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Bitcoin gets its value from many different features. Ultimately, both crypto and fiat currencies have value because they are trusted. As long as society believes in the fiat money system, money will continue to have value. The same can be said for Bitcoin: Bitcoin has value because users believe it, but there are other factors to consider.
Unlike fiat currencies, Bitcoin does not have a central bank and its decentralized nature has allowed the creation of a unique financial system. Blockchain technology offers a high level of security, usability and many other benefits. It also offered a revolutionary way of transferring value globally. Bitcoin can also act as a store of value, similar to gold in many ways.
One of the biggest challenges for crypto beginners is understanding how and why cryptocurrencies like Bitcoin (BTC) hold value. The coin is digital, there is no physical entity backing it, and the concept of mining can be very confusing. From one perspective, mining creates new bitcoins out of nothing. However, in practice, a very costly investment must be made in order to successfully mine. So how can all of this make BTC valuable?
Think about the money we all use on a daily basis. Our banknotes are no longer backed by gold or other assets. The money we borrow is mostly just numbers on the screen, thanks to fractional reserve banking. States and central banks such as the Federal Reserve can issue new coins and increase the money supply through economic mechanisms.
Although there are important differences, BTC as a digital form of money shows some similarities with the fiat money we are all used to.
Why does money have value?
In short, it is trust that gives money its value. Money is basically a tool used to exchange value. Any object can be used as money, provided its local community accepts it as payment for products and services. In the early days of civilization, all kinds of objects, from stones to seashells, were used as money.
What is fiat currency?
Fiat money is money that is issued and formalized by a government. Today, our society exchanges value using notes, coins, and digital numbers in our bank accounts (which also determine how much credit or debt we have).
In the past, people could convert their paper money into gold or other precious metals at banks. At that time, this mechanism ensured that the value of currencies such as the US dollar remained backed by an equal amount of gold. But the vast majority of countries have stopped using the gold standard, and this standard no longer forms the basis of our monetary system.
After being disconnected from gold, we now use fiat money unsupported by anything. This divergence has given governments and central banks more freedom to adopt monetary policies and influence the money supply. Some of the key features of fiat money are:
It is issued by a central authority or state.
It has no intrinsic value. It is not backed by gold or any other commodity.
It has potentially unlimited supply.
Why is fiat money valuable?
With the abolition of the gold standard, we now have a currency that has apparently no value. But the money is still used to pay for food, bills, rent and other things. As we mentioned earlier, money derives its value from collective trust. Thus, a government must strongly support and successfully manage fiat in order to be successful and maintain a high level of trust. Looking at the examples of Venezuela and Zimbabwe, we can easily see how the system deteriorates when trust in the government or the central bank is lost due to hyperinflation and unsuccessful monetary policies.
Why is crypto valuable?
Although cryptocurrencies have some common features with the standard money idea we have in mind, they also have important differences. While some cryptos like PAXG are indexed to commodities like gold, most cryptocurrencies do not have an underlying asset. Instead, trust again plays an important role in the value of a cryptocurrency. For example, people see Bitcoin as worth investing in because they know that others also trust Bitcoin and see it as a payment system and a medium of exchange.
For some cryptocurrencies, usability is also an important factor. You may need to use a service token to access certain services or platforms. Therefore, the token of a high-demand service will also be valuable. Not all cryptocurrencies are the same, so their values actually depend on the characteristics of each coin, token or project.
In the case of Bitcoin, we can narrow it down to six features that we'll talk about in more detail later: availability, decentralization, distribution, trust systems, rarity, and security.
What is intrinsic value?
Many debates about the value of Bitcoin are about whether this coin has intrinsic value. So what does this mean? When we look at a commodity such as oil, we see that it has intrinsic value in terms of energy, production of plastics and other materials.
Stocks also have intrinsic value in that they represent shares in a company that offers a product or service. In fact, many investors do fundamental analysis to calculate the intrinsic value of an asset. On the other hand, fiat money has no intrinsic value as it is just a piece of paper. As we mentioned earlier, fiat money derives its value from trust.
The traditional financial system has many investment options with intrinsic value, from commodities to stocks. Forex markets are an exception to this, as they trade in fiat currencies and traders often profit from short or medium-term currency fluctuations. So, what about Bitcoin?
Why is Bitcoin valuable?
The value of Bitcoin is a subjective subject where many different ideas are put forward. Of course, it can be said that the value of Bitcoin is its market price. But this does not fully answer our question. The main issue here is why people think Bitcoin has value in the first place. Let's take a closer look at some of the features that make Bitcoin valuable.
The value of Bitcoin in terms of usability
One of the main benefits of Bitcoin is its ability to quickly transfer large sums of value to anywhere in the world without the need for intermediaries. While it is relatively expensive to send small amounts of BTC due to transaction fees, it is also possible to send millions of dollars cheaply. Below you can see a Bitcoin transaction worth approximately $45,000,000 sent with a transaction fee of less than $50 (as of June 2021).
While Bitcoin is not the only network that makes this possible, it is the largest, safest and most popular network. Lightning Network also enables small transactions as a layer 2 application. But regardless of the amount, being able to make cross-border transactions is definitely valuable.
The value of Bitcoin in terms of decentralization
Decentralization is one of the most important features of cryptocurrencies. Blockchains eliminate central authorities, giving more power and freedom to the user community. Since Bitcoin is open source, anyone can help improve the Bitcoin network.
Even the monetary policy of this cryptocurrency works in a decentralized way. For example, the work of miners is to verify and confirm transactions, but they also allow new bitcoins to be added to the system at a predictable, stable rate.
Bitcoin's decentralization gives it a very robust and secure system. Nodes in the network cannot make decisions for everyone on their own. Group reconciliation is required for all transaction verifications and protocol updates. This protects Bitcoin from mismanagement and abuse.
Bitcoin's value in rarity
It is within the framework of Bitcoin that it has a limited supply of 21,000,000. No more new coins will be added as Bitcoin miners mine the last coin in about 2140. While traditional commodities such as gold, silver and oil are limited, new reserves are discovered each year. These discoveries make it difficult to calculate exactly how rare the commodity is.
After all BTCs are mined, in theory BTC should be deflationary. As users lose or burn coins, the supply will decrease, possibly causing prices to rise. Therefore, Bitcoin holders see great value in the rarity of the coin.
Bitcoin's rarity has also paved the way for the popular Stock-to-Flow model. This model tries to predict the future value of BTC based on annual Bitcoin mining and total stock. When tested retrospectively, the model has managed to model the price curve quite accurately to date. According to this model, the primary driver of Bitcoin's price is its rarity. A possible correlation between price and rarity causes Bitcoin holders to use the coin as a store of value.