How Do Cryptocurrencies Have Value
Bitcoin is classified as a digital currency that provides an alternative to fiat money.
The government issues fiat money, and it does not represent a physical commodity such as silver or gold. The value of such money depends on the stability of the government that issued it and the existing supply-demand relationships.
Fiat money is commonly used in everyday transactions, and a central monetary authority issues it. However, cryptocurrencies such as Bitcoin are decentralized and cannot be used as valid payments in retail transactions. This may well change in the near future due to the digital origin of Bitcoin.
Bitcoin can be compared to precious metals in that they have selective uses and are not highly abundant. They are also similar in that certain metals have industrial applications, just as the blockchain of Bitcoin has diverse applications in the financial service industry.
Why Do Traditional Currencies Have Value?
Many factors contribute to the functionality of a currency. The six main attributes include the following:
- rarity
- partibility
- acceptability
- resilience
- transportability
- consistency
These six factors ensure the safety and security of the use of currencies and protect them from monetary inflation.
If a currency can retain its value over time to a certain extent, it is a useful currency.
The history of the development of money started when societies started to use commodities such as precious metals as payment. It simply became too inconvenient to carry these various commodities around, so they were replaced by minted currency with the equivalent value of the commodity. These currencies were first made of metals such as silver, bronze, and gold, primarily due to their long shelf lives and decreased risk of devaluation.
Initially, the value of a currency was determined based on physical factors. The value of gold, for example, comes from extraction costs and the purity content.
The paper money we use today is definitely not a scarce commodity, but its value was based on how much gold it represented. Some currencies are still valued according to the amount of a certain commodity they can be exchanged for.
However, since the 17th century, currencies that have been issued by a government do not hold the value of the commodities they can be exchanged for but is instead a measure of demand due to their influence on the economy and the ability to generate trading opportunities.
The modern credit theory states that banks are the creators of money with the purpose of lending it to people who use it to purchase commodities, leading to the circulation of this currency in the economy. This theory coincides with the idea that money is a measure of its demand rather than representing a physical commodity.
What Is A Fiat Currency?
Government-issued currencies are known as fiat currencies.
Fiat currencies are not backed by any form of physical commodities such as silver or gold and were created by governments as an attempt to solve the concerns surrounding the declining supply of gold. Fiat currencies are dependent on the faith that people have in their governments, as well as the faith people have to accept and embrace that currency.
The value of fiat currencies is a function of its supply and demand relationship. Almost all countries worldwide use fiat currencies to generate trade and cycling in the economy primarily because of their durability and ability to maintain value over time. The U.S. dollar dominates international trade as it is the currency most used in the worldwide economy.
The Value of Digital Currencies
We are currently experiencing a digital revolution in which the physical attributes of currencies are of little value due to their poor mobility. Paper money also has its own problems in that it needs to be manufactured and stored and is susceptible to damage and thievery. Digital currencies have proved to be the most functional and practical means of payment in the modern age.
To better understand the practicality of digital money, let's consider the financial crisis of 2008. The Federal Reserve redeemed the American International Group and various other financial institutions during this crisis. They would have fallen into bankruptcy if the Federal Reserve didn't lend them billions of dollars by simply changing the entries in their ledgers. By marking up the sizes of their accounts, they saved these companies from disastrous consequences.
Digital currencies have the ability to streamline and increase the speed of transactions of great and small sums.
Why Bitcoin Has Value
Bitcoin differs from fiat currencies in that government authorities do not back it. It also does not make use of banks as a middle man but rather exists as a decentralized network. This network has independent nodes that approve transactions based on a set consensus. If a transaction goes wrong, there are no monetary authorities to act as coordinators that minimize risks.
Similarities between cryptocurrency and fiat money do exist, however. They are both relatively rare and cannot be reproduced. A person can only create a counterfeit with Bitcoin if they spend the same Bitcoins in more than one place, essentially leading to a duplicate record.
The immensity of the Bitcoin network makes double-spending relatively unlikely. For this to become a likelihood, a single group on the network would have to control more than 50% of all the power of the network. In this scenario, this group would be able to dominate the remaining percentage of the network to misreport record data. Such an attack is highly improbable as it would require a massive amount of computing power, capital, and effort.
The fact that Bitcoin cannot be used in retail payments decreases its utility to a great extent. The value of Bitcoin, not unlike gold, is based on its scarcity. Similar to gold, bitcoin is also a limited commodity and has a current ceiling of 21 million existing bitcoins.
As a function of its rarity, the demand for Bitcoin increases as its supply decreases. This cryptocurrency has a secret weapon that, although limited, broadens its utility. Blockchain technology has become a popular payment system as it has the ability to process transactions across borders faster and more cost-effectively than any system before it.
Bitcoin may very well become the currency used in our average day-to-day transactions.
The value of Bitcoin also gains potential when considering the marginal cost of the production of one coin. The cost of producing a Bitcoin can be likened to the selling price of that same coin. Bitcoin mining is relatively expensive in terms of electricity, but evidence suggests that the price of a Bitcoin follows the cost of production.
Where most of our current fiat currencies hold two decimal places when divided, Bitcoin can be divided to hold eight decimal places, making it much more divisible. These units resulting from the division of Bitcoin are called satoshis.
Sidechains like the Lightning Network further increase the value of the economy of Bitcoin.
When this cryptocurrency's price keeps following the increasing trend it has been, miners will be able to use this currency in daily transactions.
What Is Intrinsic Value?
A commodity has an intrinsic value if it can be exchanged to obtain goods or services. If a currency is backed by certain commodities such as silver and gold, it is said to have an intrinsic value. A currency or commodity is considered strong when it can hold its value over time. The value of a currency will increase if the thing that backs it decreases in supply.
The Difficulties of Valuing Bitcoin
Bitcoin's value of storing is a big issue that influences the utility of this currency. Bitcoin cannot be efficient as a store of value if it isn't successful as an exchange medium.
The value of this cryptocurrency varies from subject to subject due to its lack of inherent value. For the time being, the value of Bitcoin is largely dependent on each trader's anticipations of the behavior of the rest of the market. In the future, Bitcoin's value may have numerous stable equilibria, and a stable value can be established.
Thus far, Bitcoin's value has been driven by unpredictable interest. There have been multiple cases of drastic increases in Bitcoin's price, attracting a great deal of attention. As the Bitcoin network becomes mainstream, these characteristics may decline.
A real and ever-present threat to the security of any digital currency is fraud, hacks, and theft. This presents a significant challenge in securing the transferability and utility of Bitcoin. These factors affect the storage of the cryptocurrency in its exchange spaces.
A Monetarist Valuation of Bitcoin
The precise value of Bitcoin is near impossible to factually state because it depends on the market penetration this currency will achieve in each area of interest. We do not presume to know what the market penetration will be in the future, but a rough estimate of 15% can represent the store of value and Bitcoin as a currency.
Our dominant means of exchange are fiat currencies or government-issued currencies. Analyzing the value of these currencies can help us compare and draw conclusions about the stores of value and the value of the projected percentage of Bitcoin.
M1, the money supply composed of currency and all liquid deposits, was evaluated in October 2021 and stated to be worth more than 20 trillion dollars. This figure will act as the value of worldwide mediums of exchange.
We can use M3 as a comparable store of value of Bitcoin. Since October 2021, M3 minus M2 was worth 1.18 trillion dollars. We can add an estimate of the value of gold bullion worldwide that is held as a store of value.
At the end of 1999, the U.S. Geological Survey provided an estimate of 122 000 metric tons of above-ground available gold, of which 48% exist as private gold and bullion stocks. When we consider the current price of gold, that amount is worth more than 10 trillion dollars.
Other precious metals such as silver will not be included in our model. Using silver as an example, this is attributed to the lack of supply, leading to the government selling large amounts of silver bullion. Silver holds industrial applications more than it serves as a store of value.
Taking all comparable value of stores that can be compared to that of Bitcoin into account, an estimate of 47.1 trillion dollars for the global value of stores is calculated. This includes money market funds, savings accounts, and large and small-time deposits.
An estimate of 52.1 trillion dollars is attributed to the stored value and the global value of mediums of exchange. If Bitcoin achieves 15% of this estimate and the estimate remains stable, the market capitalization of Bitcoin would net around 1.8 trillion dollars. With there being a total of 21 million bitcoins circulating, one bitcoin would net $514 0000.
