Why do Bitcoins have Value?

Bitcoin has exhibited the characteristics of a bubble with drastic price run-ups and a craze of media attention. Like any asset or thing of value, the price that people are willing to pay for Bitcoins is a socially agreed upon level that is also based on supply and demand. This is because relatively few transactions are conducted in Bitcoins and very few things are denominated in Bitcoins. Thus, it is impossible to say at any given moment whether Bitcoins are fairly valued without the benefit of hindsight. Even today, some currencies are “representative,” meaning that each coin or note can be directly exchanged for a specified amount of a commodity. One can argue that Bitcoin’s value is similar to that of precious metals. The value of fiat currencies is a function of their demand and supply. Most fiat currencies can only be divided into two decimal places for everyday use. One bitcoin can be divided into up to eight decimal places, with constituent units called satoshis. Currency is useful if it works as a store of value or, to put it differently, if it can reliably maintain its relative value over time. These qualities allow a currency to find widespread use in an economy.

Bitcoin does not have the backing of government authorities, nor does it have a system of intermediary banks to propagate its use. There is no fiat authority in the form of a government or other monetary authority to act as a counterparty to risk and make lenders whole, so to speak if a transaction goes awry. Fiat currency is issued by a government and not backed by any commodity, but rather by the faith that individuals and governments have that others will accept that currency. Bitcoin (BTCUSD) is often referred to as digital currency and an alternative to central bank-controlled fiat money. Here’s an example. During the financial crisis, Ben Bernanke, who was then the governor of the Federal Reserve, appeared on CBS’ 60 Minutes and explained how the agency “rescued” insurance giant American International Group (AIG) and other financial institutions from bankruptcy by lending money to them. By controlling a majority of all network power, this group could dominate the remainder of the network to falsify records. Bitcoin’s network is decentralized, and the cryptocurrency is not used much in retail transactions. A decentralized network consisting of independent nodes is responsible for approving consensus-based transactions in the Bitcoin network.

If Bitcoin’s price continues to rise over time, users with a tiny fraction of a Bitcoin will still be able to make transactions with the cryptocurrency. Precious metals like gold are used in industrial applications, while Bitcoin’s underlying technology, the blockchain, has some applications across the financial services industries. While Bitcoin has several money-like features, economists and regulators remain unconvinced that Bitcoin currently acts as money. The digital evolution of money has moved away from physical attributes and towards more functional characteristics. There are six key attributes to a useful currency: scarcity, divisibility, acceptability, portability, durability, and resistance to counterfeiting (uniformity). Cryptocurrency does display some attributes of a fiat currency system, however. Gold was useful as currency due to its inherent physical attributes, but it was also cumbersome. After countries abandoned the gold standard in an effort to curb concerns about gold supplies, many global currencies are now classified as fiat. For a long time, the value of paper money was determined by the amount of gold backing it. Throughout history, many societies used commodities and precious metals as methods of payment because they were considered to have a relatively stable value. Why Does Bitcoin Have Value?

The development of side channels, such as the Lightning Network, may further boost the value of Bitcoin’s economy. If the price of one bitcoin were to reach $514,000, Bitcoin’s market capitalization would reach approximately 15% of the global currency market. Bitcoin’s utility as a store of value depends on how well it works as a medium of exchange. If Bitcoin does not achieve success as a medium of exchange, it will not be useful as a store of value. The predominant medium of exchange is government-backed money, and for our model, we will focus solely on that. Monetarists try to value Bitcoin as they would money, using the supply of money, its velocity, and the value of goods produced in an economy. However, such an attack on Bitcoin would require an overwhelming amount of effort, money, and computing power, thereby rendering the possibility extremely unlikely. However, the latter is valuable because it is issued by a monetary authority, backed by a government, and widely used in an economy.

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