Bitcoin (BTCUSD) is often referred to as a digital currency and as an alternative to central bank-controlled fiat money. However, the latter is valuable because it is issued by a monetary authority and is widely used in an economy. The network is decentralized, and cryptocurrency is not widely used in retail transactions.
It can be objected that the value is similar to that of precious metals. Both are in limited quantities and have selected use cases. Precious metals such as gold are used in industrial applications, while the underlying technology, blockchain, has some applications in the financial services sectors. The digital provenance of this currency means that one day it could also serve as a medium for retail transactions. The value of digital currencies
Any discussion of the value of Bitcoin must address the nature of the currency. Gold was useful as a currency because of its inherent physical attributes, but it was also cumbersome. Paper money has been an improvement, but it requires production and storage and lacks the mobility of digital currencies. The digital evolution of money has moved away from physical attributes and towards more functional characteristics. Why choose Bitcoin?
Bitcoin does not have the support of government authorities, as Biden’s regulatory approach to the matter demonstrates, nor does it have a system of intermediary banks to propagate its use. A decentralized network composed of independent nodes is responsible for approving consensus-based transactions in the Bitcoin network. There is no legal authority in the form of a government or other monetary authority to act as a counterparty to risk and make the lenders entire, so to speak, if a transaction goes wrong.
However, cryptocurrency shows some attributes of a fiat currency system. It is rare and cannot be counterfeited. The only way you would be able to create a counterfeit Bitcoin would be to perform what is known as double-spending. This refers to a situation where a user “spends” or transfers the same Bitcoin in two or more separate settings, effectively creating a duplicate record.
What makes double spending unlikely, however, is the size of the Bitcoin network. A so-called 51% attack would be needed, in which a group of miners theoretically controls more than half of all network power. By controlling most of all the power in the network, this group could dominate the rest of the network to falsify records. However, such an attack on Bitcoin would require an overwhelming amount of effort, money, and computing power, thus making the possibility extremely unlikely.
But Bitcoin fails the utility test because people rarely use it for retail transactions. The main source of value for this specific digital currency is its scarcity. The argument of Bitcoin’s value is similar to that of gold, a commodity that shares characteristics with cryptocurrency. The cryptocurrency is limited to an amount of 21 million.
The value of Bitcoin is a function of this scarcity. With the decrease in supply, the demand for cryptocurrency has increased. Investors are clamoring for a slice of the ever-growing profit pie that results from the exchange of its limited supply.
Bitcoin also has a limited utility like gold, whose applications are mainly industrial. Bitcoin: between pros and cons
The underlying technology, called blockchain, is being tested and used as a payment system. One of its most effective use cases is in cross-border remittances to increase speed and reduce costs. Some countries, such as El Salvador, are betting that Bitcoin technology will evolve enough to become a medium for everyday transactions. Some signs in this sense come from the new trend that is taking hold in the world: the crypto-stipedio.
Another theory is that the digital currency has an intrinsic value based on the marginal cost of producing a Bitcoin. Mining involves a large amount of electricity and this imposes a real cost on miners. According to economic theory, in a competitive market between producers who all make the same product, the selling price of that product will tend to its marginal cost of production. Empirical evidence has shown that the price of a Bitcoin tends to follow the cost of production.
Bitcoin is much more divisible than fiat currencies. A Bitcoin can be divided into up to eight decimal places, with constituent units called satoshis. Most fiat currencies can only be divided into two decimal places for everyday use.
If the price of Bitcoin continues to rise over time, users with a small fraction of Bitcoin will still be able to transact with the cryptocurrency. The development of secondary channels, such as lightning network, could further increase the value of Bitcoin’s economy.