What underpins the value of Bitcoin?
Unlike fiat currencies, Bitcoin is a decentralised digital currency that is not subject to the control of a government or central bank. Its value is not defined by an entity but is derived from consumer confidence. But what underpins this trust?
Despite the differences, cryptocurrencies such as Bitcoin share some similarities with the traditional fiat currencies we are all used to. Therefore, it is important to understand what gives fiat money its value before analysing why there are a large number of people who see Bitcoin as a store of value.
Long gone is a monetary system in which the value of currencies is underpinned by their convertibility to gold and this week marked 52 years since President Richard Nixon assembled his team at Camp David to announce that he was suspending the dollar’s convertibility to gold. The dollar went from being a currency that based its value on the existence of a gold counterpart, to being a fiat currency, with its value derived from the relationship between supply and demand and the stability of the issuing government.
Thus, governments and central banks can create money to expand their money supply and stimulate spending through economic mechanisms without worrying about having sufficient gold reserves, at least this is the theory. Therefore, although these fiat currencies are not backed by tangible assets, their value is given by the collective confidence in the currencies. On the other hand, the monetary policies of governments and central banks, as well as economic developments, can cause this confidence and the value of the currency to fluctuate.
Decentralisation, security and limited supply
The Bitcoin monetary ecosystem is fully decentralised, i.e. no central authority regulates the monetary base, eliminating the need for intermediaries and giving users more control over their financial transactions. By eliminating central authorities, the creation of currency is democratised, giving more power and freedom to the user community.
The creation of Bitcoins follows detailed rules in a very strict protocol that is based on blockchain. This blockchain technology uses cryptographic algorithms and makes it more secure than physical currencies and highly immune to crises. Moreover, if the user wants to make a transfer or a payment, he has total freedom, neither the bank, VISA, nor Mastercard have to authorise it. These characteristics and the fact that thousands of merchants already accept Bitcoin as payment for goods and services, have given it a helpful value.
On the other hand, since its introduction, a maximum limit of 21 million coins that can be mined was established, which introduced an element of intrinsic scarcity that also contributes to its value, when we consider the relationship between price and scarcity. This is why many people regard Bitcoin as a store of value, despite its volatility. Global regulation of crypto-assets and competition with other digital currencies will shape the future of Bitcoin, but ultimately it will be people’s trust that will ensure, or not, its existence.
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