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A Guide to Cryptocurrency (e.g.Bitcoin)

One of the biggest struggles for newcomers to crypto is grasping how and why a cryptocurrency like Bitcoin (BTC) can have value. The coin is digital, has no physical asset backing it up, and the concept of mining can be very confusing. In a sense, mining creates new bitcoins out of thin air. In practice, though, successful mining requires a very costly investment. But how can all of this make BTC valuable?

Think about the money we all use daily. There’s no longer gold or assets backing up our banknotes. Money that we borrow often exists only as numbers on a screen, thanks to fractional reserve banking. Governments and central banks like the Federal Reserve can create new money and increase its supply through economic mechanisms.

Although there are remarkable differences, BTC, as a digital form of money, shares some similarities with the fiat money we are all used to. So, let’s discuss first the value of fiat money before we dive into the cryptocurrency ecosystem.

Why does money have value?

In short, what gives money value is trust. Essentially, money is a tool used to exchange value. Any object could be used as money, as long as the local community accepts it as payment for goods and services. In the early days of human civilization, we had all kinds of objects being used as money - from rocks to seashells.

What is fiat money?

Fiat money is the one issued and officialized by a government. Today, our society exchanges value through the use of paper notes, coins, and digital numbers on our bank accounts (which also define how much credit or debt we have).

In the past, people could go to the bank to exchange their paper money for gold or other precious metals. Back then, this mechanism ensured that currencies like the U.S. dollar had their value tied to an equivalent amount in gold. However, the gold standard was abandoned by the majority of nations and is no longer the basis of our monetary systems.

After removing a currency's ties to gold, we now use fiat money without any backing. This uncoupling gave governments and central banks more freedom to adopt monetary policies and affect the money supply. Some of the main characteristics of fiat are:

  1. It’s issued by a central authority or government.

  2. It has no inherent value. It’s not backed by gold nor any other commodity.

  3. It has an unlimited potential supply.

Why does fiat have value?

With the removal of the gold standard, we seemingly have a currency without value. Money does, however, still pay for our food, bills, rent, and other items. As we discussed, money derives its value from collective trust. Therefore, a government needs to firmly back and successfully manage a fiat currency to succeed and maintain a high level of trust. It’s easy to see how this breaks down when faith in a government or central bank is lost due to hyperinflation and inefficient monetary policies, as seen in Venezuela and Zimbabwe.

Why does crypto have value?

Cryptocurrencies have some things in common with our standard idea of money, but there are some remarkable differences. Although some crypto like PAXG are pegged to commodities like gold, most cryptocurrencies have no underlying asset. Instead, trust once again plays a significant role in the value of a cryptocurrency. For example, people see value in investing in Bitcoin, knowing that others also trust Bitcoin and accept BTC as a payment system and medium of exchange.

For some cryptocurrencies, utility is also an important factor. To access certain services or platforms, you may need to use a utility token. A service in high demand will therefore provide value to its utility token. Not all cryptocurrencies are the same, so their value really depends on the features of each coin, token, or project.

When it comes to Bitcoin, we can narrow it down to six features that we’ll discuss in more detail later: utility, decentralization, distribution, systems of trust, scarcity, and security.

What is intrinsic value?

A lot of the discussion regarding Bitcoin’s worth is whether it has any intrinsic value. But what does this mean? If we look at a commodity like oil, it has intrinsic value in producing energy, plastics, and other materials.

Stocks also have intrinsic value, as they represent equity in a company producing goods or services. In fact, many investors perform fundamental analysis in an attempt to calculate an asset’s intrinsic value. On the other hand, fiat money has no intrinsic value because it’s just a piece of paper. As we’ve seen, its value derives from trust.

The traditional financial system has many investment options that carry intrinsic value, from commodities to stocks. Forex markets are an exception as they deal with fiat currencies, and traders often profit from short or mid-term exchange rate swings. But what about Bitcoin?

Bitcoin as a store of value

Most of the characteristics already described also make Bitcoin a good fit as a store of value. Precious metals, U.S. dollars, and government bonds are more traditional options, but Bitcoin is gaining a reputation as a modern alternative and digital gold. For something to be a good store of value, it needs:

  1. Durability: So long as there are still computers maintaining the network, Bitcoin is 100% durable. BTC cannot be destroyed like physical cash and is, in fact, more durable than fiat currencies and precious metals.

  2. Portability: As a digital currency, Bitcoin is incredibly portable. All you need is an Internet connection and your private keys to access your BTC holdings from anywhere.

  3. Divisibility: Each BTC is divisible into 100,000,000 satoshis, allowing users to make transactions of all sizes.

  4. Fungibility: Each BTC or satoshi is interchangeable with another. This aspect allows the cryptocurrency to be used as an exchange of value with others globally.

  5. Scarcity: There will only ever be 21,000,000 BTC in existence, and millions are already lost forever. Bitcoin’s supply is much more limited than inflationary fiat currencies, where the supply increases over time.

  6. Acceptability: There's been widespread adoption of BTC as a payment method for individuals and companies, and the blockchain industry just continues to grow every day.

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