Why does bitcoin have value?

Bitcoin (BTCUSD) is a digital currency operated on the blockchain network. But why do bitcoins have value? Let's explore this issue with Fox Crypto News.

Bitcoin (BTCUSD) is often thought of as a digital currency and an alternative to central bank-controlled fiat money. However, the latter is valuable because it is issued by the monetary authority and is widely used in the economy. The Bitcoin network is decentralized and the cryptocurrency is not widely used in retail transactions.

It can be argued that the value of Bitcoin is similar to the value of precious metals. Both are limited in number and have select use cases. Precious metals such as gold are used in industrial applications, while Bitcoin's underlying technology, blockchain, has several applications in the financial services industries. Bitcoin's digital roots mean it could even serve as a vehicle for retail transactions one day.

Why are traditional currencies valuable?

There are six main attributes to a useful coin: scarcity, divisibility, acceptability, portability, durability, and resistance to counterfeiting (uniformity). These qualities allow a currency to be widely used in the economy. They also limit currency inflation and ensure that the currency is secure and safe to use.

Currency is useful if it acts as a store of value or, in other words, if it can reliably maintain its relative value over time. Throughout history, many societies have used commodities or precious metals as a method of payment because they are considered to have a relatively stable value.

Instead of carrying large quantities of cocoa beans, gold, or other early forms of money, societies eventually turned to coinage as an alternative. The first such currencies used metals such as gold, silver, and copper, which had a long shelf life and little risk of devaluation.

The assignment of value to currency is a matter of debate. Initially, their value came from their intrinsic physical properties. For example, the value of gold comes from the cost of mining and certain qualitative factors, such as luster and purity.

In the modern era, government-issued currencies often take the form of paper money, which do not have the intrinsic scarcity nature of precious metals. For a long time, the value of paper money was determined by the amount of gold it contained. Even today, some currencies are "representative", meaning that each coin or note can be exchanged directly for a specific quantity of a commodity.

The idea of ​​the value of money began to change in the 17th century. The famous Scottish economist John Law wrote that money - money issued by a government or monarch - "is not a value that goods are exchanged, but the value for which they are exchanged."

In other words, the value of money is a measure of the need and ability to stimulate trade and business within and outside an economy.

This thinking is associated with modern credit theory for monetary systems. According to this theory, commercial banks create money (and monetary value) by lending money to borrowers, who use the money to buy goods and make money circulate in the economy.

After countries abandoned the gold standard in an attempt to curb concerns about the gold supply, many global currencies are now classified as fiat.
Fiat currency is issued by the government and is not backed by any commodity, but by the belief of individuals and the government that others will accept the currency.

Today, most major global currencies are fiat. Many governments and societies have found that fiat currencies are the most durable and least likely to depreciate over time.

The value of fiat currencies is a function of their supply and demand. The US dollar is considered valuable because the world's largest economy uses it and it governs the flow of payments in international trade.

Value of digital currency

Any discussion of the value of Bitcoin must address the nature of the currency. Gold is useful as currency due to its inherent physical properties, but it is also bulky. Paper money is an improvement, but it requires production and storage and lacks the portability of digital currencies. The digital evolution of money has moved away from physical properties and towards more functional ones.

Here is an example. During the financial crisis, Ben Bernanke, then governor of the Federal Reserve, appeared on CBS's 60 Minutes and explained how the agency "rescued" insurance giant American International Group (AIG) ) and other financial institutions from bankruptcy by lending money. surname. Confused, the interviewer asked if the Fed was producing billions of dollars. That's not entirely the case.

"So to lend to a bank, we simply use a calculator to mark the size of the account they have with the Fed," explains Bernanke. In other words, the Fed "produced" US dollars through entries in its ledger.

This ability to "tick" accounts represents the essence of currencies in their digital form. It makes sense for the speed and use of currencies because it simplifies and streamlines the transactions associated with them.

Why is Bitcoin valuable?

Bitcoin does not have the backing of government authorities, nor does it have a system of intermediary banks to propagate its use. A decentralized network consisting of independent nodes responsible for approving consensus-based transactions in the Bitcoin network. There is no legal authority in the form of a government or other money regulator to act as a counterparty to the risk and make the lender all-inclusive, so to speak, if a transaction goes wrong. malfunction.

However, cryptocurrencies display some properties of the fiat currency system. It is scarce, it and cannot be counterfeited. The only way a person can generate a fake bitcoin is by doing what is known as double spending. This refers to a situation where a user "spends" or transfers the same bitcoin in two or more separate settings, effectively creating a duplicate record.


However, what makes double spending unlikely is the size of the Bitcoin network. A so-called 51% attack, in which a group of miners theoretically controls more than half of the entire network power, would be needed. By controlling the majority of the entire network power, this group can dominate the rest of the network to falsify profiles. However, such an attack on Bitcoin would require a huge amount of effort, money, and computing power, so the possibility is extremely unlikely.

But Bitcoin often fails the utility test because people rarely use it for retail transactions. Bitcoin's primary source of value is its scarcity. The argument for Bitcoin's value is similar to that of gold, a commodity that shares characteristics with cryptocurrencies. Cryptocurrencies are limited to the amount of 21 million.

Bitcoin is more divisible than fiat currencies. A bitcoin can be divided into up to eight decimal places, with the constituent units known as satoshi. Most fiat currencies can only be divided to two decimal places for everyday use.

If the price of Bitcoin continues to rise over time, users with a small fraction of bitcoin will still be able to conduct transactions with the cryptocurrency. The development of side channels, such as the Lightning Network, could further boost the value of the Bitcoin economy.


The value of Bitcoin is a function of this scarcity. As the supply decreased, the demand for the cryptocurrency increased. Investors are clamoring for a slice of the growing profit pie as a result of trading its limited supply.

Bitcoin also has limited utility like gold, the applications are mainly industrial. Bitcoin's underlying technology, called blockchain, is tested and used as a payment system. One of its most effective use cases is transferring money across borders to increase speed and reduce costs. Some countries, like El Salvador, are betting that Bitcoin's technology will evolve enough to become a medium for everyday transactions.

Marginal Production Cost

Another theory is that Bitcoin has an intrinsic value based on the marginal cost of producing one bitcoin.

Bitcoin mining involves a lot of electricity and this poses a real cost to the miners. According to economic theory, in a competitive market between producers all making the same product, the selling price of that product will tend towards its marginal cost of production. Empirical evidence has shown that the price of bitcoin tends to follow the cost of production.

Theories of monetarism

Monetarists try to value bitcoin as the value of money, using the money supply, its velocity, and the value of goods produced in the economy. The simplest way to this approach would be to look at the current worldwide value of all mediums of exchange and of all stores of value equivalent to Bitcoin and then calculate the value. expected percentage of Bitcoin. The medium of exchange is primarily government-backed money, and for our model we will focus on that only. Roughly speaking, the money supply (M1) in the United States is worth more than $20 trillion by the end of 2021.

Assuming this total remained stable, if Bitcoin were to reach 15% of this valuation, its market cap in today's money would be around $3 trillion. With all 21 million bitcoins in circulation, that would put the price of 1 bitcoin at around $143,000.

Challenges of Bitcoin Valuation

One of the biggest problems is Bitcoin's status as a store of value. Bitcoin's utility as a store of value depends on how it functions as a medium of exchange. If Bitcoin doesn't succeed as a medium of exchange, it won't be as useful as a store of value.

Throughout its history, speculative interest has been a major driver of Bitcoin's value. Bitcoin has exhibited the characteristics of a bubble with strong rallies and a fever that has attracted media attention. This will likely subside as Bitcoin continues to gain more mainstream adoption, but the future is uncertain.

The difficulties surrounding the cryptocurrency exchange and storage space also challenge Bitcoin's utility and transferability. In recent years, hacks, thefts, and frauds have plagued digital currencies.
Why do some people believe that Bitcoin is worthless?
Like any asset or thing of value, the price people are willing to pay for Bitcoin is a socially agreed level and is also based on supply and demand. Because Bitcoins are virtual, existing only in computer networks, it is difficult for some people to understand that Bitcoins are scarce and they have a cost of production. Due to their unwillingness to accept that digital traces can hold value in this way, they still believe that Bitcoin is worthless. Others who understand the Bitcoin system agree that it has value.

Is Bitcoin Fairly Valuable?

The market price of Bitcoin is highly volatile and subject to large price swings. Therefore, the market price at any given time can vary greatly from its fair or intrinsic value. However, over time, the oversold market tends to recover and the overbought market cools down. Therefore, it is impossible to say at any point in time whether Bitcoin will be priced fairly without the benefit of insight.

Is Bitcoin Money?

Although Bitcoin has some money-like features, economists and regulators still do not believe that Bitcoin currently behaves like money. This is because relatively few transactions are done in Bitcoin and very few are counted in Bitcoin. Although people can trade Bitcoin in large volumes and transfer value over the network, little commercial activity still takes place.

How much does it cost to produce 1 BTC?

The cost to produce one bitcoin depends on the cost of electricity, mining difficulty, block reward, and energy efficiency of miners.

With a block reward of 6.25 BTC, a difficulty of 27.5 trillion, $0.15 per kWh, and an energy efficiency of 45 joules per terahash, the cost to produce 1 BTC = $35,500.

Investing in Cryptocurrencies and other Initial Coin Offerings (“ICOs”) is very risky and highly speculative and this article is not a recommendation by Investopedia or the writer to invest in coins. electronic or other ICOs. Since each individual's situation is unique, always consult a qualified professional before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns the cryptocurrency.

Aug 31, 2022

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