Why do bitcoins have value?
An asset's rarity defines its value. Before we discuss what a bitcoin is worth, let's talk about traditionally "valuable" investments, like gold.
A recent Reuters report broke the news that Uganda discovered a vast gold ore supply—31 million metric tons, to be precise. Gold has historically been one of the world's most valuable assets. However, an extra 31 million metric tons under Ugandan soil drives the global gold supply. If you’re wondering how this discovery is related to the price of bitcoin or how a relatively new digital currency can compete with a historically valuable asset like gold, we’ve got the answer: Rarity. More gold means this rare asset is now a little less rare and more readily available, and this can potentially result in a reduction in gold’s price, making it less valuable.
This is precisely what gives bitcoin their value. Due to Bitcoin's 21-million global supply cap, miners will never be able to mine more coins after they hit the limit. Bitcoin miners don't have to worry about finding a surprise blockchain supply in Ugandan soil. Instead, availability is fixed and absolute, meaning we’ll always be sure of its scarcity. This absolute, programmable scarcity is impossible to censor or take away without force and is easily portable and divisible by more than a dollar.
Additionally, it’s sufficiently decentralized, so no individual or group can rewrite its rules. It will likely exist forever with the same supply equation we can predict today, which is why it has value. This is Bitcoin's legacy.
However, recently, Bitcoin's big break came through when its price shot up within a year from around $570 (2016) to approximately $4,760 (2017). As an alternative to traditional financial methods, Bitcoin earned a reputation as a decentralized asset that could affect the world's economy.
Let’s look at a few characteristics that define Bitcoin’s valuation.
- Utility – An increasing number of businesses have been accepting bitcoins as a mode of payment. El Salvador’s government declared Bitcoin as a legal tender. One of the most important facts about Bitcoin is that you can buy it in fractions. Bitcoin is divisible into eight decimal places—potentially more in the future—and can be purchased for transactional use.
- Self-Custody and Censorship Resistance – Unlike many other assets, Bitcoin is owned by users. It’s impossible to steal unless somebody gets access to a user’s private key. Even if users wish to transact, it can’t be censored. This makes Bitcoin more powerful, especially in areas with a questionable rule of law.
- Scarcity – As discussed, Bitcoin’s rarity gives it value. Although the demand for cryptocurrencies has been rising over the years, their supply stays fixed. Investors have been looking for opportunities to buy fractions of bitcoins, but their limited supply has been contributing to its increasing value.
- Marginal cost of production – The marginal cost of generating one bitcoin suggests that Bitcoin does indeed have inherent value. It costs money for miners to produce bitcoins since Bitcoin mining uses a lot of power. In a system where producers of the same commodity compete, the selling price of bitcoin should converge to its marginal cost of production. Research shows that the production cost of bitcoins appears to influence their price.
- Monetarist theories – Monetarism is a macroeconomic theory that states a government can promote economic stability by controlling a country’s growth rate and the amount of money in circulation. Think of it this way: To determine the value of one bitcoin, a government will have to factor in all forms of money and all other repositories (like assets) comparable to Bitcoin. If this value stays constant, Bitcoin's market price in USD will be almost $3 trillion if it reaches 15% of this total (at the time of writing). As a result, the cost of one bitcoin would be nearly $143,000 if all 21 million bitcoins existed in global circulation.
Fiat currency vs. bitcoin
In essence, currencies have two fundamental uses: A store of value (which means the currency or asset maintains its worth over time) and a form of monetary exchange. The rapid emergence of cryptocurrencies like Bitcoin has prompted concerns about whether traditional currencies will remain the primary exchange form.
Bitcoin was the world's first cryptocurrency and is now the largest by market capitalization. Cryptocurrencies are digital money that, unlike government-issued fiat currencies like the U.S. dollar, aren't governed by any central authority or intermediary. Instead, cryptocurrencies exist on a decentralized network using blockchain technology.
Why do traditional currencies have value?
Historically, many cultures employed precious metals like gold, silver, and bronze due to their long shelf life and intrinsic value. Traditionally, assets like gold derived intrinsic value from their extraction process, cost, and physical properties like luster and purity.
Current government-issued currencies frequently take the shape of paper money, which lacks the inherent scarcity of gold or silver. Government-backed currencies are fiat currencies issued by a central bank or any other government-approved authority. Governments constantly print fiat money, and many currencies collapse at some point. However, some people believe cryptocurrencies like Bitcoin will survive forever and hold their value. Bitcoin’s intrinsic value comes from its scarcity, so you could say its capped supply makes it an excellent long-term store of value.
Every fiat currency has died or inflated away to nothing, but Bitcoin is more likely to live forever! Not that this is at all a certainty.
What do bitcoin investors have to know?
Bitcoin is an exceptionally volatile asset, which means that investors must be willing to tolerate large swings. It’s also an unknown and risky asset. Depending on one’s thesis of the future, it may be 1,000x in value or go to zero. This means that investors who choose to invest in Bitcoin must be willing to take a large amount of risk. Additionally, its status is subject to change regularly.
All of this points to Bitcoin being a risky asset that investors should only invest an amount that they’re comfortable with losing.
Who controls the Bitcoin network?
It’s essential to keep in mind Bitcoin’s decentralized nature. Nobody owns the Bitcoin network. All Bitcoin users worldwide have power over the cryptocurrency. Bitcoin stays operationally sound due to its users' collective consensus, incentivizing them to protect and keep it secure.
Why do some people think Bitcoin is worthless?
Skeptics argue that Bitcoin holds no intrinsic value, unlike gold or other precious metals. Some argue that paper bills have intrinsic value since people can write on them or use them as kindling. However, Uganda’s 31-million metric ton discovery shows us that even gold’s intrinsic value can drop. As for dollar bills, the Federal Reserve estimates that it costs around 17 cents to print a $100 note.
Others such as Bill Gates have stated the value of Bitcoin is only proportional to the amount “the greater fool” is willing to pay for it down the road. This is true, but also true for other assets whose value is more than their physical value such as stocks.
It can be challenging to understand a cryptocurrency's worth. However, as discussed, most businesses, financial institutions, and the internet are built on digital trust. The same logic goes for cryptocurrency, along with its scarcity and store of value.
- Bitcoin holds value due to its utility, scarcity, marginal cost of production, and monetarist theories.
- Bitcoin’s rarity is reinforced by its 21-million supply limit, earning it the nickname “digital gold.”
- Fiat currencies are government-backed, while cryptocurrencies are decentralized, meaning they have no oversight or supervision from a central authority.
- How much bitcoins are actually worth fluctuates due to the market’s demand, the cost of production through mining, the number of competing cryptocurrencies, regulations governing its sale and use, and media and news.