Why Do Bitcoins Have Value? Bitcoin Explained

Sometimes it seems likebitcoin is worth whatever Tesla founder Elon Musk says it is. Crypto hit the skids in May when Musk said the electric car company would stop accepting bitcoin as payment until it is produced using more sustainable sources of energy. Lately he’s made nice noises about crypto, though, and he pointed out on Twitter that he owns bitcoin and some other digital assets and would like for them to flourish. Crypto miners, who power fleets of energy-intensive computers to process bitcoin transactions, are powering back up after getting banned in China. The Central American nation will become the first country in the world to make the original crypto asset a national currency .

Crypto assets tend to be highly volatile, with prices that pingpong around on the latest speculation. Here are some developments that may have given the popular digital tokens a recent boost. Bitcoin was changing hands at more than $50,000 on Sept. 4, an increase of 20% from a month ago, according to CoinDesk data. From a larger frame of reference, decentralised cryptocurrencies allow new ways to coordinate without the need for a central arbiter. But because future scarcity is known in advance (predictable at four-year intervals), the halving Ethereum exchange events tend to already be priced in. Bitocoin miners today earn 6.25 bitcoins for every block mined, down from 50 bitcoins in the early years. This creates an incentive to get involved early, as scarcity increases with time. But increasing the supply of money erodes its value and leads people to look for inflation-resistant assets to hold. In this climate, Bitcoin has become a hedge against looming inflation and poor returns on other types of assets. Virtual currency is a digital representation of value in purely electronic form.

Bitcoin’s Price History

The cryptocurrency does display some attributes of a fiat currency system, however. For example, it is scarce and can be divided into constituent units called Satoshis. The only way that one would be able to create a counterfeit bitcoin would be by executing what is known as double-spending. This refers to a situation in which a user “spends” or transfers the same bitcoin in two or more separate settings, effectively creating a duplicate record. Bitcoin is often referred to as digital currency and as an alternative to central bank-controlled fiat money. If Bitcoin’s price continues to rise over time, users with a tiny fraction of a single bitcoin will still be able to take part in transactions involving the cryptocurrency. The development of side channels, such as the Lightning Network, should further boost the value of Bitcoin’s economy. As Bitcoin’s supply diminishes, demand for the cryptocurrency has increased. Investors are clamoring for a slice of the ever-increasing profit pie that results from the trading of its limited supply. Many governments and societies have found that fiat currency is the most durable and least likely to be susceptible to deterioration or loss of value over time.

Fiat currency is issued by a government and not backed by any commodity, but rather by the faith that individuals and governments have that parties will accept that currency. In the modern age, minted currencies often take the form of paper money, which does not have the same intrinsic value as coins made from precious metals. For a long time, the amount of gold backing paper money decided its value. Even today, some types of currencies rely on the fact that they are “representative,” meaning that each coin or note can be directly exchanged for a specified amount of a commodity. Facebook executive David Marcus told Bloomberg in late August that the social network could provide support for non-fungible tokens on its digital wallet, known as Novi. (Facebook is also developing its own crypto asset, known as Diem.) NFTs are kind of a digital version of one-of-a-kind artworks or trading cards typically built on the ethereum blockchain. If Facebook helps make NFTs more popular, that could drive up demand for ether, which is used to pay for computations on the ethereum network. In response to the risk of economic collapse due to COVID, governments around the world have flooded global markets with money created by central banks, in order to boost spending and help save the economy. The predominant medium of exchange is government-backed money, and for our model, we will focus solely on that.

A Functional And Decentralised Digital Currency

These attributes establish monetary policies to control inflation and ensure that they are secure and safe to use. Rather than require individuals to carry around cumbersome quantities of cocoa beans, gold, or other early forms of currency, however, societies eventually turned to minted currency as an alternative. Still, the reason many examples of minted currency were functional was that they were reliable stores of value, having been made out of metals with long shelf lives and little risk of depreciation. If Bitcoin gains scale and captures 15% of the global currency market , the total price per bitcoin would be roughly $514,000. New technology is upending everything in finance, from saving to trading to making payments. They have introduced other cryptocurrencies, such as Ethereum, which are also open platforms for the public. In order to place a value on Bitcoin, we need to project what market penetration it will achieve in each sphere. You are encouraged to form your own opinion for this projection and adjust the valuation accordingly. Puzzled, the interviewer asked whether the Fed had manufactured billions of dollars.

When that happens, the cryptocurrency’s economics will ensure that it is ready. One bitcoin has a much bigger divisibility factor compared to the standard units of fiat currencies. It can be divided up to eight decimal units into constituent units called Satoshis. A fiat currency such as the U.S. dollar is generally equal to 1/100th of a unit. And decentralised blockchain-based networks don’t just enable digital money.

The Challenges Of Valuing Bitcoin

But Bitcoin fails the utility test because people rarely use it for retail transactions. The main source of value for Bitcoin, then, is the economics of its supply and demand. The argument for Bitcoin’s value is similar to the one for gold—a commodity that shares characteristics with the cryptocurrency. Bitcoin does not have the backing of government authorities, nor does it have a system of intermediary banks to propagate its use. A decentralized network consisting of independent nodes is responsible for approving consensus-based transactions in the Bitcoin network. There is no fiat authority in the form of a government or other monetary authority to act as a counterparty to risk and make lenders whole, so to speak, if a transaction goes awry. However, one can argue that Bitcoin’s value is similar to that of precious metals. Precious metals like gold are used in industrial applications, while Bitcoin’s underlying technology blockchain has applications across the financial services ecosystem. Bitcoin’s digital provenance means that it might even serve as a medium for retail transactions one day.

This thinking hews closely to the modern credit theory for monetary systems. In this theory, commercial banks create money by lending to borrowers, who use the money to purchase goods and services and increase the velocity of a currency’s circulation in an economy. Initially, their value was a function of intrinsic physical properties. For example, gold—a popular currency—derived its value based on extraction costs and its qualitative factors, such as luster and purity content. This limit is hard-coded into the Bitcoin protocol and can’t be changed. It creates artificial scarcity, which ensures the digital money increases in value over time. Convertible virtual currency is an unregulated digital currency that can be used as a substitute for real and legally recognized currency. Another theory is that Bitcoin has intrinsic value based on the marginal cost of production to produce a bitcoin. “So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed,” explained Bernanke.

The International Monetary Fund, on the other hand, thinks this type of thing could destabilize the economy and expose the government and regular citizens to additional exchange-rate risk. Other DApps include decentralised financial tools for prediction markets, cryptocurrency borrowing and lending, investing and crowd-funding. This is anyone who chooses to run software to validate Bitcoin transactions on the blockchain. But perhaps the most groundbreaking aspect of the Bitcoin network is that it draws on the work of cryptographers and computer scientists to exist as a blockchain-based digital currency. Whereas government-issued currencies such as the Australian dollar can have their supply increased at will by central banks, Bitcoin has a fixed supply that can’t be inflated by political decisions. Bitcoin, the world’s largest cryptocurrency by market capitalisation, has a current circulating supply of 18,590,300 bitcoins and a maximum supply of 21,000,000.
Terra refers to an open-source blockchain protocol for stablecoins and apps, and one of the two main cryptocurrency tokens under this protocol. Of this, 48%, or 58,560 metric tons, was in the form of private and official bullion stocks. At an estimated current price of $1,200 per troy ounce, that amount of gold is today worth upward of $2.1 trillion. Bitcoin’s utility as a store of value is dependent on its utility as a medium of exchange. The cryptocurrency can be used for any transaction where the business can accept it. What makes double-spending unlikely, though, is the size of the Bitcoin network. A so-called 51% attack, in which a group of miners theoretically control more than half of all network power, would be necessary. By controlling a majority of all network power, this group could dominate the remainder of the network to falsify records. However, such an attack on Bitcoin would require an overwhelming amount of effort, money, and computing power, thereby rendering the possibility extremely unlikely. Currencies also demonstrate six attributes—scarcity, divisibility, utility, transportability, durability, and counterfeitability—that enable their widespread use in an economy.

Bitcoin demonstrates some attributes for a currency, but its main source of value lies in its restricted supply and increasing demand. Currencies have value because they can function as a store of value and a unit of exchange. They also demonstrate six key attributes to enable their use in an economy. Julius Mansa is a CFO consultant, finance and accounting professor, investor, and U.S. Department of State Fulbright research awardee in the field of financial technology.

Chartalism is a non-mainstream theory that emphasizes the impact of government policies and activities on the value of money. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.

Gold was favored as currency due to its inherent physical attributes. But it was cumbersome to conduct transactions using the precious metal. Paper money was an evolution, but it requires manufacturing and storage and lacks the mobility and ease of use digital currencies need to function properly. The digital evolution of money has moved the value of currencies away from their physical attributes to their function in an economy. After countries abandoned the gold standard in an effort to curb concerns about runs on federal gold supplies, many global currencies are now classified as fiat.

Mining for bitcoin involves a great deal of electricity, and this imposes a real cost on miners. According to economic theory, in a competitive market among producers all making the same product, the selling price of that product will tend towards its marginal cost of production. Empirical evidence, indeed has shown that the price of a bitcoin is reflected by this cost of production theory. The value for fiat currencies is a function of their demand and supply.

Bitcoin is predominantly traded on online cryptocurrency exchanges, but can also be sent, received and stored in “digital wallets” on specific hardware or smartphone applications. Bitcoin is a digital or virtual currency created in 2009 that uses peer-to-peer technology to facilitate instant payments. In aggregate, our estimate for the global value of stores of value comparable to Bitcoin—including savings accounts, small and large time deposits, money market funds, and gold bullion—comes to $47.1 trillion. Roughly speaking, M1—which includes M0 and is currently worth about $4.9 trillion—will serve as our current worldwide value of mediums of exchange.
We will include this as a store of value that is comparable to Bitcoin. To this, we will also add an estimate for the worldwide value of gold held as a store of value. Though some may use jewelry as a store of value, for our model, we will only consider gold bullion. Throughout much of its history, speculative interest has been the primary driver of Bitcoin’s value. Bitcoin has exhibited the characteristics of a bubble with drastic price run-ups and a craze of media attention. This is likely to decline as Bitcoin continues to see greater mainstream adoption, but the future is uncertain. These are the core obsessions that drive our newsroom—defining topics of seismic importance to the global economy.
He educates business students on topics in accounting and corporate finance. Outside of academia, Julius is a CFO consultant and financial business partner for companies that need strategic and senior-level advisory services that help grow their companies and become more profitable. A ‘bull market’ occurs when securities are on the rise, whereas a ‘bear market’ is when securities fall for a sustained period. Both terms are metaphors; a bull thrusts its horns into the air and a bear swipes its paws down. Perhaps the overt rise of digital surveillance in response to the COVID pandemic has further stoked fears about online privacy and security — again piquing the public’s interest in Bitcoin’s potential. Therefore, massive surges and falls in price typically reflect changing demand conditions, such as a growing number of new institutional investors. This gradual reduction was encoded into the network by creator Satoshi Nakamoto, who designed it this way to mimic the process of extracting actual gold — easier at first, but harder with time. They are rewarded with bitcoins, more of which are created every ten minutes. Bitcoin continues to trade close to its all-time high reached this month. Its price is now around US $34,000 — up about 77% over the past month and 305% over the past year.
However, the latter is valuable because it is issued by a monetary authority and is widely used in an economy. Bitcoin’s network is decentralized, and the cryptocurrency is not used much in retail transactions. Gary Gensler told the Financial Times that crypto executives have to heed regulations if they want to be around in the coming years. Last month, the SEC brought charges against two men who sold $30 million of securities using DeFi technology.

The U.S. dollar is considered valuable because the world’s biggest economy uses it and it dominates the flow of payments in international trade. Prominent Scottish economist John Law wrote that money—currency issued by a government or monarch—is not the value for which goods are exchanged, but the value by which they are exchanged. In other words, the value of a currency is a measure of its demand and its ability to stimulate trade and business within and outside an economy. Nakamoto’s audacious experiment in digital currency is working as intended. And what really deserves attention now is what this means for our digital, physical and social futures. In other words, it functions via a dispersed peer-to-peer network, rather than through a central authority such as a central bank.

Similar to ordinary smartphone apps, software developers around the world are building decentralised applications on top of Bitcoin and other blockchain protocols. Our total estimate for the global value of mediums of exchange and stores of value thus comes to $52.1 trillion. If Bitcoin were to achieve 15% of this valuation, its market capitalization in today’s money would be $10.8 trillion. With all 21 million bitcoins in circulation, that would put the price of 1 bitcoin at $514,000. Bitcoin also has limited utility like gold, the applications for which are mainly industrial. Bitcoin’s underlying technology, called blockchain, is tested and used as a payment system. One of its most effective use cases is in remittances across borders to bump up speed and drive down costs. Some countries, like El Salvador, are betting that Bitcoin’s technology will evolve sufficiently to become a medium for daily transactions. Any discussion about the value of Bitcoin must take place within the context of a reinvention in the nature of currency.
First launched in 2009 as a digital currency, Bitcoin was for a while used as digital money on the fringes of the economy. Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver. Difficulties surrounding cryptocurrency storage and exchange spaces also challenge Bitcoin’s utility and transferability. In recent years, hacks, thefts, and fraud have plagued digital currency.

• In many societies throughout history, commodities or precious metals served as methods of payment because they were seen as having a relatively stable value.
• A so-called 51% attack, in which a group of miners theoretically control more than half of all network power, would be necessary.
• A decentralized network consisting of independent nodes is responsible for approving consensus-based transactions in the Bitcoin network.
• It creates artificial scarcity, which ensures the digital money increases in value over time.
• The U.S. dollar is considered valuable because the world’s biggest economy uses it and it dominates the flow of payments in international trade.

It was designed to increase in value over time through the rules Nakamoto wrote into its software code — which Bitcoin’s most outspoken advocates, known as “maximalists”, vehemently defend. A public blockchain is an “immutable” database, which means the record of transaction history can’t be changed. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Investopedia does not include all offers available in the marketplace. John Kelleher is a blockchain software architect and founder of Level K. He has 10+ years of software development experience.

In other words, the Fed “manufactured” U.S. dollars through entries in its ledger. This marking up of an account size exemplifies the nature of currencies in their digital avatar. Read more about Introduction in Crypto Trading here. It has implications for the velocity and use of currencies because it simplifies and streamlines transactions involving them in an economy. Currency is functional if it is a store of value or, to put it differently, if it can reliably maintain its relative value over time. In many societies throughout history, commodities or precious metals served as methods of payment because they were seen as having a relatively stable value. The definition of value in a currency has changed over centuries from physical attributes to the velocity of its use in an economy.