Where Does Bitcoin Get Its Value?

In the span of seven years, since the value of bitcoin has been on record, its price has climbed from nothing in 2010 to above $2,000 today. Still, the idea that “bitcoin lacks intrinsic value” persists. The claim comes mostly from people who are new to the cryptocurrency, or those who want to believe gold, silver or fiat currency have some inherent value that bitcoin lacks.

According to Stanford Encyclopedia of Philosophy:

“The intrinsic value of something is said to be the value that that thing has in itself, or for its own sake, or as such, or in its own right.”

It can be argued that bitcoin gets its value from both the protocol that guides its peer-to-peer network and the cryptography that secures the distributed ledger of transactions. In the time it has been in existence, the protocol has never been hacked, and a study of its code shows that hacking it is nearly impossible. Wallets may be hacked and bitcoins can be stolen, but the Bitcoin protocol itself is believed to be secure.

Satoshi Nakamoto, Bitcoin’s creator, suggested taking the cost of mining a bitcoin—in particular the amount of energy mining rigs consume—as its base value. In his words:

In the absence of a market to establish the price [of bitcoin, estimates] based on production cost is a good guess.”

One estimation puts the cost of mining a block at $10,000. Divided by the block reward of 12.5 bitcoins, this calculates the value at $800 per bitcoin.

Digital gold

Looking at it this way gives bitcoin value from the cost of extraction in a manner similar to precious metals such as gold. Thus bitcoin is often called “digital gold.” Furthermore, bitcoin is also scarce—no more than 21 million bitcoin will ever be mined—as well as durable and divisible.

Nevertheless, what makes a currency valuable can be seen as more or less a philosophical question that applies to all currencies—government issued or not. Whether intrinsic value lies in the material substance of the currency itself is open to debate. As David Perry put it in an article on the NASDAQ blog:

“In the end, the only things of real value are those that sustain and defend life.”

What makes gold valuable, for instance, is our experience that if we owned it and wanted something that sustained and defended life, such as food or clothing, someone would be willing to accept it in exchange for those things.

In another article, the BBC explains that humans for thousands of years have used gold as consistent money not because of its usefulness, but because of its qualities. Bitcoin has qualities that make it as valuable as gold, even though it doesn’t physically exist beyond computer code.

In the history of human civilization, countless objects with useful intrinsic value have “sustained and defended life” while also serving as money. For instance, for thousands of years, people in China, Mongolia and Russia used tea bricks as medium of exchange. While the tea bricks were exchanged for goods and services, they could also be consumed as beverage or medicine.

It is debatable, though, whether tea bricks could be considered money, or simply a commodity that people exchanged in barter and trade transactions.

Compared to fiat

Aside from gold, bitcoin is also often compared favorably or unfavorably to fiat currency. In April 2013, Joe Weisenthal—a financial technology writer and the co-host of “What’d You Miss?” on Bloomberg Television—wrote an article explaining why “bitcoin has no intrinsic value” in the way that fiat money does. He wrote:

“Fiat currency has intrinsic value. Bitcoin doesn’t. … Fiat currencies have tremendous intrinsic value because governments say they do. That’s why they’re called fiat currencies. They have value by government fiat.”  

He argued that the U.S. dollar, in particular, derives its intrinsic value from the force that the U.S. army, the FBI, the CIA, the NSA, and other government institutions collectively put behind it. This way of reasoning, however, confuses government legalization of a currency as tender with the value people give currency when they place their trust in it.

In November 2016, Weisenthal hosted ZCash founder Zooko Wilcox on Bloomberg’s Odd Lots podcast. Weisenthal again made the argument that fiat currencies get their intrinsic value from the force of government. Wilcox pointed out, however, that in the end the value of a currency depends on the faith the public has in it even in the face of power. Zooko explained:

“If the people collectively started to value a currency less and less, then eventually even the army and the revenue service will start to value it less and less.”

Consensus

So, where does bitcoin get its value from?

Just like any other currency, legal tender or not, the value of bitcoin comes from the faith and consensus of its users. They feel an amount of certainty that if they have it, someone else will be willing to accept it in exchange for goods or services.

More importantly, in the case of bitcoin, the soundness of the technology on which it runs and in particular the mathematical consensus it achieves, in many ways, inspires a notable confidence and a growing trust of users around the world.

By | 2017-06-07T20:34:47+10:00 June 7th, 2017|Bitcoin, Bitcoin Technology|0 Comments