Why Does Bitcoin Have Value?
Key Questions Answered
- Bitcoin was released into the world in 2009 as an experimental type of money designed to function without banks, which its creator deemed as the ones responsible for the Global Financial Crisis.
- Bitcoin is not backed by any commodity or faith in any government. Instead, it is secured by math, therefore not subject to the control – and error – of any single centralized entity.
- Bitcoin’s value comes first and foremost from the fact that more and more people are seeing its potential to function as money; as demand for it increases, so does its value.
Why was Bitcoin created?
Bitcoin was created by an anonymous person/group in response to the growing mistrust of banks and how they were handling our money.
It was no coincidence that the Bitcoin whitepaper was released right after the 2008 Global Financial Crisis (GFC), when banks were rescued with $700 billion of taxpayers’ money because they had taken on irresponsible risks to maximize their profits and needed to be bailed out.
In February 2009, Bitcoin’s creator/s Satoshi Nakamoto wrote in an online developer forum,
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
During the GFC, millions of people lost their jobs and houses, but in the US, only one junior banker was jailed for the crisis. In Satoshi’s eyes, our need to trust the banks to manage our money also gave them the power to control it, to our loss. Bitcoin was designed as a tool for the common people to take back this power.
What does Bitcoin do?
In short, Bitcoin makes the store and transfer of value vastly more efficient. The money we use nowadays is centralized i.e. issued by governments and managed by banks.
Bitcoin, as the world’s first-ever decentralized money, is “mined” into existence and maintained by a network of computers spread across the world. It enables us to transact directly with one another in a peer-to-peer fashion i.e. without the involvement of banks, credit cards, or other payment providers like Stripe or PayPal.
Presently, this is what happens when we buy something online:
Existing online payment process involves multiple third parties, making it costly and time-consuming (Source: Chargebacks911)
All these steps are necessary to ensure one thing: that you have the money to pay for the product you ordered. The seller at the other end has no way, and no reason, to trust you, but because of all the intermediaries from the banks to the credit cards and the payment processors checking, verifying, and processing the transaction, the trade can take place.
With Bitcoin, you can bypass the entire process like this:
But so what–who cares what happens under the hood, no matter how complex?
User advantages of Bitcoin
1) No more expensive banking fees
As we can see from the above diagram, sending money to a stranger on the other side of the world takes a lot of work—and costs. There are currency conversion fees, service charges, processing fees on the part of the seller, and others.
Bitcoin, being a cryptocurrency, is stored and verified by cryptography, which means it needs no bank or middleman to manage it. This cryptographic work, in turn, is carried out by a decentralized network of users worldwide instead of a bank. As such, Bitcoin gets the job of money done at a much, much lower cost, almost for nothing. In fact, someone once transferred about $300 million worth of Bitcoin for a fee of just $0.04 in under an hour.
For the first time in history, people have the option of using something else other than a bank to transfer money, bypassing the hefty fees. This is a tremendous benefit, especially for foreign workers who need to send significant amounts of money across international borders each month for their families–according to the World Bank, remittance fees currently average 6.09% for each transaction.
Currently, sending or receiving money online takes days—this is due to the multiple layers needed to verify transactions. Plus, banks don’t work on weekends and public holidays. Bitcoin has no such downtime; transactions take anywhere from seconds to slightly over an hour at most, depending on volume.
The next two factors are much more important, however. Beyond saving money and time, Bitcoin captured the imagination of those who saw it as the ultimate freedom money.
With traditional, centralized banking systems, your transactions can be denied or your account shut down. When nations started imposing sanctions on Russia for its invasion of Ukraine in February 2022, for example, worried parents had no way of wiring any money into Russia for their children studying there.
In contrast, no one can stop you from setting up an account or sending Bitcoin anywhere in the world, as long as you have the money. No centralized party has control over how you spend your money. All you need is a smartphone, an internet connection, and the Bitcoin address of the receiver (something like an email address.)
This is why Bitcoin is also described as “permissionless” money—you don’t need anyone’s permission to use it. Again, maybe not a big deal for many who live in stable, developed countries, but a potentially life-changing difference for some two billion unbanked people globally who have no means to save, invest and trade digitally.
4) Non-inflationary store of value
Finally, and this is perhaps one of the most important value propositions of Bitcoin–its supply cannot be inflated.
Nowadays, if you simply kept your money in the bank, that money will lose its value over time, because of a thing called inflation. Inflation is the increase in the prices of goods and services over time. Inflation also means that if you’re trying to save up money, no matter how hard you worked, the rising costs of living will just offset your additional income and send you back to square one (if not further).
Inflation can be caused by several factors, but most economists and analysts agree that the main reason is this: too much money going around. The money we use today is created by governments, and they are constantly creating more of it. Unfortunately, money, like many types of other goods, decreases in value as its supply increases.
“Money that is easy to produce is no money at all, and easy money does not make a society richer; on the contrary, it makes it poorer by placing all its hard‐earned wealth for sale in exchange for something easy to produce,” says author Saifedean Ammous in his book The Bitcoin Standard.
Bitcoin, on the other hand, has a hard cap of 21 million and thus cannot be devalued through an arbitrary inflation of its supply. Right now, thousands of super-computers worldwide are working hard to “mine” bitcoins, and about 19 million are already mined.
Once the other 2+ million have been mined, there will no longer be any new supply, and the only way to accommodate any increase in demand will be through the value appreciation of each bitcoin.
How is Bitcoin different from fiat money?
The critical difference between Bitcoin and fiat money is that while both exist in digital form, Bitcoin is programmed money–which means it is self-verifying using computer code, whereas fiat money has to be verified by banks to ensure its authenticity, as we have seen from the above diagram (think about Bitcoin like a self-driving car, whereas fiat money has to be manually “driven.”)
The ability to self-verify without a third party is what makes Bitcoin a decentralized currency.
If you’re wondering how a few lines of computer code can be money, it helps to remember that money was not always this “official” commodity issued by the governments, neither was it always in the form of dollar notes and coins.
Our ancestors used whatever thing of value they had to exchange with others for what they needed–so anything from sheep to salt was once a form of money.
Over time, our money evolved to become more efficient with each new form it took (as you’re trying to make sense of Bitcoin, you can appreciate how people back then would have struggled with the idea of exchanging a cow for, say, a metal coin. After all, it cannot be eaten nor skinned for clothing!)
At the most basic level, money is just a representation of value e.g. the money that flows into your bank account each month represents the value of your work for your company. With computers, this value can be represented by digital data on a screen, bypassing all physical forms.
The caveat–this data has to be accurate and trustworthy. Until the creation of Bitcoin, the only ones who were able to ensure this were the banks.
Why is Bitcoin valuable?
While Bitcoin’s price is influenced by multiple factors, its core value comes from its ability to function as the thing it was designed to be–money. To the degree that it is able to carry out this function, people will trust it, and be willing to accept it as payment.
Money serves three main functions: as a store of value, unit of account, and medium of exchange. For any form of money to carry out these functions effectively, it has to meet six key criteria:
- Durability: it must withstand physical wear and tear
- Portability: it must be easily transported
- Fungibility: it must be interchangeable (one dollar note has to be interchangeable with another dollar note)
- Scarcity: it has to be limited in supply
- Divisibility: it must be easily divided into smaller denominations for transactional purposes.
- Recognizability: it must be widely accepted as a form of payment
As a digital currency with a hard cap, Bitcoin already meets all the above criteria–except the last. Bitcoin has not yet gained widespread recognizability as a currency, but there is a growing number of entities accepting Bitcoin as payment, including one entire country. In 2021, El Salvador made history as the first nation to accept Bitcoin as legal tender i.e. businesses have to accept it if it is offered as payment, and government tax can be paid in Bitcoin.
Bitcoin still has a long way to go in terms of adoption, but it does not take away from the fact that people can now send money as easily as sending a text message to someone, securely and trustlessly. And it’s all because its creator, Satoshi Nakamoto, solved the double spending problem.
What is the double spending problem?
The double spending problem is one that exists only in the digital world.
For the most part of modern history, money has existed in physical form. If I give a physical dollar note to Bob, I will surely not have that dollar on me anymore. Most money nowadays, however, exists in digital form; the number you see in your bank savings account is just an electronic entry.
So what is to prevent me from sending the same dollar I sent Bob, to all my other friends? This is called the double spending problem because in the digital world, there is no scarcity e.g. we can email the same file to someone a hundred times over.
Yet, we cannot do this with money, for obvious reasons. We don’t get to “resend the file” i.e. spend the same money over and over, and this is all because we have those banks and other third parties checking and verifying that we are not double-spending our money (a.k.a. committing fraud).
Double spending happens when a fraudulent party spends the same money twice (Source: Bitcoins.net)
However, as mentioned earlier, our need to trust the banks to manage our transactions also gave them the power to control and inflate it. Satoshi Nakamoto found a way to remove the banks from the picture AND prevent the issue of double spending by creating what has now come to be known as a “blockchain.”
The revolutionary idea behind it: decentralize everything by putting the entire list of who sent money to whom on an open network that everyone can access and see. Then, incentivize people in such a way that it would be in their best interest to act honestly in verifying the records (with the help of some very complicated math work and advanced computers.) This way, nobody could spend money they didn’t actually have.
What is Bitcoin backed by?
Bitcoin is not backed by a physical commodity such as gold, nor is it backed by any government, like most fiat currencies today. In order to function as money that is completely decentralized, Bitcoin, by design, needs no external backing as it is secured cryptographically.
Would you rather have money that is not backed by anything and can thus be inflated anytime? Or would you rather have money that is not backed by anything “hard”, but is self-verifying and cannot be inflated at all? This is Bitcoin’s value proposition.
What is Bitcoin’s price determined by?
This is a tricky question to answer. After all, it is not a currency backed by the strength of a national economy, nor is it a stock that can be valued according to company earnings or a bond that has a yield.
In the early days, the value of Bitcoin was arbitrary, with people bartering bitcoins for goods and services via internet forums. One of these barters ended up being immortalized in crypto history, when a programmer, Laszo Hanyecz, paid 10,000 bitcoin (reportedly valued at about $41 at the time) for two pizzas worth $25 on 22 May, 2010. At Bitcoin’s peak, those 10,000 bitcoins would have been worth $680 million.
The exchange of Bitcoin for pizza was such a momentous one that Hanyecz had to take a picture to commemorate it. Here he is with his children and the two pizzas he bought with 10,000 bitcoins (Source: Laszlo Hanyecz)
Admittedly, the volatility of Bitcoin’s price has also hampered more widespread use of Bitcoin–who would want to make the same “mistake” as Laszo Hanyecz? (To be fair, Hanyecz has gone on record saying that he does not regret the purchase.)
In the early days, ever since Bitcoin started trading at $0.0008 in July 2010, its price has mostly been driven by demand from people who saw peer-to-peer digital money as a way to disarm the powerful institutions controlling our money.
Over time, however, and especially in the last few years, as Bitcoin started attracting the attention of institutional investors and governments, its price has also been subject to speculation, manipulation and regulatory shocks–for example, Bitcoin plunged to an all-time low in November 2019 when China clamped down on the crypto industry.
The fact that many of these big players treat Bitcoin as a stock has also meant that Bitcoin is also being exposed to factors that typically affect the traditional financial markets. In March 2020, Bitcoin dropped by more than 50% as the world entered lockdown due to COVID19, and plunged again by 8% in a single day in February 2022 when Russia announced its plans to invade Ukraine.
In short, as Bitcoin finds its footing as a first-of-its-kind currency, its price is determined by a whole host of factors, from supply and demand to speculation and a web of macroeconomic factors that are financial, geopolitical, and regulatory in nature.
Bitcoin Quote From Those Who Love It & Loathe It
“[Bitcoin] is a remarkable cryptographic achievement… The ability to create something which is not duplicable in the digital world has enormous value…Lot’s of people will build businesses on top of that.” – Eric Schmidt, CEO of Google
“The relative success of Bitcoin proves that money first and foremost depends on trust. Neither gold nor bonds are needed to back up a currency.” – Arnon Grunberg, Dutch writer & journalist
“Right now, cryptocurrencies are used for buying fentanyl and other drugs, so it is a rare technology that has caused deaths in a fairly direct way.” – Bill Gates, Microsoft founder
“Probably rat poison squared.” – Warren Buffet, legendary investor
“At the end of the day, when you peel the onion and get to what’s really there, there’s nothing there,” – Peter Schiff, economist
“I personally think Bitcoin is worthless.” – Jamie Dimon, CEO of JPMorgan Chase Bank
“Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.” Marc Andreesen, co-founder of Netscape & VC firm Andreessen Horowitz