What Gives Digital Currency its Value?

12 Jun 2018
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On May 22, 2010, on a popular online forum called BitcoinTalk, a developer named Laszlo Hanyecz posted that he was hungry and craving pizza.

He offered to send someone from the forum 10,000 Bitcoin in exchange for the delivery of two pizzas from Papa John’s, ordered and paid for with a credit card.

The total purchase was valued at around $30, marking what the industry has deemed to be the first ever real-world Bitcoin transaction.

Times have changed. At the time of writing, 10,000 Bitcoins are worth around $90 million USD (roughly $9,000 per Bitcoin). Hanyecz could certainly afford more than two pizzas with that amount of Bitcoin in today’s market.

Bitcoin’s market cap is nearly $120 billion, with the entire digital currency market worth upwards of $400 billion. That is over $400 billion in monetary value that simply didn’t exist ten years ago.

By the time you’re done reading this article, those numbers might have fluctuated, but it doesn’t change the fact that Bitcoin has firmly established itself as a valuable, real-world resource.

In this article we’ll explain why digital currencies have value and why, despite fluctuations, they will likely hold as a store of value in the future.

What gives digital currency value?

In classical economic theory, intrinsic value is based on two things: scarcity and utility. People associate value with things they want, often affording opportunities or status. Gold, oil, diamonds, and dollars all have intrinsic value due to scarcity, whether real or artificially imposed (as is the case with diamonds). The exception is fiat currency, such as the U.S. dollar or euro, which are backed by government trust. The era of the Gold Standard has come and gone, making the future scarcity of fiat currency somewhat unpredictable.

Bitcoin by nature is neither tangible nor government-backed, and these have been two common criticisms leveled against the value of Bitcoin.

However, most people don’t realize that most paper or fiat currencies today suffer the same weaknesses. Most currencies used by banks and backed by governments aren’t tangible, either. In most cases, money is a matter of numbers in a database. If every citizen in the world went to their bank and asked for a cash withdrawal totaling the amount of money in their account, there wouldn’t be enough notes and coins to go around.

With the U.S. and most other countries having abandoned policies like the Gold Standard years ago, fiat currencies are backed by little more than a promise.

As NASDAQ explains, the general concept of currency has seen a shift from one system to another over the years. From gold and silver to paper notes to digital credit card transactions and digital currencies, the idea of currency is fluid and constantly evolving. NASDAQ explains that Bitcoin is not a “patch” to our current notions of monetary value, but rather “another layer of abstraction added on top of an aging and over-complex system.”

Since “tangible” monetary assets have gone by the wayside, Bitcoin and other digital currencies may very well be evolutionary steps in how we view (and contend with) supply and demand. Bitcoin gains value from end-user demand and frequency of transactions. While Bitcoin may not be tangible, its scarcity is guaranteed and capped at a maximum of 21 million Bitcoins on the network, due to the way the underlying algorithm is coded. That scarcity helps bolster Bitcoin against threats, like inflation, that fiat currencies invariably contend with.

Digital currency isn’t government-backed

A common argument against Bitcoin and other digital currencies is that they’re not government-backed. There’s no “insurance policy” for value lost in, for example, a market crash, and there are no regulators to step in to fix things when things go wrong. However, the decentralized nature of digital currencies precludes the ability of any centralized body (governmental or otherwise) from falsely manipulating, inflating, or regulating value. Middlemen are removed from the equation. Because the Bitcoin network exists within the Bitcoin community, and all members who involve themselves with the currency are independent, Bitcoin is immune from government intervention and manipulation, which is actually a good thing. 

The absence of government backing and control is one of the key traits that offers value to many digital currency users. In politically unstable countries like Brazil, where people are terrified of wealth confiscation in light of a burgeoning public deficit, exchanging fiat for digital currency offers peace of mind. Bitcoin’s value is simply out of the reach of corrupt politicians and bureaucrats.

The bottom line is that people value Bitcoin and other digital currencies primarily because their scarcity is guaranteed and they are safe from manipulation by the likes of government. As the blockchain ecosystem grows, so does the utility of Bitcoin. Now more than ever, people are willing to trade goods, services, and even fiat money to attain digital currencies.