We’ve all heard about cryptocurrencies and Bitcoin. Most of us know what they are, and some of us know how they work. But most of the struggle to understand one simple question – “how do they have any value?”. How do carefully flipped bits in servers across the world represent real monetary value?
Cryptocurrencies have no intrinsic value. They aren’t food that you can eat or water you can drink. However, the same can be said about cash. A piece of paper has no intrinsic value – however, since society as a whole has decided that a 100 rupee bill represents a certain amount of value, and it can be transacted freely in exchange for other goods and services, it is considered to have value.
So here’s how something like Bitcoin gains its value:
– Durability – since cryptocurrency does not exist in the physical world, it can never be destroyed, and will never lose its value. Even if a user loses the keys to their wallet, the currency itself will never itself be destroyed.
– Scarcity – the total supply of Bitcoin is capped at 21 million Bitcoins. Litecoin is capped at 84 million Litecoins. Increased scarcity (or lower supply) drives prices up, causing an increase in the value of such currencies.
– Divisibility – cryptocurrencies are typically more divisible than traditional currency. For example, the Indian Rupee can be precise only upto 10^-2 places. A currency like Bitcoin, however, is better in this regard – being divisible to upto 8 decimal places.
– Transportability – cryptocurrencies can be easily transferred from one cryptocurrency to another, and even to traditional fiat currency. Unfortunately, this process is not very seamless, involving hefty transaction fees. In terms of transferability, cryptocurrency can be efficiently transferred between wallets.
– Recognisability and utility – while not comparable to traditional currencies, cryptocurrencies have been gaining traction and support – it is not uncommon to see them supported for payments and donations at major retailers and distributors.
So if that’s the case, and Bitcoin is just like fiat currency, why is it’s value so volatile? Why are people still on the “crypto-fence”?
The price of a bitcoin is determined by supply and demand. When the demand for bitcoins increases, the price increases, and when demand falls, the price falls. There is only a limited number of bitcoins in circulation and new bitcoins are created at a predictable and decreasing rate, which means that demand must follow this level of inflation to keep the price stable.
Because Bitcoin is still a relatively small market compared to what it could be, it doesn’t take significant amounts of money to move the market price up or down, and thus the price of a bitcoin is still very volatile.
Such are the wonders and complexities of the modern world. Thankfully, there is little stopping an average user from dealing in cryptocurrencies, due to the increased sophistication of modern wallets and trading platforms. Meanwhile, cryptocurrencies still wait at the fringes – all set for mainstream adoption.
Disclaimer: This post does not qualify as professional financial advice. Always consult your financial advisor and think wisely before making any investment decision.
He loves technology, and spends an alarming majority of his waking hours in front of a computer screen. He supports the Free Software Movement and believes firmly in the Right to Privacy. He is passionate about custom PC building, and is a big fan of loud clicky mechanical keyboards. Besides this, he is a national-level debater and MUNner, an abacus post-graduate, literature and coffee aficionado, and lover of alt-rock.