Bitcoin derives its value from trust, just like fiat currencies. However, unlike fiat, Bitcoin operates without a central bank. Its decentralized structure enabled the creation of a unique financial system. Blockchain technology provides security, utility, and global value transfer capabilities. Additionally, Bitcoin can serve as a store of value, similar to gold.
Newcomers to crypto often struggle to understand how a cryptocurrency like Bitcoin (BTC) can hold value. Unlike physical currencies, BTC is digital and lacks physical assets or a clear explanation of mining. Mining essentially creates new bitcoins, but it requires a significant investment. So, why does BTC have value?
To make sense of BTC's value, let's consider our everyday money. Banknotes no longer rely on gold or assets as backing. The money we borrow often exists as digital numbers on screens, thanks to fractional reserve banking. Governments and central banks, like the Federal Reserve, can create new money and increase its supply through economic mechanisms.
Where Does Money Get Its Value From?
Money derives its value from the trust. Essentially, money serves as a medium of exchange for goods and services. As long as a local community accepts an object as a form of payment, it can function as money. Throughout the early stages of human civilization, various objects, including rocks and seashells, were utilized as forms of currency.
Fiat money refers to the official currency issued by a government. In our modern society, we exchange value using paper notes, coins, and digital numbers in our bank accounts, which also indicate our credit or debt. Previously, people could exchange their paper money for gold or other precious metals at the bank. This ensured that currencies like the U.S. dollar were linked to a specific amount of gold, known as the gold standard. However, the majority of nations have abandoned the gold standard, and our monetary systems no longer rely on it.
Since the disconnection from gold, we now use fiat money that has no backing. This separation grants governments and central banks greater flexibility to implement monetary policies and control the money supply. The key characteristics of fiat money are:
- It is issued by a central authority or government.
- It lacks inherent value and is not backed by gold or any other commodity.
- Its supply is potentially unlimited.
Why Does Fiat Have Value?
After the gold standard was abandoned, the value of the currency might seem uncertain. However, we still rely on money to cover essential expenses like food, bills, and rent. As we've previously established, the value of money stems from collective trust. To ensure success and maintain trust, a government must effectively support and manage a fiat currency. When faith in a government or central bank erodes due to hyperinflation and ineffective monetary policies, as witnessed in Venezuela and Zimbabwe, this trust breaks down.
Why Does Crypto Have Value?
Cryptocurrencies are distinct from traditional currencies in that they lack underlying assets, with trust playing a significant role in determining their value. For example, Bitcoin's value comes from people's trust in its use as a payment system and medium of exchange. Cryptocurrencies can also derive value from their utility, with utility tokens being required to access specific services or platforms. However, not all cryptocurrencies are identical, and their value depends on their unique features. When considering Bitcoin specifically, six key features can be focused on: utility, decentralization, distribution, trust systems, scarcity, and security. These will be explored in detail later.
About Intrinsic Value
The discussion surrounding Bitcoin's worth often centers on its intrinsic value. Intrinsic value refers to the inherent worth of a commodity, like oil, which is used to produce energy and materials. Stocks also possess intrinsic value as they represent ownership in companies that produce goods or services. Fiat money, on the other hand, lacks intrinsic value and relies on trust. In the traditional financial system, various investment options carry intrinsic value, except for forex markets that deal with fiat currencies.
Why Is Bitcoin Valuable?
Determining the value of Bitcoin is subjective and varies based on different opinions. While the market price reflects one aspect of its value, it doesn't fully address the underlying question. What truly matters is why people perceive Bitcoin as valuable in the first place. To gain a better understanding, let's explore the key characteristics that contribute to Bitcoin's value.
Bitcoin offers a significant advantage in its capability to facilitate fast and secure global transfers of large sums of value without intermediaries. It enables the cost-effective transfer of millions of dollars. For instance, a Bitcoin transaction worth approximately $100,000,000 (USD) can be conducted with a fee of less than $50.
Although other networks also enable such transfers, Bitcoin stands out as the largest, safest, and most widely adopted network. The Lightning Network, as a layer two application, further facilitates small transactions. Regardless of the transaction amount, the ability to conduct borderless transactions holds considerable value.
Decentralization is a fundamental aspect of cryptocurrencies, offering increased power and freedom to the user community by eliminating central authorities. Bitcoin, being an open-source network, allows anyone to contribute to its improvement.
Bitcoin’s monetary policy also operates in a decentralized manner. Miners play a crucial role in verifying transactions and ensuring a predictable, steady rate of new bitcoins entering the system. Bitcoin's decentralization contributes to its robustness and security. No individual node has the authority to make decisions on behalf of the entire network. Transaction validation and protocol updates require consensus among the group, safeguarding Bitcoin from mismanagement and misuse.
The more people participate in the Bitcoin network, the stronger its security becomes. By distributing transaction records among multiple users, there is no reliance on a single source of truth. This prevents the possibility of having multiple conflicting versions of the truth. In contrast to centralized systems, Bitcoin's distributed network is more resistant to cyber attacks and service outages. The involvement of thousands of users worldwide ensures its efficiency and security.
System of Trust
Bitcoin's decentralization allows for increased security and trust. It utilizes the Proof of Work consensus mechanism to incentivize positive behavior and ensure cooperation among users. Unlike traditional systems, Bitcoin's operations rely less on trusting individuals and more on the reliability and transparency of its technology. The value of Bitcoin lies in its ability to generate consensus and maintain trust without direct reliance on interpersonal trust.
Bitcoin's limited supply of 21 million BTC makes it scarce and valuable. Once all coins are mined, no more will be created. This scarcity is expected to increase its price over time. The Stock to Flow model, which analyzes mining and the overall stock, predicts Bitcoin's future value based on its scarcity. This relationship between scarcity and price adds to its value as a store of value.
Bitcoin offers strong security for your funds, surpassing traditional banks. By following best practices, such as protecting against fraud, phishing attacks, and safeguarding your private key, you can achieve a high level of security. The likelihood of a successful attack on the Bitcoin network is extremely low, as it would require owning over 51% of the mining power. Holding large amounts of cash can be risky, but with Bitcoin, you have full control over your money and no daily or monthly limits. It provides a secure and cost-effective storage solution for your funds.
Store of Value
Bitcoin has emerged as a modern alternative and digital gold, making it a promising store of value. It possesses key characteristics required for this purpose:
- Durability: Bitcoin is 100% durable as long as the network is maintained by computers. Unlike physical cash, it cannot be destroyed, making it more resilient than fiat currencies and precious metals.
- Portability: Being a digital currency, Bitcoin is highly portable. Accessing your BTC holdings requires an internet connection and your private keys, enabling you to manage your funds from anywhere.
- Divisibility: Each Bitcoin is divisible into 100,000,000 satoshis, allowing for transactions of any size, ensuring usability for various purposes.
- Fungibility: BTC and satoshis are interchangeable, making them exchangeable with other units of the cryptocurrency. This fungibility enhances its value as a global medium of exchange.
- Scarcity: With a limited supply of only 21,000,000 BTC, and considering the millions that are already lost, Bitcoin's scarcity is significantly higher compared to inflationary fiat currencies.
- Acceptability: Bitcoin has gained widespread adoption as a payment method by individuals and companies. The blockchain industry continues to grow, further expanding its acceptance and potential uses.
With these qualities, Bitcoin offers a reliable and versatile store of value in today's digital landscape.
Bitcoin's value is not easily explained by fitting into traditional asset categories. It lacks government backing like fiat currency but shares similarities with assets like precious metals. Some misconceptions and unfounded fears have led to skepticism, with terms like "scam" and "Ponzi scheme" being used. However, Bitcoin operates on a secure network and holds significant value as recognized by its community, investors, and traders.