If you had invested $1,000 in Bitcoin just five years ago, you’d be sitting on roughly $100,000 today. If you’d taken an even bigger chance and decided to invest $10,000, you would currently be a millionaire.
Of course, hindsight is always 20/20. Bitcoin network was launched as a peer-to-peer payment alternative to traditional payment methods using the cryptographic protocol. While Bitcoin (BTC) is used to send and receive its units of currency. It was the world’s leading cryptocurrency in 2009, but there’s no doubt that Bitcoin had an incredibly volatile history.
In 2017 and 2020, the coin’s value experienced unpredictable price swings, often fluctuating by fifty percent in less than a week. The uncertain value of Bitcoin has always been a deterrent for prospective institutional investors, though those with higher risk tolerances have, in fact, benefited.
Even today, twelve years into the coin’s fascinating history, asking “What determines the value of Bitcoin?” is a reasonable question. An economist might tell you, “The value of Bitcoin at any given point in time is whatever people are willing to pay for it.” And though that answer might not be exceptionally useful, it would be accurate. The value of Bitcoin, like that of any fiat currency—including the very dollars in your pocket—is dictated by the forces of supply and demand.
Below, we’ll discuss the most important things you need to know about how the value of Bitcoin is determined, including why the value of this unique digital asset is often difficult to quantify.
What Are the Problems Bitcoin Is Trying to Solve?
The 2008 global financial crisis revealed that Wall Street had created deep-seated problems with subprime mortgage securities. The result was large-scale government bailouts of the existing financial system. Banks were thought of as too big to fail, and the way to get them out of trouble was considered to be printing more fiat money, which would likely also devalue currencies.
As an alternative solution, the pseudonymous figure(s) known as Satoshi Nakamoto came up with the seminal Bitcoin white paper. The idea was to create a digital currency that wouldn’t fall under the control of a centralized institution.
Here are the problems Bitcoin was intended to fix:
- Inflation: Inflation in economics is a loss of the purchasing power of money. Partly due to repeated excessive money printing, countries are starting to experience widespread inflation, with the value of their cash dropping drastically. Bitcoin is inherently deflationary and decentralized. It can be stored, transferred and hidden safely. Bitcoin has found widespread popularity as a potential hedge against inflation.
- Transferability: Bitcoin solves the global problem of delayed money transfers. Traditional money transfers — especially international ones — involve high fees and can take days. With Bitcoin, you have complete control of your money and can transfer it to another party at any time. There are no borders, no bank holidays and no bureaucracy that delays regular transfers.
- Lower fees: Bitcoin transfer fees are lower than those charged for fiat currency transfers. More importantly, the value of the Bitcoin being transferred doesn’t significantly affect the transfer fee.
- Security: Bitcoin transactions are secured by a network of computers around the world. Transactions are irreversible, secure and publicly verifiable on the Bitcoin blockchain.
- Transparency: The transparent nature of the technology makes it impossible for any individual or group to control or manipulate the blockchain. This makes Bitcoin a “trustless” method of payment that does not require clearance through a third party.
What Is Intrinsic Value?
Intrinsic value describes the inherent or fundamental value of an asset or commodity. Crude oil, for instance, is a commodity that can be turned into valuable products, such as gasoline and plastics. Its fundamental value comes from the demand for those goods.
In the past, currencies were backed by gold and other metals, which gave them intrinsic value. However, today’s world currencies are mostly paper money, without backing by physical goods. Fiat money’s value lies in the understanding that it is a globally accepted means of exchange for goods and services.
Understanding Store of Value
A store of value is an asset, currency or physical commodity that is storable, retrievable and exchangeable. It should retain its value with time or even appreciate.
For example, gold and similar precious metals are stores of value, as they can be stored indefinitely without deterioration. The same, however, can’t be said for a banana — because it would be pretty much useless in a few weeks.
Bitcoin vs. Fiat Currencies vs. Gold
Throughout much of history, gold and fiat currency have been the standards for money. But unlike the global currency like the US dollar or any other national currency, there is no central bank or institution influencing the value of Bitcoin. Instead of relying on the actions of a federal government and its partners, Bitcoin or digital currencies generally rely on blockchain technology to stabilize its value.
With the introduction of Bitcoin and blockchain technology in 2009, Satoshi ushered in a new standard. In terms of value, how does Bitcoin match up to traditional fiat currencies and gold?
Why Fiat Currencies Have Value?
Fiat money is backed entirely by faith and trust in the government that issued it. This is in contrast to the commodity money that preceded it. Commodity-based money could be redeemed for the precious metals behind it, which give it value. So what makes fiat money valuable?
Technically, fiat currency like the US dollar has no intrinsic value. Its value lies in the public faith and creditworthiness of the government that issued it. Fiat currency only has value because society has decided it does.
How Does Gold Derive Its Value?
Gold is considered valuable mostly because people have always accepted it as a means of exchange. Throughout history, gold has been valued due to its appearance and scarcity. In recent times, gold has also acquired industrial uses, making it even more valuable. Consequently, gold can be said to have intrinsic value, unlike fiat money.
Why Does a Digital Currency Have Value?
Like fiat, cryptocurrencies’ value primarily depends on society’s trusting it as an acceptable means of exchange. But cryptocurrencies are different, and their values also depend in part on their features.
Some cryptocurrencies like Ether (ETH) derive their value from the utility: the ability to gain access to a specific platform or service. The higher the demand for an underlying service, the more valuable the token’s utility. For instance, the booming NFT market and decentralized finance (Decentralized Finance (DeFi) takes the decentralized concept of blockchain and applies it to the world of finance. Build...) play a significant role in Ether’s meteoric surge.
What Contributes to Bitcoin’s Value?
Bitcoin’s value derives from several factors.
Supply and Demand
The value of Bitcoin is directly affected by supply and demand. As with any market-priced good, its price increases with rising demand or limited supply, and decreases when demand falls relative to supply.
Bitcoin has a finite supply, and the rate at which new coins are being created is predictable. The number of buyers and sellers in the market at any given time is not easy to predict. As a result, Bitcoin can be known for its extreme price volatility.
Bitcoin was designed to have a supply cap of 21,000,000 BTC, with the last Bitcoin expected to be mined around the year 2140. After that, it won’t be possible to mint new bitcoins. This predetermined quantity of Bitcoin supply establishes it as a scarce asset.
Other traditional stores of value, like gold and oil, are also relatively scarce. But new reserves are still being discovered, and no one can confidently say the exact amount of those commodities that will be in circulation in the future. Thus, their scarcity is difficult to evaluate.
Bitcoin, on the other hand, theoretically becomes deflationary once all 21 million coins have been mined. It’s expected that some bitcoins will be lost and permanently removed from the total supply. This will reduce the supply and increase Bitcoin’s value. This is another factor that gives Bitcoin its value: the idea of its scarcity.
This takes us to Bitcoin’s “stock to flow” (S2F) model, which seeks to measure the relationship between the currently available stock of a commodity or asset and its production rate. When applied to Bitcoin, the model argues that Bitcoin’s low flow and scarcity make it an asset that keeps its value long-term. However, Bitcoin valuation cannot be based on this model alone. There are other factors which account for the value of this crypto asset.
Since Bitcoin is structurally designed to be finite (you cannot simply “print” more Bitcoin overnight), as long as it has any sort of utility (such as the ability to buy things), it’s expected to have tangible value.
One feature that gives Bitcoin some of its value is the ability to move large amounts of money quickly, anywhere in the world, without the use of intermediaries or central authority approval. In addition, Bitcoin transfer fees are relatively low and aren’t correlated to the amounts being transferred. This means that transferring $100m worth of Bitcoin isn’t going to cost you significantly more than transferring $1,000.
Cost of Production
A practical approach to valuing Bitcoin is based on its cost of production. The total cost to produce a unit of Bitcoin is made up of the cost and efficiency of the mining rig and operational expenses.
The “cost of production” model explains how Bitcoin’s price correlates with the cost of producing it. A new Bitcoin is generated through a process called “Bitcoin mining.” Individuals who processed verified transactions and secured the Bitcoin network will be rewarded with a certain amount of BTC as an exchange for their contributions.
Thus, the more efficient a mining hardware is, the more BTC a miner will get. However, a more efficient mining rig leads to a drop in production costs, while a Bitcoin block reward halving event doubles the production cost. This halving occurs because of a stipulation in Bitcoin’s source code that the number of bitcoins released in each block is reduced by 50% every four years.
This brings us to an interesting question: What happens to the value of Bitcoin when all 21,000,000 coins have been mined?
Bitcoin enjoyed a first-mover advantage by solving the problem of forming a consensus without a centralized party. Its methodology has paved the way for other crypto projects to follow. With relatively higher name recognition, Bitcoin has remained the dominant crypto in The market capitalization (or market cap) of a cryptocurrency is a measurement of its market value. In other words, it... since its introduction in 2009, despite creating thousands of new cryptocurrencies.
However, competing crypto projects like Ethereum (ETH), Binance Coin (BNB), and Cardano (ADA) are becoming more popular with investors, gradually closing the gap. More adoption of these altcoins — backed by their utility — could signal a decline in popularity and usage of Bitcoin, which could mean a loss of value for BTC.
Fungibility is the concept of sameness among units or subunits of a commodity. It means that the individual units are interchangeable.
Fungibility is an important characteristic of Bitcoin because it might be more difficult to value if each Bitcoin were unique and required its own market price. Instead, a Bitcoin or unit coming from anywhere is expected to have the exact same value, regardless of its origin or source.
Bitcoin is built on a decentralized blockchain ledger system which is almost impossible to forge and manipulated. Since the Bitcoin protocol is based on collaboratively maintaining the Bitcoin ledger. That means each transaction needs to be confirmed only after the participating nodes validate it through a joint consensus. These efforts made Bitcoin’s blockchain ledger system transparent, which also means that any attempt to fake a Bitcoin transaction will require the Herculean task of confusing the majority of Bitcoin’s vast network players.
In theory, the only way Bitcoin can be counterfeited is by executing a “double-spend,” in which a user creates duplicate records to spend the same Bitcoin multiple times.
However, the only way double-spending can be effectively carried out is through a 51% attack: a group of miners must control more than 50% of all network power and dominate the entire network in order to falsify records. What makes this impossible in the real world is the sheer amount of computing power, money, and effort required to pull it off. The secure nature of the Bitcoin network is one of the factors that give it intrinsic value.
The Struggles to Quantify the Real Bitcoin Value
Quantifying the actual value of Bitcoin and other digital assets is a problem that has befuddled economists and investors alike. Bitcoin exists only as bits of code in a vast computer network. To top it off, when compared to most “traditional” investments — namely, stocks, bonds and real estate — Bitcoin is remarkably volatile.
Volatility describes the manner in which a speculative asset’s value changes over time. Assets with high levels of volatility can create lucrative opportunities for investors, though volatility also increases one’s overall exposure to risk.
If you hope your investment will double in a short amount of time, you should also be aware that this investment could be halved (or worse) in an equally short period. This principle remains true for Bitcoin, other cryptocurrencies (altcoins) — and just about everything else.
As mentioned, 2017 and 2020 were the most volatile years for Bitcoin, with each wave of volatility simultaneously attracting a new batch of risk-seeking investors, even as risk-averse investors turned away. In exchange for accepting this volatility, Bitcoin investors who were able to time their market entries adequately have been heavily rewarded.
Is Bitcoin currently overpriced? Underpriced? Accurately priced? Unfortunately, there is no way to know until after the price trend has unfolded. Several factors combine to make Bitcoin a uniquely volatile currency — including Bitcoin adoption and laws and regulations.
The utility of Bitcoin—how useful it is in “real life”— depends on where the coin is accepted. In an increasingly digital and globalized economy, cryptocurrency or Bitcoin adoption has gained momentum over time, though there have certainly been some bumps in the road along the way.
According to the Global Crypto Adoption Index, “Global crypto adoption has taken off in the last year, up 881 percent, with Vietnam, India, and Pakistan firmly in the lead.” These three countries comprise about twenty percent of the world’s population. However, crypto adoption has been taking off elsewhere worldwide, including the Ukraine, Nigeria, and Venezuela (whose national currency is in crisis). While it seems clear that crypto adoption by financial institutions is moving in a positive direction, the rate of adoption is still difficult to predict.
Laws and Regulations
Actions from national governments and regulators can also have a strong impact on the value of Bitcoin. When governments make it more difficult to trade the coin — whether through additional taxes, burdensome regulations on a decentralized network, or the reclassifications of assets — the coin subsequently loses value.
On the other hand, increasing the flow of Bitcoin can cause it to gain value. In the United States, the SEC has recently indicated it will likely change how Bitcoin is regulated — although the lack of a clear plan, once again, leaves investors uncertain about the coin’s relative value.
So, is Bitcoin a Good Store of Value?
Whether Bitcoin can be considered a “good store of value” depends on how each investor defines the term. If you ask a financial advisor, they’ll likely say that Bitcoin is not a good store of value due to the coin’s high volatility.
However, if you ask someone whose only goal is to have more money in ten years than they do now, Bitcoin might be considered a great store of value — the coin, after all, is generally rising in value over time. If you can ignore the noise surrounding its price movements, it may be a worthwhile investment.
Bitcoin is a volatile asset with a general upward trajectory. Determining the value of Bitcoin can be problematic, especially because of changing regulations and market developments.
As time goes on, the increased acceptance of Bitcoin — coupled with structural limitations regarding its supply — could make the coin inherently more useful. All else being equal, this means Bitcoin is likely to continue its upward price trajectory as long as the cryptocurrency ecosystem is sustainable.
Of course, things are not always as simple as they seem. Very few people can forecast what Bitcoin will be worth in a year with any real degree of confidence. Nevertheless, it’s clear that this unique digital asset has changed the global economy and how we think about asset valuation.
Still, will Bitcoin be the future official global currencies with the growing everyday transactions? That still remains a question we all ponder.