First appeared on Investopedia

Bitcoin was launched in 2009 as the world’s first decentralized, private digital currency. Because it has no physical denominations, Bitcoin only exists inside of an interlinked computer network system. This is not entirely unique, as much of the U.S. dollar supply only exists in digital account balances instead of as actual green pieces of paper.

Bitcoins are generated, or “mined,” through a sequence of complex mathematical formulas run through computers. The anonymous creator of Bitcoins set a cap on total Bitcoin volume. Once that number hits 21 billion, no more Bitcoins can be generated. These digital coins can then be bought or sold with other currencies and used as an investment or money to buy goods from any sellers who accept them.

Why Does Any Currency Have Value?

Economics teaches society that values are subjective; items have economic value because people desire them for one reason or another. Currencies, or mediums of exchange, serve several different and crucial functions in an economy. For one, they make trade easier; money currencies trade for nearly any good or service.

For example, suppose a person has 5 units of lumber and wishes to purchase a dog. Without currency, his only option is to find a lumber-wanting dog owner. With currency, like U.S. dollars, he can sell the lumber to anyone who wants it and then use the money to purchase a dog.

Currency also provides a universal measurement for accounting purposes. For instance, without currency, it is difficult to compare companies that sell different goods. Currency is used as a store of value, which makes saving, investing and banking easier.

Some currencies, like gold, have value because they are useful as a commodity. Government fiat currencies, like the U.S. dollar, have value because governments grant them legal tender status and only accept taxes through them.

Why Do People Value Bitcoins?

Bitcoins do not have value as a physical commodity like gold and are not widely accepted as legal tender like dollars. Rather, Bitcoin appears to have value for the following reasons:

It is popular. In short, people accept and trade in Bitcoin because other people accept and trade in Bitcoin. It is recognized and accepted as a currency by many.

Bitcoin is decentralized and limited. This is a major factor for many Bitcoin users. Bitcoin is hard for governments to trace and tax. Also, unlike fiat money produced by central banks, there is a cap set on total Bitcoins, limiting how much the currency can devalue through inflation.

Bitcoin acts like an equity investment. The market value of Bitcoins has had wild swings in value and even a market cap.

Bitcoin is a social network. The Bitcoin “community” is active and acts like other online social networks.