Bitcoin has recently received a lot of attention. It’s one of many digital currencies that exist today that behave and operate like regular money but are completely electronic—like data in computers.
And this can be perplexing because, if there is no real physical bitcoin:
How can it be valuable?
In the real world, how do you use digital currency?
Actually, the issue of how bitcoin has any value isn’t all that dissimilar from how most real-world money has value.
To begin with, Bitcoin has no intrinsic value, which means it is of limited use to us outside of its economic background. However, most real-world currencies are the same way: money only has value because the government that issues it claims it does.
Since its value is not tied to any tangible product and relies on the backing of a government, this is referred to as “fiat currency.”
Bitcoin, unlike fiat currency, does not have an issuing authority that assigns value to it. Bitcoin is a decentralized currency, which means that its development and transactions are not governed by any central authority.
It doesn’t report to any government or company, so there’s no need for it to be valuable, but it is – and it all comes down to utility, scarcity, and supply and demand.
The Usefulness of Bitcoin Is Its Value
Before we get into the benefits of Bitcoin, let’s go through the basics of how it functions. You’re linked to the Bitcoin community through a computer network, and the ledgers that Bitcoin uses are known as blockchains: transactions are assembled into blocks, which are then linked in a chain-like fashion, hence the name.
The ledger keepers are referred to as miners because what they are doing is very similar to gold miners who work hard to find gold: they are searching for a reward in the form of bitcoins, which are restricted in quantity, much like gold.
So now you have a basic understanding of how Bitcoin functions. What does that mean in terms of its worth? Currently, everything. The usefulness of Bitcoin is its decentralization, anonymity, and transaction ease.
Let’s start with Bitcoin’s decentralized framework. Bitcoin is structured in such a way that it does not require the supervision of any governing authority. It works on a peer-to-peer network, with all transactions being registered in a blockchain.
On the most fundamental level, this means it is unattached to any state and therefore the only genuinely borderless currency. This means that when you’re using the same currency, you can conveniently conduct transactions with people from different countries.
The decentralization of Bitcoin’s infrastructure provides the prospect of changing the financial industry on a broader, even more complicated stage.
The finance industry provides a variety of options for making purchases more convenient. Credit and debit cards, money transfer services, electronic bank transfers, and so on are all available. However, in order for these schemes to work, they need a middleman—a organization or authority to facilitate the transaction.
And if you make a purchase, you’re putting your faith in the middleman, trusting that they’ll get your money through or keep it secure, among other things. There’s also the issue of transaction fees, which aren’t excessive per transaction but can quickly add up over time. This is because Bitcoin removes the need for middlemen.
Miners, as previously stated, record all transactions in the Bitcoin network in the blockchain. While the blockchain and miner network have the appearance of becoming a governing body in that they keep track of all bitcoins in circulation, they are still public and therefore cannot be monopolized.
This ensures that no one individual or group of people has control over the network, allowing bitcoin transactions to be completely open and neutral.
But who would you trust to ensure that transactions are completed if there is no official body serving as a regulator? No one, to be precise. And although it may seem to be a negative, it is actually a positive.
The Bitcoin framework is designed to function without relying on confidence. It’s a cryptocurrency, not just a digital currency, which means it’s heavily reliant on encryption techniques to keep it safe.
Rather than relying on consumer confidence, Bitcoin relies on tried-and-true mathematics (more on that later). Because of the network’s public nature, cheating is unlikely.
Not only that, but the machine is encrypted, so attempting to commit fraud will necessitate a massive amount of computing power, which would have been better spent mining more bitcoins by then.
Aside from ensuring the protection of Bitcoin transactions, the security mechanism also ensures that Bitcoin users’ identities are secured. Your account number has no meaning in your purchases, which are ultimately validated using a private and public key, unlike credit cards.
It works like this: you use your private key to digitally sign your transactions, which can then be checked by network users using your public key. The keys are encrypted in such a way that the public key can only be used if the private key was used correctly in the first place.
This means that:
- Criminals cannot steal your identity and use it to make fraudulent transactions in your name.
- In the Bitcoin network, you may opt to remain entirely anonymous, which might be useful for others.
Finally, bitcoins have the potential to have a level of convenience that exceeds what we currently have in terms of conventional payment methods. Bitcoins allow you to “send and receive bitcoins anywhere in the world at any time,” according to the Bitcoin website.
There are no public holidays. There are no boundaries. There is no bureaucracy. Bitcoin gives users complete power over their funds.”
Bitcoins Are Extremely Limited
In the sense that governments can print money whenever they want, fiat currency has a theoretically infinite supply. Obviously, they don’t do it because it would trigger inflation, so the government regulates the production and distribution of money based on extensive research into consumer patterns and needs. As you would expect, Bitcoin is not the same as cash.
Since Bitcoin is decentralized, no central authority determines when new bitcoins are created. New bitcoins can only be generated as part of a compensation scheme for miners, according to the system.
And the reward is well-deserved: cryptography, or the art of writing and cracking codes that take a lot of time to crack, is at the heart of the Bitcoin scheme.
Miners from all over the world compete to solve a particular math problem known as SHA-256, which stands for Secure Hash Algorithm 256 bit, in order to update the blockchain.
It’s essentially a math problem in which you’re given an output and must find the corresponding input, such as solving for x and y given that x + y = 2.
The only way to solve a problem like this is to guess, and to solve the SHA-256, you’d have to go through an incredible number of possible solutions before finding the answer, which would necessitate the use of a very powerful (not to mention expensive) machine.
Miners spend a lot of money on these supercomputers (as well as the enormous amount of energy they require) in order to create new Bitcoins.
In a Forbes post, Jason Bloomberg claims that the value of Bitcoin reflects this effort: because mining bitcoins is difficult, they become more expensive. The first indication of scarcity is that bitcoins are difficult to come by. To be able to build new bitcoins, you’d need a sizable investment.
However, they are made even more scarce by the fact that there can only be a finite number of bitcoins in nature, which is 21 million. (If you’re wondering why 21 million, it’s because that’s how the source code is written.)
The supply limit on Bitcoin is in place to prevent the currency from being overvalued.
It’s also built to be produced steadily: every 210,000 blocks added to the chain (i.e., every four years), the reward scheme is cut in half, and the SHA-256 problems differ in complexity depending on the number of miners—more miners means harder problems, ensuring that not too many bitcoins are created at once.
According to this pattern, the final bitcoin will be mined around the year 2140. To put things in perspective, at the time of writing, there are approximately 16.74 million bitcoins in circulation.
Since scarcity is attractive and highly marketable, the fact that less and fewer bitcoins can be mined as time passes increases people’s interest in the currency.
This raises the value of Bitcoin since it is based on a network, and the bigger the network, the more Bitcoin can be used.
Bitcoin’s value is directly affected by supply and demand.
The market value of Bitcoin, or the amount of money people are willing to pay for it, follows the same simple demand and supply law as any other commodity: a high demand raises the price, while a low demand lowers it.
Before we go any further, keep in mind that a product’s value is different from its price; value is what people think a product is worth, while price is what they pay for it. Nonetheless, value and price are inextricably linked: the price of something is proportional to its value, and vice versa.
The growing trend in the price of Bitcoin, according to an article in the Economist, is what motivates people to invest in it.
People are investing because they assume that if the current trend continues, they will be able to sell their Bitcoins for a much higher price in the future—a perfect example of the greater-fool principle, according to the report.
The greater-fool theory claims that a product’s price is dictated not by its intrinsic value, but by the consumers’ expectations and assumptions about the product.
From this viewpoint, the rising price of Bitcoin helps to make it obsolete rather than raise its real value.
The market is pushing up the price of Bitcoin because of a growing expectation that it will be worth more in the future, rather than because it is rising in value over time. Some argue, however, that the recent increase in Bitcoin prices does not indicate the existence of a bubble.
The Bitcoin website claims that it is not a bubble, claiming that bubbles are excessively overvalued products that ultimately correct themselves.
It blames the volatility in Bitcoin prices on the market’s small size and youth, claiming that “choices based on individual human behavior by hundreds of thousands of market participants is the trigger for Bitcoin’s price to fluctuate as the market seeks price discovery.”
It claims that the instability of Bitcoin prices is caused by a number of factors, including:
- A loss of faith in Bitcoin;
- A large gap between value and price that is not based on the fundamentals of the Bitcoin economy; and
- A large difference between value and price that is not based on the fundamentals of the Bitcoin economy.
Speculative demand is boosted by increased press attention, fear of uncertainty, and good old-fashioned irrational exuberance and greed.
As a result, Bitcoin argues that its rising values are due to an increasing number of people finding the commodity increasingly valuable based on its usefulness, thus validating its value.
In conclusion, Bitcoin has value due to its usefulness and scarcity, but its prices seem to send conflicting signals on whether it is genuinely valuable or not.
With more people being interested in Bitcoin, it’s possible that we’re just scratching the surface of its true worth.
How difficult is it to make a Bitcoin payment?
Bitcoin payments are easier to make than debit or credit card purchases, and can be received without a merchant account. Payments are made from a wallet application, either on your computer or smartphone, by entering the recipient’s address, the payment amount, and pressing send. To make it easier to enter a recipient’s address, many wallets can obtain the address by scanning a QR code or touching two phones together with NFC technology.