Bitcoin, also known as BTCUSD, is often described as a digital currency that provides an alternative to traditional fiat money, which is controlled by central banks. However, fiat money is valuable because it is issued by a monetary authority and is widely accepted in an economy. At the same time, Bitcoin’s network is decentralized and not widely used in retail transactions.
It could be argued that Bitcoin’s value is similar to that of precious metals, such as gold because both are limited in quantity and have specific uses. Gold is used in industrial applications, while Bitcoin’s underlying technology, the blockchain, has applications in the financial services industries. Bitcoin’s digital nature may be useful as a medium for retail transactions in the future.
The Value of Traditional Currencies
A useful currency must possess six important qualities: scarcity, divisibility, acceptability, portability, durability, and resistance to counterfeiting. These attributes enable the currency to be widely used in an economy, limit monetary inflation, and ensure safety and security in transactions.
Currency’s usefulness is measured by its ability to maintain its relative value over time, making it a reliable store of value. Initially, societies used commodities or precious metals as a means of payment because of their perceived stability. However, due to the inconvenience of carrying large amounts of these items, societies eventually adopted minted currencies made of metals such as gold, silver, and bronze, which were durable and had a low risk of depreciation.
Determining the value of currencies has been a topic of discussion. Originally, the value of currencies was based on their intrinsic physical characteristics. For instance, the value of gold was determined by its extraction cost and its qualities such as its purity and luster.
However, with the advent of government-issued paper money, the intrinsic scarcity of precious metals was no longer relevant. The value of paper money was initially tied to the amount of gold backing it, and some currencies still have a representative value, where each note or coin can be exchanged for a specific amount of a commodity.
In the 17th century, the concept of a currency’s value began to change. John Law, a well-known Scottish economist, argued that money issued by governments or monarchs is not the value for which goods are exchanged, but rather the value by which they are exchanged. This means that a currency’s value is based on its demand and its ability to encourage trade and commerce within and beyond an economy.
This idea aligns closely with the modern credit theory of monetary systems, which states that commercial banks create money and add value to currencies by lending to borrowers who use the money to buy goods and circulate currency in an economy.
After the abandonment of the gold standard to address concerns about gold supplies, many global currencies are now classified as fiat. Fiat currency is not backed by any commodity but is issued by a government and relies on the belief that others will accept it.
Today, most major global currencies are fiat, as governments and societies have found them to be the most durable and resistant to value loss over time. The value of fiat currencies is determined by their demand and supply, and the US dollar is highly valued due to its use by the world’s biggest economy and its dominance in international trade payments.
Why does Bitcoin Have Value?
To discuss Bitcoin’s value, we need to consider the nature of the currency. While gold was once used as currency due to its physical attributes, it was also inconvenient. Paper money was an improvement, but it requires manufacturing, and storage, and lacks the flexibility of digital currencies.
As money has evolved digitally, it has moved away from physical properties and towards more practical features. For instance, during the financial crisis, the Federal Reserve’s governor explained how they “rescued” companies like AIG by lending them money, rather than printing billions of dollars.
Bitcoin operates independently of government authorities and does not rely on intermediary banks. Transactions are validated through a decentralized network of independent nodes, without the involvement of a monetary authority to mitigate risk. Although Bitcoin shares some characteristics of fiat currency, such as scarcity and the inability to be counterfeited, there is a risk of double-spending where a user could spend the same bitcoin in multiple transactions, creating a duplicate record.
The reason why double-spending is unlikely in the Bitcoin network is due to its large size. In order for a 51% attack to occur, a group of miners would need to control more than half of the network power, which would allow them to manipulate records. However, this type of attack would require an enormous amount of effort, money, and computing power, making it highly improbable.
However, Bitcoin’s practicality as a currency is often questioned as it is not frequently used for retail transactions. The primary value of Bitcoin lies in its scarcity, which is similar to that of gold. The cryptocurrency has a finite limit of 21 million, which is a characteristic it shares with the commodity.
The value of Bitcoin depends on its scarcity. As there is less supply, the demand for cryptocurrency grows. Investors are eager to obtain a share of the increased profits that come from trading this limited supply.
Bitcoin has a limited function similar to gold, as it mainly has industrial applications. Its underlying technology, called blockchain, is used as a payment system and has been tested. It has been most successful in the area of cross-border remittances, where it can increase speed and lower costs. Countries such as El Salvador believe that Bitcoin’s technology will continue to improve and eventually be used for daily transactions.
An alternative idea suggests that Bitcoin possesses inherent worth determined by the cost of producing a single unit. The process of mining Bitcoin requires significant energy, which results in tangible expenses for miners. Economic principles suggest that in a market where multiple producers are creating identical goods, the price of the product will ultimately approach its production cost. Observations have indicated that the price of Bitcoin generally aligns with its production costs.
The Challenges of Valuing Bitcoin
The main concern with Bitcoin is whether it can function as a reliable store of value. In order for it to do so, it must also work well as a medium of exchange. If it fails to gain acceptance as a medium of exchange, it will not be useful as a store of value.
Historically, Bitcoin’s value has been driven by speculation, resulting in extreme price fluctuations and media hype. As Bitcoin gains more mainstream acceptance, this trend may subside, but there is uncertainty regarding its future.
Additionally, issues surrounding the storage and exchange of cryptocurrencies make it difficult for Bitcoin to be widely used and easily transferred. The digital currency has been plagued by hacks, thefts, and fraud in recent years.
Bitcoins have a value determined by supply and demand, just like any other asset. However, some people struggle to accept the idea that virtual currency can be valuable since it exists only in computer networks. They fail to acknowledge that Bitcoins are scarce and have a production cost. Consequently, they believe that Bitcoins are worthless. Meanwhile, those who understand the Bitcoin system acknowledge its value.
The value of Bitcoin in the market fluctuates significantly and is prone to significant price changes, which means that the current market price may not reflect its true or intrinsic value. However, historically, oversold markets tend to recover while overbought markets tend to calm down over time. As a result, it is difficult to determine if Bitcoin is currently fairly priced without hindsight.
Although Bitcoin has characteristics similar to money, economists and regulators are not yet convinced that Bitcoin can be considered money due to the low volume of transactions and the limited number of goods and services priced in Bitcoins. While Bitcoin is often traded and used for value transfers across its network, it is still not widely used in commercial activities.