One of the biggest struggles for newcomers to crypto is attempting to understand why and how does Bitcoin have value. The coin is digital, has no physical asset backing it up, and the concept of mining can be very confusing. In a sense, mining creates new bitcoins out of thin air. In practice, though, successful mining requires a very costly investment. But how can all of this make BTC valuable?
Think about the money we all use daily – there’s no longer gold or assets backing up our banknotes. Although there are remarkable differences, BTC, as a digital form of money, shares some similarities with the fiat money we are all used to. So, let’s discuss first the value of fiat money before we dive into the cryptocurrency ecosystem.
Why Does Money Have Value?
In short, what gives money value is trust. Essentially, money is a tool used to exchange value and in that sense, any object could be used as money as long as the local community accepts it as payment for goods and services. In the early days of human civilization, we had all kinds of objects being used as money - from rocks to seashells.
Why Does Fiat Have Value?
With the removal of the gold standard, we seemingly have a currency without value. Money does, however, still pay for our food, bills, rent, and other items. As we discussed, money derives its value from collective trust. Therefore, a government needs to firmly back and successfully manage a fiat currency to succeed and maintain a high level of trust. It’s easy to see how this breaks down when faith in a government or central bank is lost due to hyperinflation and inefficient monetary policies, as seen in Venezuela and Zimbabwe.
Why Does Crypto Have Value?
Cryptocurrencies have some things in common with our standard idea of money, but there are some remarkable differences. Although some crypto like PAXG are pegged to commodities like gold, most cryptocurrencies have no underlying asset. Instead, trust once again plays a significant role in the value of a cryptocurrency. For example, people see value in investing in Bitcoin, knowing that others also trust Bitcoin and accept BTC as a payment system and medium of exchange.
For some cryptocurrencies, utility is also an important factor. To access certain services or platforms, you may need to use a utility token. A service in high demand will therefore provide value to its utility token. Not all cryptocurrencies are the same, so their value really depends on the features of each coin, token, or project.
When it comes to Bitcoin, we can narrow it down to six characteristics that we’ll discuss in more detail later.
How Does Bitcoin Have Value?
The value of Bitcoin is a subjective topic with many differing opinions. Of course, one could say that the market price of Bitcoin is its value. However, that doesn’t exactly answer our question. What’s more important is why people judge it to have value in the first place. Let’s dig a bit deeper into what is the underlying value of Bitcoin.
Utility
One of the major benefits of Bitcoin is its ability to quickly transfer large amounts of value worldwide without the need for intermediaries. While it can be relatively expensive to send a small amount of BTC due to fees, it’s also possible to send millions of dollars cheaply. For example, a Bitcoin transaction worth around $45,000,000 (USD) could be sent with a fee of just under $50.
While Bitcoin isn’t the only network that makes this possible, it’s still the largest, safest, and most popular. The Lightning Network also makes small transactions possible as a layer two application. But regardless of the amount, being able to make borderless transactions is certainly valuable.
Decentralization
Decentralization is one of the key features of cryptocurrencies. By cutting out central authorities, blockchains give more power and freedom to the community of users. Anyone can help improve the Bitcoin network due to its open-source nature.
Even the cryptocurrency’s monetary policy works in a decentralized manner. The work of miners, for example, involves verifying and validating transactions, but it also ensures that new Bitcoins are added into the system at a predictable, steady rate.
Bitcoin’s decentralization gives it a very robust and secure system. No single node on the network can make decisions on everyone’s behalf. Transaction validation and protocol updates all need to have group consensus, protecting Bitcoin from mismanagement and abuse.
Distribution
By allowing as many people as possible to participate, the Bitcoin network improves its overall security. The more nodes connected to Bitcoin's distributed network, the more value it gets. In distributing the ledger of transactions across different users, there’s no need to rely on a single source of truth.
Without distribution, we can have multiple versions of the truth that are difficult to verify. Think about a document sent via email that a team is working on. As the team sends the document among themselves, they create different versions with different states that can be difficult to track.
Also, a centralized database is more susceptible to cyber-attacks and outages than a distributed one. It’s not uncommon to have issues using a credit card because of a server issue. A cloud-based system like the one of Bitcoin is maintained by thousands of users around the world, making it much more efficient and secure.
Systems of Trust
Bitcoin’s decentralization is a huge network benefit, but it still needs some safeguarding. Getting users to cooperate on any large, decentralized network is always a challenge. To solve this problem, known as the Byzantine General’s Problem, Satoshi Nakamoto implemented a Proof of Work consensus mechanism that rewards positive behavior.
Trust is an essential part of any valuable item or commodity. Losing trust in a central bank is disastrous for a nation's currency. Likewise, to use international money transfers, we have to trust the financial institutions involved. There is more inbuilt trust in Bitcoin's operations than other systems and assets we use daily.
However, Bitcoin users don't need to trust each other. They only need to trust Bitcoin's technology, which has proven to be very reliable and secure and the source code is open for anyone to see. Proof of Work is a transparent mechanism that anyone can verify and check themselves. It’s easy to see the value here in generating consensus that is almost always error-free.
Scarcity
Inbuilt within Bitcoin's framework is a limited supply of 21,000,000 BTC. No more will be available once Bitcoin miners mine the last coin around 2140. While traditional commodities like gold, silver, and oil are limited, we find new reserves every year. These discoveries make it difficult to calculate their exact scarcity.
Once we have mined all BTC, Bitcoin should, in theory, be deflationary. As users lose or burn coins, the supply will decrease and likely cause an increase in price. For this reason, holders see a lot of value in Bitcoin's scarcity.
Bitcoin's scarcity has also led to the popular Stock to Flow model. The model attempts to predict BTC's future value based upon Bitcoin mining per year and the overall stock. When back-tested, it quite accurately models the price curve that we have seen so far. According to this model, the main driving force in Bitcoin's price is its scarcity. By having a possible relationship between price and scarcity, holders find value in using Bitcoin as a store of value – more on this later below.
Security
In terms of keeping your invested funds safe, there aren’t many other options that provide as much security as Bitcoin. If you follow the best practices, then your funds are incredibly secure. In developed countries, you can easily take for granted the security offered by banks. But for many people, financial institutions cannot provide them the protection they need, and holding large amounts of cash can be very risky.
Malicious attacks to 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 is extremely low, and even if it happens, it won’t last long.
The only real threats to the storage of your BTC are:
1. Fraud and phishing attacks
2. Losing your private key
3. Storing your BTC in a compromised custodial wallet where you don’t own the private key
By following best practices to make sure the above doesn’t happen, you should have a level of security that exceeds even your bank. The best part is that you don’t even have to pay to keep your crypto safe. And unlike banks, there are no daily or monthly limits. Bitcoin allows you to have full control over your money.
Bitcoin as a Store of Value
Most of the characteristics already described also make Bitcoin a good fit as a store of value. Precious metals, U.S. dollars, and government bonds are more traditional options, but Bitcoin is gaining a reputation as a modern alternative and digital gold. For somETHing to be a good store of value, it needs:
- Durability: So long as there are still computers maintaining the network, Bitcoin is 100% durable. BTC cannot be destroyed like physical cash and is, in fact, more durable than fiat currencies and precious metals.
- Portability: As a digital currency, Bitcoin is incredibly portable. All you need is an Internet connection and your private keys to access your BTC holdings from anywhere.
- Divisibility: Each BTC is divisible into 100,000,000 satoshis, allowing users to make transactions of all sizes.
- Fungibility: Each BTC or satoshi is interchangeable with another. This aspect allows the cryptocurrency to be used as an exchange of value with others globally.
- Scarcity: There will only ever be 21,000,000 BTC in existence, and millions are already lost forever. Bitcoin’s supply is much more limited than inflationary fiat currencies, where the supply increases over time.
- Acceptability: There's been widespread adoption of BTC as a payment mETHod for individuals and companies, and the blockchain industry just continues to grow every day.
Closing Thoughts
There is unfortunately no single and neat answer as to why Bitcoin has value. The cryptocurrency has the key aspects of many assets with worth, like precious metals and fiat, but doesn't fit into an easily identifiable box. It acts like money without government backing and has scarcity like a commodity even though it's digital.
A general lack of knowledge and misunderstanding has led some to question how does Bitcoin have value at all. With words like "scam" and "Ponzi scheme" used, it's easy to see that some people have unfounded fears. But ultimately, Bitcoin runs on a very secure network and the cryptocurrency has a considerable amount of value placed on it by its community, investors, and traders.
