The Truth about Bitcoin & Cryptocurrency

When I got my first satoshis a couple of years ago and decided to jump into the blockchain life, I had a whole different idea about cryptocurrency (and money itself) that's why if we're going to have a discussion about the value of ₿itcoin we must first explore the nature of money and the history of currency. Let's begin by reviewing the basics about money and cryptocurrency.

What is money and why does currencies have value?

Money (as we knew it) can be defined as a current medium of exchange in the form of banknotes and coins. We can also say that money is a commodity accepted by general consent as a medium of economic exchange. It is the medium in which prices and values are expressed. It circulates from person to person and country to country, facilitating trade, and it is the principal measure of wealth.

Money is any object that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally, a standard of deferred payment.

Currencies have value because they can function as a store of value and a unit of exchange.

There are six key attributes to a useful currency: scarcity, divisibility, acceptability, portability, durability, and resistance to counterfeiting (uniformity). These qualities allow a currency to find widespread use in an economy. They also limit monetary inflation and ensure that the currencies are secure and safe to use.

It's important to notice that the measure of value in a currency has changed over centuries from physical attributes to the velocity of its use in the economy nowadays.

Currency is useful if it works as a store of value or, to put it differently, if it can reliably maintain its value over time. Throughout history, many societies used commodities or precious metals as methods of payment because they were considered to have a relatively stable value.

Rather than carry around cumbersome quantities of cocoa beans, gold, or other early forms of money, societies eventually turned to minted currency as an alternative. The first such currencies used metals like gold, silver, and bronze, which had long shelf lives and little risk of depreciation.

Assigning value to currencies is a matter of debate. Initially, their value came from intrinsic physical properties. For example, gold's value comes from the costs of extraction and certain qualitative factors, such as luster and purity content.

In the modern age, government-issued currencies often take the form of paper money, which does not have the same intrinsic scarcity as precious metals. For a long time, the value of paper money was determined by the amount of gold backing it. Even today, some currencies are "representative," meaning that each coin or note can be directly exchanged for a specified amount of a commodity.

The idea of a currency's value began changing in the 17th century. Prominent Scottish economist John Law wrote that money—currency issued by a government or monarch—"is not the value for which goods are exchanged, but the value by which they are exchanged."

In other words, the value of a currency is a measure of its demand and its ability to stimulate trade and business within and outside an economy.

After countries abandoned the gold standard in an effort to curb concerns about gold supplies, many global currencies are now classified as "fiat".

Fiat currency is issued by a government and not backed by a commodity, but rather by the faith that individuals and governments have that others will accept the currency.

Today, most major global currencies are fiat. Many governments and societies have found that fiat currency is the most durable and least susceptible to loss of value over time.

The value of fiat currencies is a function of their demand and supply. The U.S. dollar is considered valuable because the world's biggest economy uses it and it dominates the flow of payments in international trade.

What is a cryptocurrency?

Cryptocurrency is a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority.

They allow payments to be made electronically and function in a similar way to standard currencies that use physical cash. However, unlike standard currencies that can be exchanged physically using notes and coins, cryptocurrencies are only exchanged electronically using lines of computer code.

How are cryptocurrencies different from standard money?

Most "paper currencies," such as the euro, have legal tender status. This means the currency is the country’s officially recognized currency, and must be accepted as payment of a debt.

Cryptocurrencies on the other hand, do not have legal tender status. This means there is no legal obligation for them to be accepted.

The Value of Digital Currencies

Gold was useful as currency due to its inherent physical attributes, but it was also cumbersome. Paper money was an improvement, but it requires manufacturing and storage and lacks the mobility of digital currencies. The digital evolution of money has moved away from physical attributes, and towards more functional characteristics.

Why do ₿itcoins have value?

Bitcoin (BTC) is often referred to as a digital currency and as an alternative to central bank-controlled fiat money. However, the latter is valuable because it is issued by a monetary authority and is widely used in an economy. Bitcoin's network is decentralized. Bitcoin's are created and controlled using a technology known as “blockchain” or “distributed ledger technology”.

A good way to understand Blockchain technology is to think of it like one big public file – or ledger – that is shared and stored across a huge network of computers. This file contains all the transactions made using the cryptocurrency. Because it is publicly shared and its contents validated by so many different people, it makes it virtually impossible for anyone to include a fraudulent transaction on it, but still, the cryptocurrency is not used much in retail transactions.

So, is bitcoin a currency?

A common question relating to bitcoin (and other cryptocurrencies) is whether it is a currency and if it can function as money. A well-functioning currency has the following three functions:

• Store of value

• Unit of account

• Medium of exchange.

Bitcoin struggles to meet these criteria for the following reasons:

• Store of value

  To be a store of value, a currency should be stable over time. Due to large price fluctuations, this is not the case for bitcoin.

• Unit of account

  A unit of account means that the money should allow us to easily form an understanding of the value of goods and services, and allow us to compare them to each other. The volatility of bitcoin makes it difficult to perceive it as a unit of account.

• Medium of exchange

  A medium of exchange means money should facilitate buyers and sellers to make transactions. In some ways, bitcoin fulfills this condition – as buyers and sellers can use it for some transactions. However, limitations such as slow transaction speeds, high transaction costs, as well as bitcoin’s unstable value make it difficult for it to properly function as a medium of exchange.

In general, bitcoin, and cryptocurrencies are more like very high-risk, speculative assets than a standard currency.

One can argue that Bitcoin's value is similar to that of precious metals. Both are limited in quantity and have select use cases. Precious metals like gold are used in industrial applications, while Bitcoin's underlying technology, the blockchain, has some applications across the financial services industries. Bitcoin's digital provenance means that it might even serve as a medium for retail transactions one day.

One of the biggest issues is Bitcoin's status as a store of value. Bitcoin's utility as a store of value depends on 2 things: how well it works as a medium of exchange and if it can maintain its value over time. If Bitcoin does not achieve this two requirements, it will not be useful as a store of value.

El Salvador is betting that Bitcoin's technology will evolve sufficiently to become a medium for daily transactions and became the first country to make Bitcoin legal tender exactly one year ago, on Sept 7, 2021.

Is Bitcoin Money?

While Bitcoin has several money-like features, economists and regulators remain unconvinced that Bitcoin currently acts as money. This is because relatively few transactions are conducted in Bitcoins and very few things are denominated in Bitcoins. While people may trade Bitcoin in large volume and transfer value across the network, little commercial activity still takes place.