One of the most difficult challenges for newbies to cryptocurrencies is understanding how and why a cryptocurrency like Bitcoin (BTC) might have value. The token is digital, with no actual object to back it up, and the concept of mining can be perplexing. Mining, in a sense, creates new bitcoins out of thin air. In practice, however, successful mining necessitates a significant investment. But how does all of this add value to BTC?
Consider how much money we all spend on a daily basis. Our currency is no longer backed by gold or assets. Because of fractional reserve banking, the money we borrow is frequently merely represented as digits on a screen.
Why does money have value?
In summary, trust is what gives money its value. Money is essentially an instrument for exchanging value. As long as the local community accepts it as payment for goods and services, any object can be used as money. From rocks to seashells, various types of things were utilized as money in the early days of human civilization.
What is fiat money?
Fiat money is money that is issued and legalized by a government. Today, our society exchanges value using paper bills, coins, and digital numbers on our bank accounts (which also describe how much credit or debt we have).
People used to be able to go to the bank and exchange their paper money for gold or other precious metals. This method maintained that the value of currencies such as the US dollar was linked to an equivalent amount in gold. However, the majority of nations abandoned the gold standard, and it is no longer the foundation of our monetary systems.
After removing a currency’s ties to gold, we now use fiat money without any backing.This decoupling offered governments and central banks more leeway in implementing monetary policies and influencing the money supply. Some of the main characteristics of fiat are:
- A central authority or government issues it.
- It has no intrinsic worth. It is not backed by gold or any other precious metal.
- It has an infinite supply potential.
Why does fiat have value?
With the absence of the gold standard, we appear to have a currency devoid of value. Money, on the other hand, still pays for our food, bills, rent, and other necessities. Money, as previously mentioned, derives its worth from collective trust. To succeed and maintain high trust, a government must strongly support and properly manage a fiat currency. When trust in a government or central bank is lost owing to hyperinflation and ineffective monetary policies, as witnessed in Venezuela and Zimbabwe, it’s clear to understand how this breaks down.
Why does crypto have value?
Cryptocurrencies share certain characteristics with our traditional concept of money, but they also have significant distinctions. Although certain cryptocurrencies, like PAXG, are tied to commodities like gold, the vast majority of cryptocurrencies have no underlying asset. Instead, trust plays an important role in the value of a cryptocurrency once again. People, for example, find value in investing in Bitcoin because they know that others trust Bitcoin and accept it as a payment system and means of exchange.
The utility is also a significant consideration for several cryptocurrencies. A utility token may be required to access specific services or sites. As a result, a high-demand service will contribute value to its utility coin. Because no two cryptocurrencies are the same, their value is determined by the characteristics of each coin, token, or project. When it comes to Bitcoin, we can boil it down to six characteristics, which we’ll go over in more detail later: utility, decentralization, distribution, trust systems, scarcity, and security.
What is intrinsic value?
Much of the debate about Bitcoin’s worth is around whether it has any intrinsic value. But what exactly does this mean? When we look at a commodity like oil, we can see that it has intrinsic value in the production of energy, polymers, and other products.
Stocks have intrinsic worth as well since they represent equity in a company that produces goods or services. In reality, many investors use fundamental analysis to determine an asset’s inherent worth. Fiat money, on the other hand, has no intrinsic value because it is merely a piece of paper. As we’ve seen, its worth stems from trust. From commodities to equities, the traditional financial system offers numerous investment possibilities with inherent value.
Why is Bitcoin valuable?
The value of Bitcoin is a very debatable topic with many opposing viewpoints. Of course, one could argue that Bitcoin’s market price is its value. That, however, does not directly answer our question. What matters more is why people think it has value in the first place. Let’s delve a little more into some of the factors that contribute to Bitcoin’s value.
Bitcoin’s value in utility
One of Bitcoin’s most significant advantages is its capacity to instantly transfer enormous sums of wealth around the world without the use of intermediaries. While fees might make sending a modest amount of BTC quite expensive, it is also possible to send millions of dollars affordably. A Bitcoin transaction worth around $45,000,000 (USD) was sent with a charge of slightly under $50 (as of June 2021).
Bitcoin’s value in decentralization
One of the primary characteristics of cryptocurrencies is decentralization. Blockchains give the community of users more power and freedom by eliminating central authorities. Because the Bitcoin network is open source, anyone can contribute to its improvement.
Even the monetary policy of the coin is decentralized. Miners, for example, authenticate and validate transactions while also ensuring that new bitcoins are added to the system at a consistent and predictable rate.
The decentralization of Bitcoin makes it an extremely resilient and secure system. No single node in the network can make choices on behalf of everyone else. Transaction validation and protocol upgrades require group consensus in order to protect Bitcoin from mismanagement and misuse.
Bitcoin’s value in a distribution
The Bitcoin network increases its overall security by enabling as many users as possible to participate. The greater the number of nodes connected to Bitcoin’s distributed network, the greater its value. There is no need to rely on a single source of truth when sharing the ledger of transactions across multiple users.
We may have various versions of the truth that are difficult to check if we do not distribute them. Consider an email-sent document that a team is working on. As the team circulates the document, it generates multiple copies with varying stages that can be difficult to track.
Bitcoin’s value in systems of trust
Bitcoin’s decentralization is a significant network benefit, but it still needs some protection. It is always difficult to get users to cooperate on any vast, decentralized network. Satoshi Nakamoto created a Proof of Work consensus method that rewards positive behavior to tackle this dilemma, known as the Byzantine General’s Dilemma.
Trust is a necessary component of any desirable goods or commodity. Loss of faith in a central bank is devastating for a country’s currency. Similarly, in order to use international money transfers, we must have faith in the financial institutions involved. Bitcoin’s operations are more trustworthy than other systems and assets we utilize on a regular basis.
Bitcoin’s value in scarcity
Bitcoin’s architecture includes a restricted supply of 21,000,000 BTC. When Bitcoin miners mine the last coin around 2140, there will be none left. While traditional commodities such as gold, silver, and oil are limited, fresh reserves are discovered every year. These discoveries make calculating their exact scarcity problematic.
Bitcoin should be deflationary once we have mined all of the BTC. As users lose or burn coins, the supply decreases, causing the price to rise. As a result, holders place a high value on Bitcoin’s scarcity.
The scarcity of Bitcoin has also given rise to the popular Stock to Flow paradigm. Based on Bitcoin mining per year and the overall stock, the model attempts to forecast BTC’s future worth. When back-tested, it accurately models the price curve witnessed thus far. The main driving force in Bitcoin’s price, according to this hypothesis, is scarcity. Holders find value in using Bitcoin as a store of value because of the potential relationship between price and scarcity. We’ll go over this notion in further detail at the end of the post.
Bitcoin’s value in security
There aren’t many other solutions that provide as much security as Bitcoin in terms of keeping your investment assets safe. Your cash is extremely secure if you follow best practices. In wealthy countries, the security provided by banks is often taken for granted. However, for many people, financial institutions cannot provide the necessary protection, and storing huge quantities of cash can be extremely hazardous.
Malicious attacks on the Bitcoin network require owning more than 51% of current mining power, making coordination on this scale almost impossible. The probability of a successful attack on Bitcoin(BTC) is extremely low, and even if it happens, it won’t last long.
The only real threats to the storage of your BTC are:
- Fraud and phishing attacks
- Losing your private key
- Storing your Bitcoin (BTC) in a compromised custodial wallet where you don’t own the private key
You should have a level of protection that exceeds even your bank if you follow best practices to prevent the aforementioned from happening. The best aspect is that you don’t have to spend anything to keep your cryptocurrency safe. There are no daily or monthly limits, unlike banks. Bitcoin gives you complete control over your money.
Bitcoin as a store of value
Most of the attributes already mentioned make Bitcoin an excellent choice as a store of value. Traditional possibilities include precious metals, US dollars, and government bonds, but Bitcoin is emerging as a modern alternative and digital gold. To be a good store of value, something must have the following characteristics:
- Durability: Bitcoin is unbreakable as long as the network is maintained by computers. Bitcoin, unlike actual cash, cannot be destroyed and is, in fact, more durable than fiat currencies and precious metals.
- Portability: Bitcoin, as a digital currency, is extremely portable. To access your BTC holdings from anywhere, all you need is an Internet connection and your private keys.
- Divisibility: Because each BTC is split into 100,000,000 satoshis, users can conduct transactions of any magnitude.
- Fungibility: Each BTC or satoshi can be exchanged for another. This feature enables cryptocurrency to be used as a medium of trade with individuals all around the world.
- Scarcity: There will only ever be 21,000,000 BTC, and millions have already been lost forever. Bitcoin’s supply is significantly more limited than the quantity of inflationary fiat currencies, which expands over time.
- Acceptability: BTC has seen significant use as a payment method for consumers and businesses, and the blockchain industry is expanding by the day.
Unfortunately, there is no simple explanation for why Bitcoin is valuable. Cryptocurrency contains many of the characteristics of valuable assets, such as precious metals and fiat currency, yet it does not fit neatly into any of them. Even though it is digital, it behaves like money without government backing and has scarcity like a commodity.