Cryptocurrencies such as Bitcoin are often touted as an alternative to centralized fiat currencies such as the USD. However, many wonder, “why does bitcoin have value” in the first place?
Traditional fiat currencies have value because they are issued by a centralized monetary authority (central banks or governments) and are critical in the functioning of the economy.
Some argue that Bitcoin derives value similarly to precious metals because both are scarce and have select use cases.
But is there more to it? This article will explore the different characteristics that give bitcoin value and its role in the financial system.
- Fiat currencies, such as USD, have value because they are issued by monetary authorities and can function as a store of value and a unit of exchange.
- Bitcoin has several attributes that it shares with traditional currencies. However, its primary value source is its high demand and limited supply.
- Bitcoin is highly decentralized, allowing users to carry out transactions without an intermediary.
What Is Fiat Currency?
Before moving ahead, it is vital to understand fiat and its value. Governments and central banks officially issue fiat currencies, and users can exchange value through coins, paper notes, and digital numbers in bank accounts. Fiat currency derives its value from the relationship between its supply and demand and the stability of the government or authority issuing it. Almost all major global currencies are fiat currencies, including the euro and the USD.
Because fiat money is not backed by physical reserves such as a national stockpile, it is at risk of losing value due to inflation or falling prey to hyperinflation. For a long time, the value of fiat money was determined by the number of physical assets backing it. Even today, some currencies are “representative,” meaning holders can exchange them for a specific amount of the asset backing it.
So, Why Does Bitcoin Have Value?
As an asset, Bitcoin does not command an intermediary or institution that propagates its use, nor does it have the backing of a central or government authority. Instead, decentralized nodes are responsible for securing and approving transactions on the Bitcoin network. Transactions also do not involve intermediaries, which means they are faster and cheaper. However, users do not have any recourse if a trade goes awry.
However, Bitcoin does share some characteristics with fiat currencies, such as scarcity, divisibility, and value. So let’s look at some factors that give Bitcoin value.
One significant advantage of Bitcoin is that it allows holders to transfer substantial amounts of value to any corner of the world within minutes without an intermediary. While sending microtransactions in BTC could be expensive large transactions can be done for extremely low fees.
Additionally, Bitcoin is far more divisible than fiat currencies, with the former divisible up to 8 decimal places. If the bitcoin price continues to increase, users can make smaller transactions using bitcoin, increasing utility even further. The addition of sidechains, such as the Lightning Network, could also give a significant boost to the utility of bitcoin.
Bitcoin has introduced built-in digital scarcity. The total number of bitcoins that can be mined is capped at 21 million. Plus, the number of bitcoins released into circulation is halved every 21,000 blocks or roughly every four years. The first bitcoin halving occurred in 2012, dropping the reward to 25 BTC. Subsequently, in 2016, the reward dropped to 12.5 BTC, further dropping to 6.25 BTC in 2020. Over time, fewer bitcoins will be left to mine as it approaches the 21 million limit. Because of the limited availability of Bitcoin, the asset experiences deflation, seeing a steady increase in value.
Decentralization is a crucial feature of all cryptocurrencies, not just bitcoin. Unlike traditional fiat currencies, cryptocurrencies such as bitcoin are not controlled by central authorities such as banks or governments. Removing centralized power centers gives users complete control, meaning anyone can help improve bitcoin, thanks to its open-source nature. Decentralization also provides BTC with a robust and secure system, as decisions must be taken collectively, meaning no one node can influence the system.
Accessibility And Distribution
Anyone can participate in the bitcoin network, which helps improve the network’s security. The more nodes connected to the bitcoin network, the more value the network and the asset accrue. With transactions distributed between different nodes, users do not have to rely on a single source to confirm the validity of a transaction. Distributed databases are also more secure than centralized ones, with the latter more susceptible to hacking attacks.
Marginal Cost Of Production
Bitcoin also has value based on the marginal cost of producing one bitcoin. Bitcoin mining requires miners to expend considerable energy, which imposes a high cost on miners. Economic theory states that all producers making the same product in a competitive market see the price of the product drift toward its marginal cost of production. Evidence has shown that the bitcoin price tends to follow the cost of production.
When securing funds, few better options are available other than Bitcoin. If you follow the best practices when securing your bitcoin, your assets are incredibly secure. Any potential attack on the Bitcoin network would require the hacker or hackers to have control of over 51% of the current mining power, which can get illogically expensive. The only legit threat to a user’s bitcoin comes from the user’s negligence or naivety.
Store of Value
Bitcoin is an excellent store of value. Some users believe it is a better option than traditional stores of value, such as gold and government bonds. The cryptocurrency’s reputation as a store of value has earned it the moniker of “digital gold.” So why is bitcoin considered a good store of value? Because it demonstrates all of the following characteristics.
- Durability – As long as nodes maintain the bitcoin network, the cryptocurrency is durable. Bitcoin cannot be destroyed like fiat currencies and offers much more durability in value than traditional currencies and precious metals.
- Portability – Bitcoin is a digital currency which makes it highly portable. All users need to access their bitcoin is an internet connection and their private keys.
- Divisibility – A single bitcoin can be divided into 100,000,000 satoshis, enabling users to make transactions ranging from large to micro.
- Fungibility – Users can easily change one BTC with another, allowing it to be used worldwide as a medium of exchange.
- Scarcity – As mentioned earlier, there will only be 21,000,000 BTC. From this figure, millions have already been lost (misplaced wallets, disposed of hard drives, etc.). This limited supply differs from inflationary currencies, which means that the price of bitcoin would increase as its supply dwindles.
It is safe to assume that cryptocurrencies like bitcoin can provide a genuine alternative to fiat currencies. But, to answer the question about what gives it value? Well, there is no single answer to that. However, bitcoin’s built-in scarcity and deflationary mechanism can be a game-changer in an economy that’s being wrecked by inflation.