To understand why cryptocurrencies like Bitcoin have value, we have to understand why we need money and how money has evolved over time.
Why We Need Money
Money serves as a common form of payment. We need a common form of payment, or a common medium of exchange, because it’s much more efficient to value a good or service using money than to barter your goods and services for another person’s goods and services.
Imagine you are a hat maker living in a barter-based economy. You would need to keep track of the current value of any number of goods and services – such as apples, loaves of bread, or pairs of shoes – that your potential customers may want to exchange with you for a hat. To further complicate things – what if a customer doesn’t have something you want? Do you take what they have and try to barter with someone else, or do you turn the customer away?
Having a common form of payment greatly simplifies how we assign value and trade with each other, making the economy more efficient for us all.
A Very Brief History of Money
Over the years, humans have used a variety of things as money. Ancient civilizations used commodities – things that have value besides being used as money – such as salt, cattle, or gold bars. Though commodities were backed by their usefulness, they could be difficult to carry around, or to divide up for the purchase of smaller items.
Coins made money more portable and divisible, and for many years coins were created from precious metals and stamped by an authority that guaranteed there was a standardized amount of gold, silver, or other valuable material in each coin. Though authorities sometimes re-minted their coins, lowering the amount of precious materials in the coin – and the coin’s value.
Later, large and small financial institutions around the world began issuing paper money. This system was called representative money, as each bill represented a deposit of coins or precious metals that could be claimed by whoever owned the bill. Over time, national banks became the only institutions that could legally issue paper money.
After World War II, when a number of economies were in a shambles, delegates from around the world met and formed the Bretton Woods system (named for where the agreement took place). In it, a deal was made to tie several international currencies to gold and the US Dollar, which resulted in a number of nations keeping dollars in their reserves in addition to gold.
The Bretton Woods system experienced varied success until 1971, when US President Nixon declared that US dollars would no longer be convertible to gold. Since Nixon’s announcement, currencies around the world have become fiat currencies – currencies that are no longer backed by anything of value, but are deemed legal tender by a government.
As a result, the currencies we use today, such as the dollar, pound, yen, and euro, are only valuable because we believe they are valuable; because we believe the currency will continue to represent value and that another person will accept that currency in the future as payment.
Enter Bitcoin (& Cryptocurrencies)
In a few ways, Bitcoin is much like our sovereign (government-issued) fiat currencies – it is valuable because its users believe it is valuable; they believe another person will accept it for payment in the future.
In addition, Bitcoin and our sovereign currencies are both digital. Just as there are no physical bitcoins to send around the world, your bank does not hold paper money to cover every dollar of deposits, nor do they send physical dollars when you make a debit card payment. It is merely an exchange of 1s and 0s, an adjustment that lowers your account balance and increases someone else’s.
Still, Bitcoin differs from sovereign currencies in key ways that many see as advantageous.
Bitcoin is a worldwide, decentralized network that isn’t controlled by any one person, bank, or government. It’s maintained by its users and controlled by computer code that always runs as designed.
This means no one can manipulate the supply of Bitcoin. We know exactly how many Bitcoins have been created, how many will be created, and when they will be created.
On the other hand, national banks have the ability to print more money as needed, which can severely devalue a national currency. The US Federal Reserve printed billions of dollars through its “quantitative easing” policy following the recession, and developing nations around the world have experienced hyperinflation. Venezuela’s current year on year inflation rate is around 14,000%!
Bitcoin eliminates the need for intermediaries. You can have direct control of your money without having to entrust it to a bank, and you can send money directly from one person to another without having to trust any other party to complete the transaction – because the network is designed to be trustless.
Bitcoin is global and fast. There are no extra transaction fees, exchange fees, or delays when sending money internationally – no matter where you or the recipient is located.
The Bitcoin network does not have a single point of failure. If a government fails, what happens to its money? If a bank fails, are customers guaranteed any type of bailout?
With Bitcoin, your money cannot be lent out, devalued, or held without your permission, and your transaction records are backed up thousands of times all around the world. So as long as you have access to the internet, you can access your money – there is simply no way to shut down the Bitcoin network without shutting down the entire internet.
Beyond Bitcoin – Crypto Commodities
Not all cryptoassets are true currencies, like Bitcoin. There are a number of cryptoassets that are better classified as commodities – meaning they have inherent value besides being used as a form of payment.
For example, ether (the native token of the Ethereum network) is a resource that acts as a “gas” of sorts, and it is needed to use decentralized applications that run on the Ethereum network. So ether can be used as a form of payment, or it can be used to access applications on the network; and as with gold or silver, the long-term price of ether will largely depend on market demand and valuation of the underlying commodity.
Ethereum is only one network of many that uses such a “gas”, but there are many other types of crypto commodities, such as those that represent rights to storage space, computing power, or bandwidth on a network.
We can’t know what the future of Bitcoin or our national currencies will be. But we do know that our national currencies only have value because governments say these currencies can be used as money – and people believe them. And we can reasonably predict, based on history of both the developed and developing worlds, that a number of national currencies will be subject to manipulation or loss of value in the coming years.
The future of Bitcoin is promising; more and more people are beginning to believe in Bitcoin’s value. Not because a government or bank has told them to, but because they see the benefits it can provide – if nothing else as a hedge against the unpredictable future of their own national currencies.