Why does Bitcoin hold value?
(8 min read)
Before we dive into the bigger question, we should first establish what Bitcoin is on a VERY base level. Let's refer to the original white paper released in 2008 by the inventor of Bitcoin, Satoshi Nakamoto. Satoshi Nakamoto was the name used by the presumed pseudonymous person or persons who developed Bitcoin.
Shatoshi describes Bitcoin as the following: “A purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution.”
Full whitepaper can be accessed here:
Satoshi coded a supply cap of 21 million coins into the Bitcoin protocol and also created a "list," commonly referred to as the "timechain" or "blockchain." This list is a tamper proof string of digital blocks. New blocks are added to this chain every 10 minutes, hence the term "time-chain." Each block holds a digital record of all transactions made in a given 10 minute period. The time-chain serves to keep track of current ownership and provides a history of all previous transactions, all in an anonymous manner.​ In summary, Bitcoin is a private, peer-to-peer, digital cash with a supply cap of 21 million coins, and it maintains a historical record of ownership. Now that we have clarified what Bitcoin is at a very basic level, let's dive in.
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Ultimately, the value of Bitcoin lies in the community of users who have chosen to use it. To understand why Bitcoin holds value, we must first comprehend why people opt to use it. To do this, we must first answer some important questions: What is money? Why do we use it? What are the functions of money? And how is money chosen?​
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When asked this question people often scoff at the simplicity of it but once they try to answer it soon becomes apparent that they actually have a very limited understanding of a function they use every single day. Simply put, money is a medium for exchanging value; it's a social agreement between people and communities. If I give you a "token" of value for a service or good in return, we have both agreed that the token I gave you is worth the service or good you gave me in return. Therefore, we have established the value of the token I gave you.​
Throughout history, many "tokens" have played the role of money, including gold, silver, copper, seashells, stones, salt, cow hides, rice, fish, glass beads, and, in many cases, alcohol and tobacco. What makes a token successful in the economy as a new form of money is its "hardness." A hard money is one whose supply is difficult to increase, while an easy money is one whose supply can be easily increased. People are usually free to use whatever monetary tokens they please as their medium of exchange, although there is an incentive to use the hardest money available. Those who choose to hold the hardest form of money will profit the most over time, as the hardest medium of exchange will retain more value over time, unlike softer forms of money, which will lose value.
But WHY does Bitcoin hold value?
What is money?
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This question may seem slightly silly but it is important to understand. Many people today are of the opinion that we should all go "back" to barter, then things would be all hearts and rainbows once more. However, realistically barter is too clunky and comes with scaling issues that affect the efficiency of an economy, therefore stifling growth and innovation.​
The primary issue of barter's inefficiency is famously known as the "double coincidence of wants." In a barter economy, two parties must have exactly what the other wants in order to make a trade. For example, imagine a farmer who grows apples and wants to acquire shoes. Without money, the farmer must find a shoemaker who specifically wants apples in exchange for shoes. This requirement can be difficult and time consuming, as the farmer might struggle to find a shoemaker who needs apples at the same time the farmer needs shoes.
Money solves this problem by acting as a universally socially accepted medium of exchange. Instead of directly bartering apples for shoes, the farmer can sell his apples to anyone who wants them in exchange for money. The farmer, can then use that money to buy shoes from any shoemaker, regardless of whether the shoemaker wants apples. This significantly simplifies transactions and makes trading more efficient.
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Additionally, the apple farmer may want to buy a house one day, but the house is equivalent to 3000 apples! Since his apples are perishable the current homeowner would be unlikely to trade their home for thousands of pieces of fruit that would rot before they could be consumed.
Why do we use it?
Money primarily has three main functions:
1. Medium of exchange, to facilitate trade and removing the need for barter.
2. Store of value, allowing people to store and save wealth over time.
3. Unit of account, providing a measure for valuing everyday goods and services.
Fiat currency, issued by central banks, is widely used for everyday transactions, this makes it an effective medium of exchange plus unit of account. However, its value is easily eroded by inflation, making it a bad store value. Gold on the other hand is a strong store of value, because of its scare nature but it is not practical for daily transactions. There are also stocks and bonds that are used as investments, these can be used as stores of value, but they cannot used as a medium of exchange or unit of account. Each has strengths and limitations in fulfilling the functions of money.
The Functions of Money
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Now that we have established what money is, why we use it, and the functions it serves, how do we choose a good, hard form of money?
We can measure the robustness of a currency against other mediums of exchange by examining certain properties of money. Any currency that most effectively fulfills these properties will naturally rise to dominance given a free market to decide.
These properties are as follows:
1. Durable - the ability to withstand erosion or damage.
2. Portable - the ability to be easily carried or moved across time and space.
3. Divisible - This property describes an asset's ability to be divided into smaller chunks.
4. Fungible - Easily interchangeable with other identical units without loss of value.
5. Scarce - Money must be scarce so that it holds value.
6. Immutable - Cannot be altered.
Let's take a look at Bitcoin through this spectrum of characteristics, measured against other currencies and assets.
How is money chosen?
DURABILITY
Bitcoin exists in frictionless digital space making it resistant to erosion or physical damage of any kind.
PORTABILITY
This characteristic is facilitated by its digital nature, allowing users to send and receive bitcoin instantly and securely over the internet without the need for 3rd parties or physical transport.
DIVISABILITY
Bitcoin is easily the most divisible monetary asset in the world. AUD or USD can be divided down to the cent but bitcoin can be divided down to its fraction term known as a "sat" or "satoshi".
There are 100 million sats to 1 Bitcoin!
FUNGIBILITY
Fungibility means a money's individual unit is interchangeable with no loss of value. For example any $5 dollar note can be exchanged for any other $5 dollar note. ( i.e. 1 Bitcoin = 1 Bitcoin )
SCARCITY
Unlike fiat currencies that can be printed forever by central banks, bitcoin has a capped supply of 21 million coins. This is enforced by the Bitcoin protocol. Unlike the dollar, bitcoins value and purchasing power will increase over time because of its limited availability plus growing demand. This makes bitcoin a great hedge against inflation and the most powerful store of value on earth.
IMMUTABILITY
Once a transaction is added to the blockchain and confirmed by the network it becomes permanent and cannot be changed. This characteristic safeguards the integrity and security of the recorded history of bitcoin transactions, unlike in traditional banking systems where transactions, records and balances can be modified or tampered with. Bitcoin holds an incorruptible record of who owns what, without compromising privacy.
In conclusion
As we can see, bitcoin holds value because it out-performs all other currencies and commodities. It displays the key properties of money and successfully performs all three functions of money, eliminating the need for diversification into stocks, bonds, or precious metals.
Satoshi performed a magic trick by merging the durability and scarcity of gold with the portability and fungibility of fiat currency. Unlike other forms of money that were discovered, Bitcoin was engineered to be the ideal currency for scaling a global economy, optimising for trading efficiency and peer-to-peer transactions while maintaining anonymity.
Bitcoin's supply is strictly governed by mathematics and code, and it is enforced by its network of users. It allows for instant global transactions without the excessive costs and taxes often associated with traditional financial systems. Participation is permissionless, and the network is to censorship free. Bitcoin is a very real, but also an intangible asset that exists everywhere and nowhere all at once. Wrap your head around that!
