Why is Bitcoin valuable?
Even after eleven years of experience and a Bitcoin price of nearly $20,000, skeptics continue to exist. I understand why. Bitcoin is not comparable to conventional financial assets.
Even referring to it as an asset is deceptive. It is distinct from a stock, a payment system, and money. It shares characteristics with each of these, but is not identical to them.
Bitcoin’s identity is contingent on its utility as a method for storing and transferring value, which in turn depends on secure titles to ownership of a scarce good. All of this is frustrating for people who don’t know much about the industry because it’s hard to see how it helps.
I am updating an analysis I wrote six years ago in this article. It is still valid. My thesis, for those who do not wish to read the entire article, is that Bitcoin’s value derives from its underlying technology, which is an open-source ledger that keeps track of ownership rights and enables their transfer. Bitcoin was able to combine its unit of account with an on-ledger payment system. Its innovation is the reason for its value, which continues to increase.
Consider the criticism offered by traditional proponents of gold, who for decades have advocated the notion that sound money must be backed by something real, solid, and independently valuable. Bitcoin is not eligible, correct? Maybe it does.
2009 marked Bitcoin’s debut as a potential rival to national, government-issued currencies. The white paper by Satoshi Nakamoto was published on October 31, 2008. This paper’s organization and tone communicated that this currency is for computer technicians, not economists or political commentators. The newspaper had a limited circulation, and those who did read it were confused.
But the lack of interest did not prevent the progression of history. Two months later, those who were paying attention witnessed the emergence of the “Genesis Block,” the first group of bitcoins generated by Nakamoto’s concept of a distributed ledger that resided on any computer node in the world willing to host it.
After all these years, the current price of a single bitcoin is $18,500. The currency is held and accepted by tens of thousands of online and offline institutions. Its payment system is popular not only in developing nations but also in countries with limited banking infrastructures. And major institutions, such as the Federal Reserve, the OECD, the World Bank, and major investment firms, are integrating blockchain technology into their operations with due regard.
Enthusiasts, who can be found in every country, assert that its exchange value will increase even further in the future due to its strictly limited supply and vastly superior system compared to government money. Bitcoin is transferred directly between two individuals. It is relatively inexpensive to trade. It has a consistent supply. Durability, fungibility, and divisibility are essential characteristics of money. It establishes a monetary system independent of trust and identity, much less central banks and governments. It is a brand-new system designed for the digital age.
Hard lessons for tough cash
To those educated in the “hard money” tradition, the entire concept has presented a formidable obstacle. Speaking for myself, I took me two years of reading about bitcoin before I came close to comprehending it. There was something about the concept that irritated me. It is impossible to make money out of nothing, much less computer code. So, why is it valuable? Clearly, something is amiss. This is not the monetary reform we anticipated.
Our expectations constitute the issue. We should have paid more attention to Ludwig von Mises’ theory of the origins of money, not to what we believe he wrote, but to what he actually wrote.
Mises published “The Theory of Money and Credit” in 1912. It was a huge success in Europe when it was released in German, and the English version was translated. While covering every aspect of money, his most significant contribution was tracing the origins of the value and price of money, not just money itself. In other words, he explained how the value of money is determined by the goods and services it purchases. This process was later dubbed the “regression theorem,” and as it turns out, bitcoin satisfies the theorem’s conditions.
Carl Menger, Mises’s professor, demonstrated that money originates from the market, not the state or the social contract. As monetary entrepreneurs seek an ideal form of commodity for indirect exchange, it emerges gradually. Instead of simply bartering with one another, individuals acquire a good to trade rather than consume it. This item is converted into money, the most marketable commodity.
But Mises added that the value of money can be traced back to its value as a commodity exchanged for other goods. According to Mises, this is the only way for money to have value.
The theory of the value of money as such can only trace the objective exchange value of money back to the point at which it ceases to be the value of money and becomes the value of a commodity. If we continue in this direction, we will eventually reach a point where there is no longer any component in the objective exchange value of money that derives from valuations based on money’s function as a common medium of exchange; where the value of money is nothing more than the value of an object that is useful in some way other than as money.Before it was common to acquire goods on the market not for personal consumption but in order to trade them for those that were truly desired, the value of each individual commodity was determined solely by subjective evaluations based on its direct utility.
Mises’s explanation clarified a long-mysterious issue that had perplexed economists. It is an account of hypothetical history, but it makes perfect sense. Would salt have become a currency if it had been completely ineffective? Would beaver pelts have acquired monetary value if they were not utilized for clothing? Silver and gold would not have had monetary value if they had no value as commodities. In all instances of monetary history, the answer is clearly negative. Prior to becoming widely traded as money, the initial value of money derives from its direct utility. Through historical reconstruction, this explanation is demonstrated. This is the regression theorem of Mises.
Bitcoin’s Use and Value
At first glance, Bitcoin would seem to be an exception. A bitcoin cannot be used for anything other than currency. It is not wearable as jewelry. This material cannot be used to create a machine. It cannot be consumed or even used for decoration. It is only valuable as a unit that facilitates indirect trade. However, bitcoin is already money. It is utilized daily. You can view the transactions in real time. This isn’t a myth. It is the real thing.
It might seem like we have to choose. Is Mises in error? Perhaps we must discard his entire theory. Or perhaps his point was purely historical and does not apply to the digital age of the future. Or perhaps his regression theorem is evidence that bitcoin is a fad with no staying power because it cannot be reduced to its utility value.
However, complex monetary theory is not required in order to comprehend the sense of alarm surrounding bitcoin. Many people, including myself, have an uneasy feeling about money that has no physical foundation. Sure, you can print a bitcoin on paper, but having a piece of paper with a QR code or a public key will not alleviate your unease.
How can this issue be resolved? In my own mind, I debated the matter for over a year. It perplexed me. I pondered whether Mises’ insight was applicable only to the pre-digital era. I followed online rumors that bitcoin’s value would be zero if not for the national currencies it is converted into. Perhaps the demand for bitcoin exceeded that of Mises’s scenario due to the desperate need for an alternative to the dollar.
As time progressed and I read the works of Konrad Graf, Peter Sura, and Daniel Krawisz, the solution eventually materialized. Bitcoin is a payment system as well as a currency. The source of value is the payment system, while the accounting unit merely expresses this value in terms of price. The unity of money and payment is its most peculiar characteristic, which most commentators have struggled to comprehend.
We are accustomed to considering currency and payment systems as distinct entities. This way of thinking reflects the technological limitations of the past. There are both dollar and credit cards. There is the euro as well as PayPal.There are both yen and wire services. Money transfers rely on third-party service providers in each instance. In order to utilize them, you must establish a “trust relationship” with them, which means that the institution arranging the transaction must believe that you will pay.
This barrier between money and payment has always been there, except when people were close enough to touch.
If I pay you $1 for a slice of pizza, there is no third party. However, once geographic proximity is lost, payment systems, third parties, and trust relationships are required. Then companies such as Visa and institutions such as banks become indispensable. They are the software that makes the financial software do what you want.
The catch is that the current payment systems are not accessible to everyone. In fact, a vast majority of humanity lacks access to such tools, which is a major cause of global poverty. The economically disadvantaged are restricted to local trade and cannot expand their global trading relationships.
This was a major, if not the primary, motivation for developing Bitcoin. The protocol aimed to combine the currency feature with a payment system. Both are interconnected within the code’s structure. This connection is what distinguishes bitcoin from any existing national currency and any currency throughout history.
Permit Nakamoto to speak from the abstract of the introduction to his white paper. Consider how integral the payment system is to the monetary system he designed:
A peer-to-peer version of electronic currency would enable online payments to be sent directly from one party to another, bypassing financial institutions. Digital signatures provide a portion of the solution, but the primary advantages are lost if a trusted third party is still necessary to prevent double-spending. We propose a peer-to-peer network solution to the double-spending problem. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, thereby creating an immutable record that cannot be altered without recomputation of the proof-of-work. The longest chain not only serves as evidence of the observed sequence of events, but also as evidence that it originated from the largest CPU pool. As long as the majority of CPU power is controlled by nodes that are not working together to attack the network, they will generate the longest chain and outpace attackers. The network requires minimal structure on its own. Messages are broadcast using the best efforts, and nodes are free to leave and rejoin the network at will, accepting the longest proof-of-work chain as evidence of what occurred while they were absent.
Not even a single mention of the currency unit itself is made in this paragraph, which is quite remarkable. There is only a passing reference to the issue of double-spending, (which is to say, the problem of inflationary money creation beyond what the protocol would otherwise permit which is to say, the problem of inflationary money creation beyond what the protocol would otherwise permit. Even according to the words of its creator, the innovation here is the payment network, not the coin. The value of the network is only expressed by the coin or digital unit. It is an accounting tool that absorbs and transports the network’s value across time and space.
This is the blockchain network. The ledger resides in the digital cloud on a decentralized network, and its operation can be observed by anyone. It is strictly monitored by every user. It enables the transfer of secure, non-replicable bits of information from one person to another, anywhere in the world, with these bits being protected by a digital form of property title. Nakamoto termed these “digital signatures.” His invention of the cloud-based ledger enables the verification of property rights without the need for a third-party trust agency.
The blockchain resolved what has become known as the problem of the Byzantine generals. In the presence of potentially malicious actors, this is the problem of coordinating action across a large geographic region. Because generals separated by distance must rely on messengers, which requires time and trust, no general can be certain that the other general has received and confirmed the message, let alone that it is accurate.
This issue is resolved by making a public ledger accessible via the Internet. Every transaction’s amounts, times, and public addresses are recorded in the ledger. The information is shared globally and is continually updated. The ledger ensures the system’s integrity and enables the currency unit to be transformed into a digital form of property with a title.
Once this is understood, it becomes clear that the value proposition of bitcoin is tied to its associated payment network. Mises’ reference to use value can be found here. It is not rooted in the unit of currency, but rather in the brilliant and innovative payment system on which bitcoin thrives. If it were possible to separate the blockchain from bitcoin (which, in reality, is impossible), the currency’s value would immediately drop to zero.
Evidence of concept
To further comprehend how Mises’ theory relates to bitcoin, it is necessary to comprehend an additional aspect of the cryptocurrency’s history. On the day of its release (January 9, 2009), bitcoin was worth exactly zero dollars. Thus it remained for ten months following its release. Throughout this time, transactions were occurring, but the posted value never exceeded zero.
The first Bitcoin price was published on October 5, 2009. $1 was worth 1,309.03 bitcoins on this exchange, which many considered overpriced at the timehis exchange, which many considered overpriced at the time. In other words, bitcoin was initially valued at slightly more than one-tenth of a penny. Yes, if you had purchased $100 worth of bitcoins back then and not sold them in a panic, you would be worth $500 million today.
Therefore, the question is: What occurred between January 9 and October 5 of 2009 to give bitcoin a market value? Traders, enthusiasts, entrepreneurs, and others were experimenting with the blockchain. They wanted to know if it was effective. Did it transfer the units without spending them twice? Did a system that relied on voluntary CPU power suffice to confirm and verify transactions? Do the bitcoins that are awarded as payment for verification services arrive in the correct location? Most importantly, did this new system actually accomplish the seemingly impossible, i.e., the secure movement of title-based information across geographic space without the use of a third party but rather peer-to-peer?
Ten months were required to develop confidence. It took another 18 months before bitcoin and the U.S. dollar reached parity. This history is crucial to comprehend, especially if you rely on a theory of money’s origins, such as Mises’ regression theorem, that speculates about the prehistory of money. Bitcoin was not always a valuable currency. Once, it was a purely accounting unit connected to a ledger. This ledger possessed “use value,” as defined by Mises. Thus, every condition of the theorem is satisfied.
To summarize, if someone claims that bitcoin is based on nothing but air, that it cannot be a currency because it has no real history as a genuine commodity, regardless of whether they are a novice or a highly trained economist, you must bring up two key points. Bitcoin is not a currency in its own right, but rather an accounting unit attached to an innovative payment network. Two, this network and, by extension, bitcoin only obtained their market value through real-time market testing.
In other words, once the glitzy technical features are taken into account, bitcoin looks exactly like any other currency, from salt to gold.People found the payment system to be beneficial, and the accompanying accounting was portable, divisible, fungible, durable, and scarce.
A new form of currency was created. The addition of a weightless and spaceless payment network that is trustworthy and verifiable in real time enables the entire world to trade without the need for third parties.
However, take note of something vitally important here. The blockchain is not limited to monetary transactions. It pertains to any data transfer that requires security, confirmations, and absolute assurance of authenticity. This applies to all types of contracts and transactions conducted peer-to-peer.
Certainly, the industry has become dominated by third parties that primarily serve as custodians. The crucial point is that this is a consumer-driven market development that is not required for the system to function. In addition, thousands of additional tokens now operate and compete in the crypto sector, which has a market capitalization of $560 billion at the time of writing.
Imagine a world devoid of necessary third parties, including the most dangerous third party ever conceived by man: the state and the central bank. Imagine this future, and you’ll start to understand how big the implications of our future are.
Bitcoin would amaze and surprise Ludwig von Mises. However, he may also take pride in the fact that his monetary theory from more than a century ago has been validated and given new life in the twenty-first century.