of Bitcoin, at the current $18K price is up 2.5x from the beginning of year level, seemingly minting new millionaires and billionaires every day.

While this is all great, the risks cannot be ignored. We only need to look back at 2018 to see what happened. After touching $20K early in the year, Bitcoin collapsed, reaching a low of about $3K in December of that year. Crypto is still only a 12-year-old phenomenon, with the first Bitcoin minted in January 2009. While the recent Bitcoin run-up appears to be supported by a more solid foundation due to deep pocketed and stable parties such as Microstrategy and Mass Mutual backing and evangelizing cryptocurrencies, there is no guarantee that crypto volatility has been eliminated. How can an investor with significant crypto assets reduce the volatility of his/her portfolio? Close readers of mine know the answer to this….commercial real estate!

I founded my company RedSwan CRE in 2018 to provide an easier, faster, more affordable and digitally native way for investors to be able to invest in quality Class A and B commercial real estate from the comfort of home. Specifically, we digitize equity limited partnership interests in individual properties and make them available to Accredited Investors in the US and to anyone overseas as well. Therefore, an investor who invests in any one of our offerings is essentially buying a token that represents an equity interest in, say, a luxury apartment building in one of the hottest sections of New York City. Why real estate? Including residential, the global real estate market is over $280 trillion and represents the largest asset class in the world and the source of most fortunes. However, even more important for today’s discussion is the stability of real estate. The following graph shows the monthly value of the unlevered Green Street Commercial Property Price Index, which is a composite index that represents the evolution of US commercial real estate values (the index’s five largest components are Retail, Office, Multi-Family, Health Care and Industrial).

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As you can see, other than during extreme events such as the Great Financial Crisis and the recent “flash crash” caused by COVID-19, the evolution of commercial real estate value has been remarkably stable month to month, with an overall up trend over a long period of time. Eyeballing this chart alongside something similar for Bitcoin and one can see a huge difference in the volatility. Therefore, it seems smart to diversify one’s digital assets portfolio into something that can hold up even if cryptocurrencies are experiencing wild swings. In this way, the volatility of the entire portfolio is dampened versus one in which 100% of the monies are allocated to crypto.

What has prevented many investors historically from investing in commercial real estate is two-fold: 1) Accessibility, and 2) Liquidity. In the past, access to Class A and Class B commercial real estate investments have been limited to deep pocketed investors who are able to invest in club deals arranged by large banks and private equity firms. Even an affluent investor with $1mil to $10mil of investable assets had difficulty investing in this market. Second, liquidity has been an issue. Once investors place money in the club deal, they are typically locked up until the property is sold. Even if an investor can unload his/her stake the process can be time consuming and involve a lot of manual processing and shuffling of paperwork. Tokenization eliminates the hassles of investing in commercial real estate by digitally representing property interests on the blockchain and technology partnerships can facilitate secondary market sales through online quotation bureaus. The long-term vision is to make real estate tradable like stocks.

Another compelling use case for commercial real estate investing has surfaced that has ties to crypto. In the past several years, we have observed innovative fintech firms emerge that are trying to disintermediate the traditional banking system. Fundamentally, the business model is like traditional banking in the sense that a spread is earned between the interest rates charged for alt coin loans and the amount paid on interest bearing alt coin deposits. However, in some cases, the firms are taking the model further by providing preferred rates for depositors if they agree to earn and collect their interest income with the firm’s own native utility token even if the underlying deposit is in a different crypto such as a USD stablecoin. This in turn allows the fintech to offer very attractive borrowing rates. This attracts both borrowers and deposit customers and we have observed that the underlying utility tokens issued by such fintech firms have risen in value in concert with the increases in core lending and deposit activity. This looks fantastic but there is a vulnerability. At the end of the day, the tokens have little intrinsic value and are simply a function of money flows driven by borrowing and lending volumes. For the interest rates to hold up, there must be a belief in the long-term value of the issuing firm and hence the value of the associated token. If for whatever reason that belief goes away, due to competitive pressures or other reasons, the value of the tokens can quickly collapse and those attractive interest rates on deposit accounts go to zero (as an aside….yes, I know one can argue even traditional fiat currency is based on a belief system, but we will table that discussion for another day). However, what if these same fintech financial intermediaries invested at least a portion of their capital in commercial real estate-backed digital tokens? Now, you essentially have a hard asset that provides some floor value to the utility token. Even better, since commercial real estate generates income, the crypto intermediary can use the income and reward their utility token holders with some kind of dividend!

In closing, I am excited about the opportunity ahead of us. Digital assets will become more mainstream in the years ahead, but it cannot just be about Bitcoin, Ethereum and a few other cryptos. You need complementary assets for diversification and volatility mitigation. The ecosystem must expand and RedSwan CRE is taking the pole position with commercial real estate.

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