Although Bitcoin has been around since 2009, it wasn’t until the events of late 2017 that the world’s first cryptocurrency was able to catch the attention of the masses. Not only did Bitcoin increase its market awareness, but the value of Bitcoin reached all-time highs of just under $20,000. For those that have little knowledge of how the Bitcoin and blockchain phenomenon work, it can seem somewhat confusing as to how something can be worth so much money when it doesn’t actually exist in a tangible form.
With that in mind, we are going to explore where Bitcoin gets its value from. Once we’ve covered the basics, we’ll then take a closer look at some of the factors that have led to Bitcoin’s exponential growth. Moreover, we’ll also discuss the similarities Bitcoin has with traditional assets such as gold.
Why is Bitcoin Valuable?
In the grander scheme of things, value is essentially based on what people are willing to pay for something. This is especially true in the financial markets, wherein the price of an asset is determined by supply and demand. If there are more buyers than sellers, then naturally this will force the price of an asset to increase. On the contrary, should investor sentiment swing towards the sellers, then the price will decrease.
Just like any other financial instrument available to trade on the open marketplace, Bitcoin can be bought and sold. Similar to how real-world stock exchanges such as the NASDAQ operate, Bitcoin trading is performed on a cryptocurrency exchange. The value of Bitcoin is therefore determined by the amount of people that want to buy it and the price they are willing to pay for it.
While supply and demand is at the heart of why Bitcoin is valuable, it doesn’t explain why there is demand for Bitcoin in the first place. Why is it that so many people are willing to pay for Bitcoin at all? There are three primary reasons:
Bitcoin is a Speculative Investment
Although Bitcoin was created with the view of disrupting the global payments system, Bitcoin is primarily purchased as a speculative instrument. In other words, people buy it with the hope that it will be worth more in the future. This speculative approach to Bitcoin has been a major factor in the coin’s exponential growth over the past few years.
When the network was first launched in 2009, Bitcoin was worth a fraction of 1 cent. In fact, it wasn’t until 2011 that it reached parity with the U.S. dollar. Moving forward to 2017, Bitcoin grew from $1,000 all the way up to $20,000 in less than 12 months, illustrating a growth of almost 2,000%!
Ultimately, if you are wondering ‘Why is Bitcoin valuable?” — if people decide to purchase coins because they think they will be worth more in the future, then this alone gives it value in the open marketplace. However, there are other factors to consider too, as we will explore in the following sections.
Bitcoin is a Medium of Exchange
As we briefly mentioned earlier, the main purpose behind the creation of Bitcoin was to allow people to send and receive funds without relying on a trusted third party (like a bank or payment provider). In facilitating these payments, Bitcoin is acting as a digital medium of exchange. While the number of people who regularly use Bitcoin as a medium of exchange is relatively small, this function gives Bitcoin clear utility in some situations. So how does this affect Bitcoin’s value?
The answer is related to the claims made in the previous section: the more people that look to buy Bitcoin, the higher its value. If people are buying Bitcoin so that they can use it to purchase goods or transfer funds, then essentially it will create more demand in the market. When the demand goes up, as will Bitcoin’s real-world value.
This is exactly the same as real-world fiat currencies like USD/EUR/GBP. For example, as the vast majority of oil exportation transactions are conducted in USD, other nations must obtain the currency in order to make oil purchases. This gives USD additional value, as people need it to transfer value in certain situations.
In the next part of our ‘Why is Bitcoin valuable?’ guide, we are going to look at Bitcoin’s role as a store of value.
Bitcoin is a Store of Value
Many believe that the underlying characteristics of the Bitcoin system make it better suited as a store of value, rather than a medium of exchange. To clarify, a medium of exchange refers to an asset that is used to purchase everyday goods and services (such as the USD), and a store of value is just what it says on the tin: it’s used to store value. An example of a traditional store of value would be gold.
People don’t purchase gold with the aim of using it to pay for things; rather, most people who invest in gold are looking for a way to preserve their wealth outside of the traditional financial system. The reason gold is perfect for this purpose is that it has a finite supply and obvious utility, which secures its value.
This is exactly the same as Bitcoin, insofar that there will only ever be a maximum of 21 million coins. Once this figure is reached (predicted in 2140), no more Bitcoin will ever be issued. As a result, many believe that by holding Bitcoin as a store of value, its price will naturally increase over time.
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Why is Bitcoin worth so much?
Although its price has since retracted, Bitcoin was at one point worth a remarkable $20,000. When one compares this amount to the early days of the project, this is truly a phenomenal level of growth. However, in comparison to the wider financial markets, Bitcoin’s worth is still relatively low.
For example, it is estimated that the total market capitalization for the entire supply of gold in circulation amounts to around $7 trillion. In the same way, it is believed that the total value of USD currently in circulation is close to $11 trillion (based on the number of physical notes).
Even if we were to base our figures off of Bitcoin’s all-time high of $20,000, this would have amounted to a total market capitalization of only $320 billion. Therefore, although the value of Bitcoin might sound high, in comparison to more traditional financial assets, it still has a long way to go.
An additional reason that Bitcoin appears to be worth so much is because of the way the coins are denominated. Although the price illustrated is based on an entire Bitcoin, everyday transactions rarely amount to this much. At the time of writing in October 2018, the average value of a Bitcoin transaction comes in at just under $250. This indicates that people normally transact in quantities that resemble a fraction of a Bitcoin, rather than an entire coin.
These fractions are known as Satoshis, and there are 100 million of them in each Bitcoin. It is highly likely that if the value of Bitcoin continues to rise over time, transactions will one day be quoted in Satoshis. Otherwise, it makes it difficult for consumers to figure out just how much they are paying.
Either way, as Bitcoin has increased its market awareness, adoption rates and media-interest, more and more people are entering the market. Subsequently, this has the desired effect of increasing Bitcoin’s real-world value.
Why is Bitcoin valuable? The Verdict
The Bitcoin journey has been nothing less than remarkable. What started as a programmer’s pipedream has since turned into a global phenomenon. Naturally, as more and more people have decided to jump on the Bitcoin bandwagon, the value of Bitcoin has subsequently followed.
In terms of understanding why Bitcoin is valuable, many would argue that the vast majority of Bitcoin’s value is derived from speculation. People are purchasing it with the aim of selling it for a higher price in the future and as such, it has value because people want to buy it. However, as the benefits of the underlying technology become understood by the masses, we could one day see value determined by other factors. Notably, this will correlate to Bitcoin’s ability to be used as a medium of exchange, a store of value, or a combination of both. Ultimately, Bitcoin is an excellent example of an asset class that derives value without having any tangible properties.