Bitcoin: Valueless Coins or the Currency of the Future?
More than one decade ago, in 2010, a bitcoin trader could purchase a single bitcoin for around US$0.08. On March 22, 2021, the price of one bitcoin was US$68,411.
This unprecedented growth of bitcoin, backed by large corporations investing billions, sparked many retail traders to get in on the action. Bitcoin, and other cryptocurrencies like it, are gathering attention by “Average Joes” hoping to make huge sums of money.
The excitement surrounding the potential growth of cryptocurrencies raises major concerns by specialists in finance and economists all over the globe — where does the value of cryptocurrency come from?
The answer? Not so simple.
Where does value even come from?
To understand how and why the value of a cryptocurrency matters, let’s use the stock market as a frame to guide us to the answer.
Stocks, or equities, are what are traded within the stock market every single day. Stocks themselves are just portions of equity of a public company. These public companies list themselves in the stock market for any and all investors to buy portions of these equities. The way that day traders and investors make money is through two main functions: Dividends, and Capital Gains.
Dividends refers to a predetermined set of money that is distributed between certain shareholders of a stock. This money is used to incentivize shareholders to continue to support the company.
On the other hand, Capital Gains refers to the price of a share of a company. It’s the result of buying low and selling high. What Capital Gains actually looks like is the appreciation of stocks, which is how two thirds of the profit of the stock market is made.
Assume that we are analyzing Stock X. At the beginning of 2021, Stock X was worth 5 dollars a share, and we bought 100 shares. This means that we have given a $500 investment to Company X, in return for equity of Company X. Fast forward to the end of March, Stock X has now risen in value to $10 a share. If we sell our 100 shares in Stock X at the end of March, we would earn back $1000, which is double what we started with!
However, one thing that needs explaining is the actual buying process. Most people assume that when they buy and sell stocks in the stock market, they are dealing with the company itself. Although companies may occasionally buy back some of its stocks, these operation are usually not covered under the scope of day to day tasks.
Rather, when a person, like you or me, wants to buy or sell several stocks of Stock X, we instead trade them between other investors. This is an important distinction to make within the stock market, that the majority of transactions within the stock market actually occur between different investors, and not companies themselves. (Obviously, companies could be counted as individual investors when investing in other stocks)
Knowing this, we can now explain why a Stock X’s price fluctuates on the minute.
A basic economic concept is Supply and Demand. The simple relationship between them, is when there is more Demand and less Supply, the quantity demanded of any product is in a deficit, which raises the price of the product. Conversely, when supply is larger than demand, it results in a surplus of a given product. This excess supply leads to lower prices as there is less quantity demanded.
Likewise, in the stock market, the law of Supply and Demand still hold true. When there is a lot more demand from investors for a certain stock than there are sellers, the price of the stock rises until a shareholder decides to sell their stock. The converse happens when there is more supply within a stock. This is why the stock market is constantly fluctuating, as supply and demand are extremely volatile in the stock market.
Moreover, the law of Demand and Supply can also explain the importance of value within stocks. Specifically, when Demand for a certain product sporadically increases, the Quantity Demanded and the Price of a certain product both increase.
In the stock market, one of the major shifters of demand is the value, or outlook of a company. This is why major headlines, such as layoffs, scandals, breakthroughs- they all are leading factors that contribute to the volatility of the stock market.
Generally, the price and trends of a company’s stock price should reflect the growth and potential for the company. The more growth within a stock market, the more demand there will be for the given stock, and the price will rise. In short, stocks with value will continue to rise in price.
However, there are notable exceptions to this rule of thumb. GameStop, a company which has been devastated by the pandemic, has been reporting less and less sales each year. What this means is that the company is essential dying. Likewise, the price of GameStop’s stock was progressively decreasing.
However, due to a large amount of retail investors who unexpectedly bought large amount of the stock, the price artificially rose, as the demand for GameStop’s stock was significantly greater than the supply, or amount of people who wanted to sell the stock.
What About Bitcoin?
Bitcoin is the most viral and prominent cryptocurrency, which is why it helps us understand the behavior of cryptocurrency as a whole on the market.
Specifically, trading bitcoin is like trading any other stock on the stock market. However, similar to Forex, Bitcoin can be traded 24/7. The principals still apply in the bitcoin stock market.
Buyers and paired with sellers via third party apps to create transactions and exchanges. The price of Bitcoin (not to be confused with the value of Bitcoin,) is heavily influenced by external factors, which ultimately influence the demand of Bitcoin.
Bitcoin is heavily influenced by the news and media all over the world. We can see that the more relaxed restrictions on Bitcoin become, the higher demand there is for Bitcoin.
There are many reasons for the recent exponential growth of Bitcoin and Ethereum, but some factors that impacted the price include Elon Musk’s tweets regarding Bitcoin, the implementation of Bitcoin within various corporations, relaxed policy regarding Bitcoin internationally, etc.
Additionally, cryptocurrency markets are significantly more volatile than stock markets. One of the major reasons is because of bitcoin’s value. Bitcoin is extremely volatile due to varying perceptions of the intrinsic value, the actual worth of an asset, of Bitcoin. Because there is no real value in an asset like Bitcoin, it is hard to determine how much it is worth.
Why does this value even matter?
Another commonly traded asset that faces the same question as Bitcoin is gold.
Originating decades ago, gold is still being traded to this day. In fact, its one of the most traded natural resources on the market! This is because the metal is abundant enough to create coins but rare enough so that not everyone can produce them. Gold has value because it humans are physically and emotionally attracted towards it. Societies and economies believe that gold has value, therefore giving gold actual value.
However, bitcoin and gold has its differences. For starters, bitcoin, and other cryptocurrencies like it, is not physical. It is purely digital, with the only proof of purchase being a few characters of text on a secure website. Moreover, it has no value or emotional attachment that humans have developed in gold.
There are two realities for bitcoin. The first, is where bitcoin has an intrinsic value and is believed to have value. The second, is that bitcoin has no intrinsic value, and investors are just buying pieces of digital code.
The importance of this answer can determine the future of bitcoin, and if it will be considered a good investment by professionals.
So, do Cryptocurrencies Like Bitcoin Have Value?
On one side of the story, Bitcoin optimists such as Elon Musk, Twitter founder Jack Dorsey, and even PayPal are all currently investing millions in the decentralized currency.
The argument for the value of Bitcoin originates from the entire concept of why money and currency currently have value.
Like the US Dollar and the Canadian Dollar, Bitcoin carries similar attributes. Bitcoin is quickly recognizable; it is also unable to be counterfeited. It has no physical weight, feel, touch, or smell. It is able to be moved at distance without trusting a third party.
However, it is also significantly better than fiat currency. First, Bitcoin is provably scarce. There will only ever be twenty one million of them in existence, with no more, nor less. Bitcoin never ages like paper bills and metal coins. Moreover, Bitcoin is able to enable all forms of economic activity often without middlemen or human arbitration.
As well, Bitcoin itself is a decentralized currency. This means that it is not regulated or controlled by any form of government, which is unique to cryptocurrencies.
Rather, Fiat Money is controlled by the government via fiscal policy, which can control the amount of production of fiat money. Fiat money in itself is valueless; it isn’t backed by any commodity like gold, but instead the supply and demand is derived from the trust between citizens and the government in which the government will continue to uphold the current’s stability.
This means that Fiat Money is not scarce. Any amount of money can be produced at any point in time by governments, which some argue contradicts the entire idea of a free market.
Because Bitcoin is decentralized, this means that the cryptocurrency is a better alternative for a majority of people, as it can be accessed by any person, regardless of where they currently are, or where they were born from. It is more efficient, practical, and convenient to use than Fiat Money in certain situations, which is what gives Bitcoin its intrinsic value.
We know that societies demand fiat money such as the Canadian Dollar because of how useful it is, which is why there is demand for such money. However, because Bitcoin is far better and more convenient than fiat money, this means that slowly but surely, the demand for Bitcoin will rise and hence, the value of Bitcoin will increase intrinsically.
The Other Side of the Story
Alternatively, business executives like Warren Buffett, CEO of JPMorgan Chase Jamie Dimon, and economists such as Peter Schiff believe that Bitcoin is the equivalent of fools gold; practically worthless.
Peter Schiff’s argument for why Bitcoin is valueless can be summed up like this:
Even if what pro-Bitcoin debaters may say about the similarities of Bitcoin and gold are true, Bitcoin lacks one of the key concepts of gold; the scarce ore itself.
We know that gold has been used for decades as trade due to its emotional and physically attraction that humans have developed for it, which gives gold the demand it needs to be valuable. Gold is useful not only as a medium for trade, but it is also used in cellphones, jewelry, and even food!
Bitcoin may be portable, efficient, and convenient, but it doesn’t have the real value that a metal like gold may have.
Moreover, fiat currency and money have a unique property; it’s exchange rate and price are relatively stable. Conversely, Bitcoin is notorious in the Financial Sector for how volatile it is. People using bitcoin to negotiate contracts would have to constantly be editing the amount of bitcoin to reflect the volatility. It would be extremely difficult to buy a CAD$5.00 of coffee using bitcoin, as the price would be changing rapidly.
These signs point to the fact that Bitcoin currently doesn’t have a place in the market. The only value that Bitcoin has is the confidence that societies will be accepting it as legal tender in the future. It’s the same situation with all currencies around the world, with the only difference being that Fiat money has been engrained into society.
Currently, demand for Bitcoin is skyrocketing. However, this doesn’t necessarily mean that Bitcoin’s intrinsic value has increased.
Rather, a majority of investors in bitcoin are holding their assets in the market because they believe that the price of Bitcoin will continue to increase. However, the price can only continue to increase if there is more demand backed by the speculation of even more demand.
This positive feedback loop creates a bubble within the Bitcoin economy, which will inevitably burst. The so-called “value” within bitcoin may just be speculative, and may just be imaginary.
What This Means for the Future of Bitcoin
The rise of bitcoin, with a growth of more than 175,000%, will never be forgotten in history.
It is likely that the price of bitcoin will still continue to rise, as large corporations backing the currency are pouring millions into the Bitcoin economy, while also incentivizing retail investors to hop on the action.
However, as was mentioned in this article, a question that attacks the fundamental principal of Bitcoin still looms in the back of economist’s mind: Does Bitcoin have value or not?
The future is uncertain for the price of bitcoin; optimists claim that the price will only rise in the long run due to the “halving” within the bitcoin mining community. Others believe that there is no future for bitcoin, and that it has no place in society.
