Bitcoin is the most popular digital currency and probably the main alternative to the well-known fiat money, controlled by the central bank. The latter gets its value due to its wide use in the economy and the fact that it has a monetary authority. On the other side, Bitcoin is not used a lot in retail transactions and it doesn’t have a centralized network.
Still, you can notice that the value of Bitcoin is almost as that of some precious metals. It doesn’t have an unlimited quantity and it does have select use cases. Bitcoin’s blockchain technology is very important for the financial services ecosystem, while precious metals like gold are also used in industrial applications. Experts even predict that BTC is going to serve as a medium for retail transactions due to its digital provenance.
The Value of Fiat Money
For many years now, a currency is considered to be functional if it can maintain its relative value over a prolonged period. In other words, if a currency is a store of value, it will be functional for many. Precious metals and commodities were methods of payment in many societies throughout history, simply because these things always had stable value.
Eventually, society figured out that it would probably be better to use minted currency as an alternative to carrying around gold, cocoa beans, or animal skin. Minted currency has always been very functional, mainly because it was always made out of precious metals that have a long shelf life and very little risk of depreciation. They were always stores of value.
A currency needs to have six main attributes to be able to spread in an economy – durability, transportability, scarcity, utility, divisibility, and counterfeit ability. Monetary policies establish these attributes to make sure currencies are safe to use, secure, and control inflation.
In today’s world, paper money is the main form of a minted currency. Still, as you may guess, the paper doesn’t have the same value as coins that were made of precious metals back in the day. Gold used to back up paper money and decide its value for a long time. Today, you can still often find some currencies that rely on the fact that each note or coin can be exchanged for a commodity.
Somewhere in the 17th century, the value of currency began to take another path. A popular Scottish economist came to the conclusion that money is the value by which goods are exchanged, not the value for which goods are exchanged. In simple words, the value of money is measured by its ability to stimulate trade and by the demand for it.
This type of thinking is closely related to the system we created today with all the credit cards and monetary systems. Commercial banks create money from nothing, then lend it to borrowers, they use the money to purchase services and goods, therefore the velocity of circulation of the currency is increased.
The gold standard was abandoned in the past, and many currencies in the world became classified as fiat. This type of currency is not backed by any commodity, is issued by a government, and relies upon that the governments and individuals will simply accept the currency. This is why most major global currencies today are considered fiat money.
The Value of Bitcoin
When talking about Bitcoin, or actually any other digital currency, it is important to mention that its main purpose is to reinvent the nature of the currency. Gold was used for its amazing physical attributes, but it wasn’t very convenient to use it. Paper money lacks mobility, and it requires storage and manufacturing. Digital currencies focus completely on their function in an economy.
Bitcoin is not backed by any government authority and it doesn’t belong to any intermediary bank’s system. Consensus-based transactions are approved by the decentralized network that consists of independent nodes. If a transaction goes wrong, there is no monetary authority that will act as a counterparty to risk.
One of the reasons why Bitcoin has intrinsic value is thanks to the costs of its production. For example, bitcoin cloud mining requires miners to waste a lot of electricity, bringing up their costs of production. Economists say that when producers are all making the same product, especially in a competitive market, the selling price of the product will be close to the marginal costs of production. The evidence we have today on the Bitcoin price actually supports this theory.
The main value of this cryptocurrency is actually the economics of its demand and supply. Some will say that the argument for its value is very similar to one for the gold and they actually share very similar characteristics. They also both fail the utility test since people rarely use these currencies for retail transactions, but they do find their way into the economy. Bitcoin is also limited, much like gold, but its quantity is only 21 million.
And this is where we can come to a conclusion that the value of Bitcoin is actually a function of this scarcity. As the supply for this crypto diminishes, its demand will exponentially increase. Investors are now all looking to get their hands on this coin since it promises an increasing profit considering that its supply is very limited at the moment.
Another argument for Bitcoin’s value is that it has a very big divisibility factor when you compare it to fiat currencies and their standard units. BTC can be divided up to eight decimal units, usually referred to as Satoshis. For example, the U.S. dollar is about 1/100th of that unit, which is incredible to even think about.
Bitcoin holders with just a tiny fraction of the coin will, without a doubt, be able to participate in transactions if the price of the coin continues to rise. Some separate side channels are currently in development, and it is believed that these will further increase the value of Bitcoin, and it is believed that this will happen very quickly.