What is the Value of Bitcoin?
Originally published June 27, 2021
What is the value of bitcoin? The question of the century as people observe this “crypto craze”, with bitcoin hitting as high as $64,863 and dropping to the low ~$30,000 in a span of few days. Why do people invest in this unstable, volatile…thing that doesn’t exist in the physical world? Sure, there are traders that make money off the volatility but what about the long term investors (termed “HODLERS”). Why do they hold onto this asset?
Note — Every cryptocurrency has its own value proposition that needs to be analyzed and thought through independently. I only cover bitcoin in this article.
Before, I give my insight, here are some of the prominent negative/bearish sentiments on bitcoin:
“There is no intrinsic value.”
“It’s only used for speculation”
“Bitcoin is a tulip mania”
I don’t 100% disagree with these sentiments. There are truth elements to these and I will address some of these in my article.
In this article, I’ll be breaking down my thinking to:
- Starting with the dollar
- Exploring the role of supply vs. demand
- Exploring the concept of money
- And applying these concepts to bitcoin
The Dollar
To understand the value of bitcoin, we can try to start with something more familiar to us — the dollar. Like bitcoin, the value of the dollar fluctuates — albeit not as volatile as bitcoin. What you could buy with $1 in 2021 is significantly different from what you could have bought in 1980 and and will be significantly different from what you could buy 30 years from now. Try measuring the dollar in terms of other things — the big mac, a banana, a house in California, the EURO — and you will see that the value of the dollar does not stay the same.
Supply vs. Demand
At a high level, the dollar fluctuates in value due to supply and demand. Everything has value because there is demand for it. And the level of supply vs. demand determines the value. High demand + low supply = high value. Low demand + high supply = low value. In the case of the dollar:
Dollar’s Supply: The dollar’s supply is controlled by the Fed. They can “expand” and “contract” the supply based on what they think of the economy.
Dollar’s Demand: This is multifaceted but some high level factors may include:
- Export vs. Import levels
- The belief in the stability and power of the U.S. government
- The dollar is legal tender in the U.S. & other countries and is required to conduct economic activities.
What is Value of Money?
Dollar is money and bitcoin aims to be money. But what is the value of money?
If I told you I would give you a billion dollars (or any currency) but you can’t spend nor lend any of it, would you want it? Probably not. You would only want the billion dollars if you are able to get things with intrinsic value, such as food, shelter, pleasure, comfort, fun, experience, and so on. Money by itself has no intrinsic value. But rather, it has a transient value, because of the expectation/belief that it will be turned into something of intrinsic value at a future point in time.
Bitcoin
Like the dollar, bitcoin’s value is ultimately determined by supply and demand. In the case of bitcoin.
Bitcoin’s Supply
Bitcoin’s supply is (will be) capped at 21 million units. No one can create more bitcoin. That’s how the protocol is programmed and it will not change.
Bitcoin’s Demand
Since the supply of bitcoin will be capped at 21 million, the value of it is largely driven by the demand for bitcoin. What causes the demand?
The demand for bitcoin ultimately comes from the belief/expectation that bitcoin will act as a form of global money in the future.
Like the dollar, no one will want bitcoin if the only thing they can do is hold it. People hold onto bitcoin with the belief that it will give them something of intrinsic value in the future. Bitcoin by itself has no intrinsic value.
Currently — since bitcoin is not really used to purchase goods by the majority, it is used mainly for…yes, speculation. And the volatility of it makes it feel like a tulip mania. Although, in 2021, we are slowly seeing bitcoin becoming adopted as legal tender (e.g. El Salvador), the majority use case right now for bitcoin is not for spending. People holding onto bitcoin are “speculating” that bitcoin will play a role as a global money in the future. Note — speculation sounds negative. But every form of investment is a form of speculation as it requires an expectation of the future.
And the belief that bitcoin will act as global money in the future comes from understanding the qualities of money that the technology behind bitcoin enables. I hope to cover these in detail in later articles but some qualities are:
- Peer-to-peer: Anyone can send anyone bitcoin as long as they have internet (or some connection to the network). No need for a bank account.
- Limited supply: No one can “print” or “create money out of thin air”.
- Decentralized: No governing entity can control bitcoin.
- Secure Independent Storage: Bitcoin allows people to store their bitcoin independent of any entity (like a bank).
The Value of Bitcoin
In short, the way I see it, the value of bitcoin is the belief that it will be used as a global money in the future and the expectation that more and more people will see it that way. And the price is whatever people think it will have to be for bitcoin to act as a global money considering there will only be 21 million units. Currently, bitcoin is still far from being a global money in terms of technological, economic, political, and social factors. An investment into bitcoin is a bet that bitcoin will be adopted as global money in the future. Whether that becomes the case…we’ll have to observe the trend (which I hope to do through my articles).
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