Often referred to as a digital currency, bitcoin is an alternative to fiat money that is issued by central banks. However, the latter is deemed useful because it is widely used in an economy and is backed by a monetary authority. Since Bitcoin’s network is decentralized, the cryptocurrency is seldom used in retail transactions.
The value of Bitcoin, however, can be compared to precious metals. The quantity has a limited supply and can be used in specific situations. While precious metals such as gold are used only for industrial applications, cryptocurrency and bitcoin’s underlying technology, blockchain’s application can be used all over the financial services ecosystem. One day, Bitcoin may even serve as a platform for retail transactions because of its digital provenance.
The Value of Traditional Currencies
Traditionally, the currency is considered functional if it can function as a store of value or, more precisely, if it can maintain its relative value over time. The value of commodities and precious metals was considered relatively stable throughout history, which made them excellent payment methods. Our societies switched from carrying large quantities of gold, cocoa and other forms of currency to minted currency.
Still, minted currency was functional because much of it was made of metals that had long shelf lives and low depreciation risks, which made them reliable stores of value.
The six features that enable a currency to be widely used in an economy are divisibility, scarcity, utility, durability, counterfeit ability and transportability. By emphasizing these attributes, monetary policies can be established to ensure its safety and security and to control inflation.
Currency valuation is an issue that is debated. At first, their value was determined by their intrinsic physical properties. However, minted currencies do not have these same values. In the past, the value of paper money was determined by how much gold-backed it.
To this day, some currencies are based on principles that they are representative which means that each note or coin can be exchanged for a certain amount. However, after many countries have changed from using gold standards to fiat currency, many societies and governments have recognized the potential of the fiat currency and know that they will not lose their value over time.
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The Value of Cryptocurrency
A Bitcoin transaction is not backed by the government nor is it protected by an intermediary banks system. The Bitcoin network relies on an independent node for consensus-based transactions. Governments or monetary authorities cannot act as counterparties to risk or hold down lenders if a transaction goes wrong.
Although cryptocurrency is a digital medium of exchange, it does share some attributes with a fiat currency system. As an example, it is rare and is divided into the constituent unit. There is no way to counterfeit it. It would only be possible to create a counterfeit by double-spending. Here, duplicate records are created when the user transfers or spends the same bitcoin in two or more separate locations.
A large cryptocurrency network, however, makes double-spending unlikely. Their overall value is determined by their demand and supply. cryptocurrency value can be compared to that of gold, a commodity with similar properties.
The scarcity of each of their coins determines their value. Despite Bitcoin’s decreasing supply, demand has increased for the cryptocurrency. Profits from the trading of its limited supply are generating ever-increasing interest from investors.
Bitcoin is also limited in utility, like gold, primarily used for industrial purposes. The technology behind Bitcoin, called blockchain is also tested and trusted that is why it is used as a payment system. In addition, there is the theory that states that bitcoin’s value is based on the marginal production cost. The mining process consumes a large amount of electricity, and this causes the miners some real money.
Bottom Line
Suppose that there is a competitive market among producers who make the same product, and the selling price of that product tends to be closer to its marginal cost. A cost of production theory does indeed reflect the price of bitcoin, according to empirical evidence.
