What Gives Bitcoin Its Value
Many people wonder what gives Bitcoin its value. The first question many people ask is whether
Bitcoin is backed by anything. The answer: Bitcoin is backed by its code as well as its utility—that
is, what it can do. If Bitcoin stops being useful, it will lose its value.
People will often argue that Bitcoin’s value comes from what people think it is worth. This statement can be made about anything, yet it is not quite accurate. You may be willing to pay a dollar for a bottle of Aquafina, or two dollars, depending on what you perceive that bottle of water to be worth. So yes, our perception of a thing’s value does have a direct effect on that value. But if Aquafina started putting out water that was unfiltered and partially filled with mud, it would be less refreshing and people would not be willing to pay as much because it wouldn’t be as useful.
The utility of Bitcoin is the foundation on which everything else is built. Without this utility, everything else falls apart. All the speculative day trading is just noise. Its scarcity is a big factor but ultimately that also goes back to utility. Bitcoin has a hard cap on the number of coins that will be created. There will only ever be 21 million bitcoins in existence. New bitcoins are created when miners solve a new block and are rewarded for their trouble through a combination of new coins and the miner fee. (You “solve a new block” when your computer—or more often, dedicated mining software—figures out the complex mathematical problems that confirm the accounts sending bitcoin shave the bitcoins to send and have digitally signed their transactions. Each block currently has 750KB to 1MB worth of transactions.) Roughly every four years, the number of new coins created per block will be cut in half, until 21 million are eventually created—and at that point, miners will have to sustain themselves entirely on fees. This is forecast to occur sometime in the next century. Knowing the parameters of Bitcoin in advance makes Bitcoin more useful as a speculative investment and as a
currency.
When proponents of the gold standard make their pitch, they often point out that gold has utility. A dollar is simply a piece of paper. Gold, they argue, holds real value as a commodity, as a valuable mineral for electronics, and—as it has been for thousands of years—as an attractive material for jewelry. Yet even a commodity-backed currency is dependent on the word of the issuing body. Although gold and other precious materials will likely always hold some value, if every government office shuts down, a piece of paper that says it is worth an ounce of gold is still just a piece of paper. If you are living in the United States, the thought of the government disappearing overnight might not seem like a realistic fear, but for citizens of third world countries, or even traditional first world countries with economic problems, such as Greece, that fear is a bit more palpable.
Bitcoin gets its value from what it can accomplish without any issuing body. This is different from saying that is where it gets its price. Bitcoin’s price is influenced by a lot of things: adoption, speculation, and value all make up major pieces of the equation. But its actual value comes from its utility. In a theoretical world where speculation doesn’t affect the price of Bitcoin, the price of one bitcoin would be whatever it is because of its value and scarcity, and that value is made up entirely of its utility. Furthermore, without that value, everything else would collapse like a house of cards. What that utility is, is still being developed. Bitcoin already has many uses and I will cover them in a later chapter, but let me briefly run through some of the more obvious ones. First, Bitcoin can be sent anywhere in the world for an extremely small fee—generally around $0.02—opening up huge opportunities for remittance.
Bitcoin and other technologies based on blockchains are also programmable, giving them utilities
that haven’t even been thought of yet. For example, people have been able to use Bitcoin to invest in
securities, stocks, valuable materials, and even other currencies from around the world, without the
fees and high cost of entry typical of traditional methods for investment in those areas.
For the economically paranoid, Bitcoin also offers a store of value outside the direct influence of governmental organizations as well as offering the possibility of anonymity for embarrassing or illegal services. From a merchant perspective, Bitcoin also has the advantage of not having large fees from credit card companies that cut into their profits. Credit card companies typically charge between three to four percent for each transaction, a fee the merchant normally takes on themselves.
For merchants with small profit margins, that fee could eat up half or more of their profits for each credit or debit
card transaction. As noted earlier, Bitcoin, by contrast, has a miner fee of around $0.02 and could
therefore greatly increase merchants’ profit margins.
Early in the life of the Internet, many pioneers envisioned an economy run entirely online. In the
early 1990s, author Bill Eager was writing books about marketing on the Internet before marketing on
the Internet was something most companies spent much time thinking about. At the time, buying
something online, particularly physical goods, wasn’t just rare. For most items, it was impossible.
In 1994, Eager made a striking prediction. In his book The Information Superhighway Illustrated,
he wrote, “Online shopping is a $200 million business that has the potential to increase to $4.8
billion annually by 1998.”1
As it turns out, Eager’s prediction was too conservative. The year 1998 ended up being a pivotal
one for online shopping as it transitioned from technology-minded consumers to mainstream
consumers. According to a report by the Boston Consulting Group released in December 1998, online
shopping generated $4.4 billion in the first six months of the year alone. That number was expected to
jump to more than $13 billion by the time the year was out and holiday shopping was factored in.
The late 1990s and early 2000s are remembered as the era when the dot-com bubble finally popped. But that wasn’t the case for online retail shopping, which continued to grow every year. There was a lot of blood in the water as traditional retail businesses came online and challenged the web-only sites for market share, but total spending grew and continues to grow today at a rate that would have been unfathomable to most of us just 20 years earlier. By 1999, online spending had doubled to $27 billion and grew again to $45 billion in 2000.2 By 2013, business-to-consumer online
retail sales accounted for $803.76 billion in total revenue, a figure that is doubled when you account
for online business-to-business transactions.3
The early visions of an Internet economy have been fulfilled. We buy everything from clothes to music to cars, even our pets, online. Buying something online is no longer a novelty; it is expected. People who haven’t bought anything online are an increasingly rare breed—even a sizable portion of the elderly have purchased something online.4
Many of the early Internet pioneers envisioned an Internet with its own currency. “The Internet is global,” they argued. For a global, instant, and digital economy to run correctly, we need a global, instant, and digital currency to go along with it. If Bitcoin doesn’t evolve any further, it will still be all of these things. It already is a global currency that is instant and, like the Internet, open for use by nearly everyone. Early Internet pioneers did not talk about the speculative possibilities that the Bitcoin ecosystem is so obsessed with today. That unfortunate aspect of the Bitcoin culture only arose after the wild price swings.
Kevin Kelly, the first executive editor of Wired magazine, predicted the development of an electronic money system and the effect it would have on our world in his 1994 book Out of Control: The New Biology of Machines, Social Systems and the Economic World. Kelly wrote: By its decentralized, distributed nature, encrypted emoney has the same potential for
transforming economic structure as personal computers did for overhauling management and communication structure. Most importantly, the privacy/security innovations needed for emoney are instrumental in developing the next level of adaptive complexity in an information-based society. I’d go so far as to say that truly digital money—or, more accurately, the economic mechanics needed for truly digital cash—will rewire the nature of
our economy, communications, and knowledge.5
Although predictions related to how much time and money we would spend online were fulfilled, the Internet never got its own currency. There were attempts but the centralized nature of the currency issuer always made emoney incompatible with the decentralized nature of the Internet. Somecurrencies failed because the company issuing them merely acted as money transactors themselves, adding an unnecessary middleman instead of eliminating one. Others failed because the issuer abused their power and scammed those who had bought in. Yet others ran afoul of government regulations.6 These issues are avoided with decentralization. When Satoshi Nakamoto invented the blockchain by combining the distributed ledger and proof-ofwork concepts, he fulfilled the long-held vision of a workable, distributed, decentralized currency for the Internet. With it, anyone can transfer virtually any amount for a few cents or less.
The blockchain tracks every transaction and its distributed nature ensures that no government agency can shut it down.
The details of how this works will be covered in another chapter but the first use case of Bitcoin and the blockchain is the ability to transfer value on the Internet as easily as sending an email and almost as cheaply. More uses for the blockchain are being developed every day but this is the most obvious. Many experts have called money transfer the first “application” of the blockchain; however, even that one application has near-endless uses. Using the QR code found in the front of this book, any reader with a Bitcoin wallet can send bitcoins to me, the author. No banking institution needs to approve it; it doesn’t matter where you are or when you are reading this. If I still have access to the wallet, I can receive the money. In fact, regardless of whether I have access to that wallet, any user can send money to that address at any time for as long as the Bitcoin blockchain is in existence.
This might not sound impressive. After all, banks can transfer money. The banks will take their cuts but there are ways people can send money digitally using the legacy system. However, the difference between having to ask for permission and not having to ask for permission is not a small one. Using Bitcoin, any user can send any amount of money to any business or any individual in the world with a Bitcoin wallet, without restrictions. If someone in Russia wants to launch a crowdfunding project, he or she has to find a service that can deposit money into a Russian bank account and then move it to a crowdfunding site that will either deny or approve his or her project. Then that site will take its own cut simply for connectinginvestors and inventors. Bitcoin can cut out those middlemen. Using Bitcoin, people can send
someone money without asking for permission from anyone.
This is also a freedom issue. Centralized and legacy systems have the ability to prevent users from sending money to certain entities. At the height of the controversy over a leaked video showing American helicopter pilots joking while shooting people who seemed to be civilians, for instance, whistleblower site Wikileaks lost PayPal and credit card support.7 Although there might not be any legal basis for this type of ban, individual companies can decide to prevent individual people from sending money to support causes.