Why Does Bitcoin Have Value?

Introduction

For newcomers to cryptocurrency, one of the biggest challenges is understanding the source of value for cryptocurrencies like Bitcoin (BTC). Bitcoin is a digital token that lacks tangible assets for backing, and the concept of mining can be confusing. On one hand, it seems that mining can create new bitcoins out of thin air, yet successful mining requires substantial investment. So, how does all this confer value to Bitcoin?

We can think about the currency we use daily; these banknotes no longer require gold or other assets for support. Thanks to the fractional reserve banking system, the money lent often exists merely as numbers on a screen. Governments and central banks (like the Federal Reserve) can issue new currency through economic mechanisms, increasing the money supply. Despite clear differences, Bitcoin as a digital currency shares some similarities with the fiat currencies we are familiar with. Therefore, before delving into the cryptocurrency ecosystem, we must first understand the value of fiat currency.

Why Does Currency Have Value?

In simple terms, trust is at the core of what gives currency its value. Currency serves as a tool for exchanging value; as long as a consensus is reached within the local community, any item can serve as a medium for trading goods and services. In early human civilizations, various items, including stones and shells, acted as forms of currency.

What is Fiat Currency?

Fiat currency is the official currency issued by a government. In modern society, value is exchanged through paper money, coins, and digital amounts in bank accounts (which also serve as proof of personal loans or debts). In the past, people would go to banks to exchange paper money for gold or other precious metals, ensuring that currencies like the dollar were pegged to a specific amount of gold. However, the gold standard has been abandoned by most countries and is no longer the foundation of currency systems.

Once currencies were no longer tied to gold, modern fiat currency lost any substantial backing. This decoupling allows governments and central banks greater flexibility to formulate monetary policy and influence the money supply. The main characteristics of fiat currency include:

Issued by a central authority or government.

Lacks intrinsic value, with no backing from gold or other commodities.

Potential supply with no upper limit.

Why Does Fiat Currency Have Value?

Although the abandonment of the gold standard may seem to strip currency of value, we can still use money to pay for food, bills, rent, and more. As mentioned earlier, the value of currency relies on public trust. Governments must firmly support and effectively manage fiat currency to maintain this trust. If hyperinflation or ineffective monetary policy occurs, public trust in the government or central bank can collapse—Venezuela and Zimbabwe serve as classic examples of this failure.

Why Does Cryptocurrency Have Value?

Cryptocurrencies share conceptual similarities with traditional currencies, but there are also significant differences. While cryptocurrencies like PAXG are pegged to commodities such as gold, most cryptocurrencies lack actual underlying assets. Trust continues to play a crucial role in maintaining the value of cryptocurrencies. For instance, people recognize the investment value of Bitcoin and understand that others also trust Bitcoin, thereby accepting it as a payment system and medium of exchange.

For some cryptocurrencies, utility is also a key factor in conferring value. Certain services or platforms require utility tokens for proper functioning, and thus the demand for these tokens creates value. There is a wide variety of cryptocurrencies, each with its own circumstances. The value of each token or project ultimately depends on its unique characteristics.

We summarize the characteristics of Bitcoin into six aspects: utility, decentralization, distribution, trust framework, scarcity, and security. We will explore these in more detail next.

What is Intrinsic Value?

In discussions about the value of Bitcoin, intrinsic value often emerges as a central topic. But what exactly does intrinsic value mean? Take oil, for example; it is a critical resource for energy, plastics, and other materials, which gives it significant intrinsic value.

Similarly, stocks represent ownership in a company’s production or services, thus also possessing intrinsic value. Many investors conduct fundamental analysis to assess an asset's intrinsic value. However, fiat currency itself lacks intrinsic value; after all, it is merely a piece of paper. As we know, its value derives from public trust.

In traditional financial systems, there are many investment options with intrinsic value, such as commodities and stocks. The foreign exchange market is an exception, as trading primarily revolves around fiat currencies, with traders typically profiting from short-term fluctuations in exchange rates. So, how is Bitcoin's value formed?

Why is Bitcoin Valuable?

The value of Bitcoin is a highly subjective topic. Some believe that Bitcoin's market price is equivalent to its intrinsic value, but this perspective does not truly answer our question. What is crucial is identifying the factors that initially led people to perceive Bitcoin as valuable. Let’s delve into the characteristics that confer value to Bitcoin.

The Utility Value of Bitcoin

One of Bitcoin's significant advantages is its ability to transfer large amounts of value globally and quickly, without relying on any intermediaries. Although the fees for small Bitcoin transactions can be relatively high, transferring millions of dollars can be quite economical. For instance, a transfer valued at approximately $45 million incurred a fee of less than $50 (as of June 2021).

While many networks offer such utility, Bitcoin is one of the largest, most secure, and most popular networks. Through the Lightning Network, a Layer 2 application, small transactions become feasible. In reality, regardless of the amount, the convenience of cross-border transactions is the true embodiment of Bitcoin's value.

The Decentralized Value of Bitcoin

Decentralization is a crucial characteristic of cryptocurrencies. By avoiding oversight from central authorities, the blockchain provides users with greater autonomy. Bitcoin’s open-source nature allows anyone to contribute to the improvement of its network, including its monetary policy, which is also conducted in a decentralized manner.

For example, miners are tasked with verifying and validating transactions while ensuring that new bitcoins are introduced into the system at a predictable and stable rate. Decentralization enables Bitcoin to function as a robust and reliable system. No single node in the network can make decisions based on personal will; transaction validation and protocol updates require collective consensus, preventing mismanagement or abuse.

The Distributed Value of Bitcoin

The Bitcoin network allows as many users as possible to participate, thereby continuously enhancing overall security. The more nodes that connect to the Bitcoin distributed network, the higher its overall value. Transaction records are distributed among different users, eliminating reliance on a single source of information.

Without this distribution, it would be challenging to verify different versions of information. For instance, imagine a team sending a document via email. As the document is passed among team members, multiple versions may arise, making it difficult to track the original.

Moreover, distributed databases are generally less susceptible to network attacks and power outages compared to centralized databases. Server failures can often disrupt credit card usage. In contrast, a system like Bitcoin relies on thousands of users worldwide to maintain its integrity, making it evidently more secure and efficient.

The Trust Framework Value of Bitcoin

Decentralization is one of Bitcoin's significant advantages, but this does not mean that security should be overlooked. Facilitating collaboration among users in a large decentralized network is never a simple task. To address the challenge known as the "Byzantine Generals Problem," Satoshi Nakamoto introduced the proof-of-work consensus mechanism, rewarding those who actively participate.

Trust is a crucial component for any valuable item or commodity. If the public loses faith in a central bank, the national currency can suffer severe consequences. Similarly, when making international remittances, we must trust the financial institutions involved. Compared to other commonly used systems and assets, people generally have a higher level of trust in how Bitcoin operates.

However, Bitcoin users do not need to trust one another; they only need to trust the technology behind Bitcoin. This verified technology is reliable and secure, with its source code open to all. The proof-of-work mechanism serves as a transparent system that allows anyone to conduct self-verification. This clearly demonstrates that Bitcoin's value lies in its ability to generate consensus almost flawlessly.

The Scarcity Value of Bitcoin

The supply of Bitcoin is capped at 21 million coins. When Bitcoin miners mine the last coin around the year 2140, no new bitcoins will be created. While traditional commodities such as gold, silver, and oil also have limited supplies, new reserves can still be discovered each year, making their scarcity difficult to quantify accurately.

Theoretically, once all bitcoins are mined, deflation could occur. The loss or destruction of users would reduce the supply, potentially driving prices up. Therefore, holders firmly believe in the scarcity value of Bitcoin.

Bitcoin's scarcity has also given rise to a popular stock-to-flow ratio model. This model analyzes the annual mining output relative to the total stock, attempting to predict Bitcoin's future value. Backtesting has shown that this model can accurately simulate past price movements. According to the model analysis, Bitcoin's scarcity is a primary driver of its price. Understanding the relationship between price and scarcity leads holders to recognize Bitcoin's potential as a store of value, a concept we will discuss further at the end of this article.

The Security Value of Bitcoin

In terms of protecting investment funds, Bitcoin's security significantly outperforms other options. With proper handling, funds can be absolutely secure. In developed countries, banks are expected to ensure the safety of funds, yet many believe that financial institutions fail to provide adequate protection, making it risky to hold large amounts of cash.

If malicious actors attempt to launch an attack on the Bitcoin network, they would need to control over 51% of the mining power, a feat that is nearly impossible to achieve at that scale. Even if an attack were initiated, it would not last long, and the chances of success are minimal.

The real threats to Bitcoin savings primarily include:

Fraud and phishing attacks

Loss of private keys

Storing Bitcoin in compromised custodial wallets without private keys

As long as best practices are followed to prevent these scenarios, Bitcoin's security will far exceed that of traditional banks. Additionally, cryptocurrency security measures incur no fees. Unlike banks, cryptocurrency transfers do not have daily or monthly limits, allowing users complete control over their Bitcoin funds.

Bitcoin as a Store of Value

The aforementioned characteristics demonstrate that Bitcoin is an ideal choice for storing value. As a modern alternative to traditional stores of value like precious metals, U.S. dollars, and government bonds, Bitcoin is increasingly recognized and referred to as "digital gold." A quality store of value should possess the following advantages:

Durability: As long as computers maintain the network, Bitcoin can exist indefinitely. Unlike paper currency, Bitcoin is not subject to physical degradation, making it more durable than fiat money and precious metals.

Portability: As a digital currency, Bitcoin's portability is evident. Users can access Bitcoin assets anytime and anywhere, as long as they have an internet connection and hold their private keys.

Divisibility: Each Bitcoin can be divided into 100 million satoshis, allowing users to conduct transactions of any size.

Interchangeability: Each Bitcoin or satoshi can be exchanged for like assets, making cryptocurrencies a medium for global value exchange.

Scarcity: With a capped supply of 21 million bitcoins and millions already permanently lost, Bitcoin's supply is far lower than that of inflationary fiat currencies, which increase over time.

Acceptability: An increasing number of individuals and companies accept Bitcoin as a payment method, and blockchain technology continues to evolve.

Conclusion

Unfortunately, there is still no straightforward answer to why Bitcoin has value. Compared to precious metals and fiat currencies, cryptocurrencies also possess key attributes of valuable assets but cannot easily be categorized alongside them. Bitcoin operates without government backing, yet as a digital currency, it exhibits the scarcity of a commodity.

A minority of individuals lacking common sense and harboring biases question Bitcoin's value, even labeling it as a "scam" or "Ponzi scheme," which is clearly driven by unfounded panic. In summary, Bitcoin operates within a highly secure network, and the community, investors, and traders collectively confer significant value upon it.

Risk Warning

While the cryptocurrency market offers significant growth potential and innovation opportunities, it also carries a high level of market risk and price volatility. The value of crypto assets can fluctuate dramatically in a short period, potentially leading to substantial financial losses for investors. Additionally, the cryptocurrency market faces multiple risk factors, including technical risks, legal and regulatory uncertainties, cybersecurity threats, and market manipulation. We strongly advise users to conduct thorough research and due diligence before making any investment decisions and to consult professional financial advisors. All investment decisions are made at the user’s own risk. Thank you for your trust and support of Venkate!

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