Why Bitcoin Has Value

This article appeared in print edition 5.1 of yBitcoin. Click here to see the full issue. Click here to order your copy.

By David Hollerith

Since the dawn of civilization, people have found ways to satisfy their needs. Society itself arose from the discovery that forming groups and dividing labor made meeting our needs easier. 

When these early groups grew into larger communities, they developed a more intricate process for exchanging goods. The first marketplaces emerged as forums for bartering where people who produced a single good could attain a diverse number of other goods.

Though bartering improved life, the early marketplaces had their limits. If on the same day that a fisherman came to market seeking wheat, but no farmer desired fish, the fisherman would have to conduct a complex series of trades to acquire something he could trade for wheat. In each transaction, the fisherman could be expected to lose a percentage of his fishes’ original value, and he must be able to understand the exchange rate of every good with respect to all other goods. After a long day of fishing, this situation would not be ideal. Our concept of trade needed to be further refined.

Improvement came in the idea to use a single good as an intermediary, the introduction of currency. Using currency saved time and effort and it would enable trade to work on a greater scale. By agreeing on a single intermediary good, two is the maximum number of exchanges anyone in the marketplace would ever need to make. This meant that there would be only one exchange rate for every good that held value: its cost in currency. 

However, selecting a good to serve as an intermediate currency wasn’t simple. For instance, dirt would not make a good currency. A decent currency needed to be something durable, easily divisible and transportable.

By this criteria, coins were settled upon as early currency. But even these had their limits. When trading on an extremely small or large scale, their material size and weight could be problematic. While bringing a wheelbarrow’s worth of silver coins to a market is a better alternative than doing the same with fish, it still has flaws.

Banking on Value

Banks were introduced as a means of securing wealth in exchange for fees and accreditation. Instead of withdrawing wealth to purchase something, people traded their banknotes for the goods they wanted. Without a doubt, the use of paper currency brought convenience. However, it also presented bankers with the opportunity to invest their clients’ deposited wealth for additional profit. This worked as long as not all of a bank’s clients withdrew their money at the same time. If that did take place, the number of banknotes that had already circulated throughout the system would be rendered worthless and the system altogether would collapse. 

To prevent such a catastrophe, European nations legalized the act of bankers lending more credit than what they possessed, as long as the banks followed regulations set in place by each nation’s governing body. Central banks were created for this explicit purpose. They are typically the only banks that have the right to issue legal tender, thus controlling and regulating the value of each country's currency. 

In 1971, U.S. President Richard Nixon chose to “leave the gold standard.” The Federal Reserve, the country’s central bank, would no longer permit new dollars to be redeemed for their value in gold or silver, something their existence had always been predicated on. Without material backing, the American dollar became what is called a “fiat currency,” one that has been declared legal tender by a government, though not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand, instead of relying upon the actual value of the material the money is printed on. Today, only about 8 percent of the United States’ dollars in circulation are paper. While paper money has its advantages, debit, credit cards and other forms of digital payment like Venmo and PayPal offer better incentives and efficiency. 

But as we continue to improve the speed with which we communicate and share information across the internet, the prevalent electronic bookkeeping methods are beginning to lag behind in the privacy, security and speed they offer. Currently, any verified financial transactions are made possible through a trusted third party like governments, banks, accountants and notaries. While this method predominates at the moment, it is riddled with added costs, transaction delays and security breaches. Primarily, this method gives significant power and authority to trusted third parties. 

Entering the Modern Era

Bitcoin isn’t just an unregulated transaction system. It is a digital currency made possible by a pioneering technology that presents people with a fundamentally better method of trade. 

The Bitcoin software is enabled by a network of computers participating in collective bookkeeping or “verification” and it is decentralized, meaning it is not controlled by a central party. The network is hosted on a digital ledger, the blockchain, open to anyone who joins. Every piece of information, including time, amount, senders and receivers, surrounding a transaction is verified by hundreds of participating computers. The complex mathematical process in which participating computers race to verify and maintain transactions on the ledger for a reward of bitcoins is called mining. The mathematical principles that are involved in the mining process ensure that all participating computers must automatically and continuously agree on every transaction. This process can be thought of as having a virtual and trusted third party present at every digital transaction. Many see Bitcoin as a long-dreamed-about replacement not just for our outdated financial system but for the whole concept of money. 

In the relatively short time that Bitcoin has existed, its foundational value has come from technological features that make it more transparent than any other transactional system. The caveat: to transact in the Bitcoin system, one must use the designated bitcoin currency. 

Therein lies the second — and potentially greater — level of Bitcoin’s value. As a commodity, Bitcoin’s value runs according to the strength of the network. The more people who use the technology, the more valuable the currency it becomes. It’s an economic concept inherent in adopting most comprehensive technologies. The internet, for example, increased in the diversity of information it contained and the communication opportunities it presented as the number of its users grew. 

Thinking back to society’s earliest markets, currency first emerged as an intermediary out of the need to improve trade speed, costs and efficiency. What Bitcoin shares with the earliest forms of money, such as gold and silver, is that there is a finite supply. Even for those who don’t see Bitcoin superseding our current monetary system, the technology still demands the question: What should the money of our time look like?