Why is Bitcoin Valuable?
A lot of people that are not familiar with Bitcoin ask fundamental questions to understand it. A question that comes up a lot is: what makes Bitcoin valuable?
This is because they see the price of Bitcoin going up, but they cannot understand why. They are looking for valid reasons. Especially because Bitcoin is not issued by central banks or governments and is not a standard currency.
Bitcoin as Money
Bitcoin was made to act like money. According to the St. Louis Fed, money needs to fulfil certain criteria. As a result Bitcoin has to fulfil 3 functions and needs to have 6 characteristics.
However with money in the past that is not government backed, people gradually adopt the money. That goes for Bitcoin too so it might not necessarily meet all the criteria right now. Regardless let us see how Bitcoin measures up.
3 Functions of Money
|Function of money||Bitcoin|
|Store of value||✓|
|Unit of account||✘|
|Medium of exchange||✘|
- A Store of value – Bitcoin is transitioning from a collectible to a store of value. Whoever holds Bitcoin might lose some value over the short term. However over the long term the Bitcoin price keeps going up.
- A unit of account – This means that goods and services are priced in a particular currency. Bitcoin is not yet a unit of account. There are isolated cases or areas where Bitcoin is used as a unit of account. However there are not that many globally.
- Medium of exchange – This means that a lot of people will happily accept Bitcoin as a payment. There are more and more merchants accepting Bitcoin as payment. However more need to accept Bitcoin for it to become widely classed as a medium of exchange.
By time Bitcoin is likely to fulfil all of the 3 functions of money. Especially with growing adoption. People are adopting cryptocurrency twice as fast as the internet. Additionally Bitcoin is the most popular cryptocurrency with the highest market cap.
This concept in crypto can be best represented by this chart. Already it is the fastest rate of adoption of any technology in human history (113% per annum vs 63% for the internet).
Sourced from Raoul Pal’s Twitter Account
6 Characteristics of Money
|Function of money||Bitcoin|
- Durable – Bitcoin cannot deteriorate or break. It is not like paper that needs replacing. Or a food which were used as currency like for example salt or cocoa beans. Bitcoin is digital which makes it one of the most durable currencies to date.
- Portable – You can have a Bitcoin wallet app on your phone and make payments with it.
- Divisible -Bitcoin is highly divisible. It has 8 decimal points after the point. This makes it more divisible than fiat.
- Uniform – Each Bitcoin is the same as the other. There is no difference between one digital coin and another.
- Scarce. Bitcoin can only have 21 million coins on its blockchain. It is a finite amount that no one can alter.
- Acceptable – Not everyone accepts Bitcoin as payment. However more merchants are adopting it by time.
From the characteristics point of view Bitcoin is pretty good. On the other hand, fiat currency (US dollar, Euro, British Pound etc.) is not as good. Fiat is not as divisible, durable and as scarce as Bitcoin. So with this information you can already start to see why Bitcoin is valuable.
What is Bitcoin backed by?
I have to address one thing. Some people say ‘Bitcoin is backed by nothing’. Which in a sense is correct. It is not backed one-to-one by gold or anything like that. Additionally it is not backed by any government.
When someone says ‘Bitcoin is backed by nothing’ they want to imply that Bitcoin has no value. However we know that Bitcoin has value. Otherwise the price would not be where it is today. The counter argument to this is that even the US Dollar, Euro, British Pound etc. are not backed by anything.
Fiat money is a type of money that is not backed by any commodity such as gold or silver. It is typically declared by a decree from the government to be legal tender. Sourced from Wikipedia
For this reason all the currencies around the world are classed as fiat currencies. All currencies whether government backed or cryptocurrencies have value because people perceive them to have value.
So What Makes Bitcoin Valuable?
The crux of why Bitcoin has value is because it is an innovation of money. Bitcoin is a superior form of money than fiat money or gold.
Software has innovated all industries over the last couple of decades. However it had not innovated banking. The banking industry has not had any form of innovation for the past few decades. As a result it was only a matter of time before banking was going to get a much needed upgrade.
The internet of money, Bitcoin, is releasing 50 years of pent up innovation in finance. Because it offers innovation without permission.Andreas Antonopoulos
For an innovation to work it has to provide some benefits over what already exists. Otherwise it is not worthwhile. Let us go into detail on what makes Bitcoin valuable.
1. Bitcoin Fixes the Problems in Banking
Cryptographers were trying to make better money. They tried to find a solution to fix the problems in banking for a long time.
Along comes Satoshi Nakamoto and creates and releases Bitcoin in 2008. In the Bitcoin whitepaper Satoshi explains that Bitcoin fixes:
- Double spending: the same money gets spent twice instead of once. It is a form of fraud, whether intentional or unintentional.
- Disputes between merchants and customers: this increases costs for banks, merchants and clients.
- High cost of small transactions
Bitcoin solved 2 of these problems. The only issue left was that the cost for all transactions were high. This is because as more people use the network the fees increase automatically on the network.
Various other cryptocurrencies have tried to address these problems, as you can see in this Ripple vs Bitcoin article.
However developers created the Bitcoin lightning network at a later stage. The lightning network is a second layer development over Bitcoin’s original blockchain. As a result the cost of Bitcoin transactions that use the lightning network has gone down. So Bitcoin has managed to address all the issues.
2. Bitcoin is Scarce and Secure
Unlike fiat money that central banks can print in unlimited amounts, Bitcoin is scarce. There can never be more than 21 million Bitcoins in existence. It is hard coded into the network and no one can ever modify it.
Scarcity for whatever item, whether collectibles or artwork is always a good thing. It is what makes things more valuable. Scarcity is partly what makes Bitcoin valuable.
In fact with money this is especially important because you cannot create inflation. This makes the money more hard. Effectively hard money is a net benefit to society at large.
Inflation is an increase in the quantity of money without a corresponding increase in the demand for money.Ludwig von Mises
Moreover Bitcoin’s network is secure. The larger the network grows the more decentralised and secure it gets. It also does triple entry accounting which is brilliant. This is because as transactions get approved and included in the blockchain they are audited on the spot. The network takes around 10 minutes which is the time it takes to create a new block.
3. Bitcoin Has Economic Incentives
Bitcoin coins come into existence when you mine the Bitcoin blockchain. Similarly to gold mining, but with computers instead. Additionally since it is scarce it gives people economic incentives to mine Bitcoin. Once they mine Bitcoin they can sell it and get a return on investment.
If Bitcoin had unlimited supply and the coins were already available on the network it would not have value. It would be as if you picked up a pebble from a beach. Pebbles do not have value because there are many. The best forms of money in the past whether cocoa beans, rai stones or gold had scarcity.
Additionally people will always pick the better form of money. So other forms of money that are inferior will end up phased out. There is an argument that bitcoin will flippen gold. Satoshi created the best economic incentives for Bitcoin to thrive. This is another reason for what makes Bitcoin valuable.
In fact Bitcoin keeps growing in value because it is superior money. True it is volatile. That is, it goes up and down by large amounts, but over time it has increased in value.
Bitcoin Game Theory
Game theory is in play with Bitcoin. Essentially game theory studies strategic decision making.
In essence Bitcoin adoption is like a game like for example chess. You want to you win and to do that you have to defeat your opponent. As a result while you are playing you have to see how you are going to get ahead. Additionally you have to anticipate what your opponent is going to do to try to defeat you. The moves you both make are dependent on the other.
The same thing applies to money. People want to get ahead financially. To do that they have to outmanoeuvre everyone else and that means accumulating as much money as possible.
Since Bitcoin has great economic incentives people start accumulating coins. Additionally since it is scarce the value goes up. As a result it is a net benefit for Bitcoin holders. Other people see the Bitcoin price going up and they want in too.
This starts a cycle where more and more people get involved in Bitcoin. Here is how it is playing out:
Source BTC Sessions Twitter
As time goes by you will notice a new company or country adopting Bitcoin in some form. Either including Bitcoin in treasuries, adopting it as legal tender or enabling Bitcoin payments. Or perhaps adopting it in some other way. Moreover the portion of new Bitcoin wallets will also increase with the amount of people adopting Bitcoin.
The announcements and data will start pouring in more and more frequently.
Other Reasons That Make Bitcoin Valuable
Anyone can take part in the Bitcoin network. Whether to mine or approve transactions. In other words it is very different from banking. Our banking system is centralised and a small group of made up of banks control the system.
However with Bitcoin all you need is an internet connection to participate. Additionally you can help the network and get rewarded for it. There are no third parties and it is all peer-to-peer and decentralised. It makes Bitcoin very democratic in that sense.
Banking the Unbanked
Worldwide there are many hundreds of millions of people that do not have a bank account. To clarify there are several reason why some people are unbanked. One problem is that having a bank account costs money. So when you have little money, the fees can add up and eat away at your savings.
Another problem is that some people do not have government issued IDs or documentation. As a result they cannot open a bank account. However with Bitcoin you do not need documentation. You can just download a wallet, buy or receive Bitcoin and make payments from your mobile.
Banking the unbanked with Bitcoin will create a hot bed for more economic activity. It is another important factor on what makes Bitcoin valuable. That is to say, this is exactly what is happening in Africa.
“Africa is leading the way for global Bitcoin adoption… the Western narrative paints a negative picture of Africa… But their role in this financial revolution tells a different story. We are seeing an unrivalled explosion of wealth, technological advancement and ingenuity that speaks volumes.”Bitcoin Magazine
If we get even a portion of the unbaked to use Bitcoin is a net benefit for Bitcoin. Likewise it will benefit people that are already using Bitcoin. This is because it gives value to the network and increases the demand of Bitcoin. As a result the value of Bitcoin goes up because of the basic principle of supply and demand.
Why is Bitcoin worth so much?
Bitcoin is valuable, but there are several factors why Bitcoin is worth so much. Here are the factors that affect Bitcoin’s price:
- The available supply of Bitcoin
- Market demand
- Mining costs
- Global news
Supply and Demand
Just because there are x amount of Bitcoins that people own, it does not mean they want to sell. A lot of people tend to hold (slang: hodl) Bitcoin. As a result there is a small pool of Bitcoin that gets traded. Sometimes it increases and other times it decreases.
Supply and demand are interlinked. The less supply and the more demand will increase the price. If there is more supply and less demand the price will decrease.
Mining costs are also a really important factor of the Bitcoin price. Firstly gone are the days when you could mine with a simple a standard computer. Today to make a profit a miner has to buy ASIC miners which are expensive. Some are tens of thousands to buy.
Additionally you have to factor in the cost of electricity to run the miner, cool it and maintain it.
The miner has to make a profit. Since costs are high the Bitcoin price needs to reflect the cost of production. You can get an idea of the cost of mining here in how to make crypto mining profitable.
Bitcoin at times is sensitive to any Bitcoin related economic news. Whether a country or company is buying Bitcoin for its treasury or adopting it in some other form. Or whether companies are including it as a method of payment. All these factors add up to help Bitcoin go up in price.
Additionally if geopolitical tensions are high, Bitcoin could act like a safe haven asset like gold. In fact we cover this in the article Bitcoin, gold and nuclear war.
Frequently Asked Questions
What makes Bitcoin valuable?
What is Bitcoin backed by?
Why is Bitcoin worth so much?
1. The available supply of Bitcoin
2. Market demand
3. Mining costs
4. Global news