We all have what feels like an intrinsic understanding of value, though it is actually learned as we come to know our world. A gold bar has value, an empty soda can, not so much. When we encounter new things it’s usually fairly easy to assess what kind of value they might hold, but Bitcoin is a different beast. Bitcoin is harder to define and understand, and for many beginning Bitcoiners the question of value is one of the most puzzling. So why does Bitcoin have value?
To begin, we really need to understand why anything has value. Fans of post-apocalyptic fiction will often point out that in the end, the only things of real value are those that sustain and defend life. Perhaps they’re right on one level, but with the rise of civilized societies things got a bit more complex, because the things that sustain and defend those societies also gain a certain degree of value. It is in this context that all moneys, Bitcoin included, gain their value. Since our societies rely heavily on trade and commerce, anything that facilitates the exchange of goods and services has some degree of value.
From Barter to Money
Imagine, for example, a pre-money marketplace where the barter system is king. Perhaps you’re a fisherman coming to mar- ket with the day’s catch and you’re looking to go home with some eggs. Unfortunately for you, the chicken farmer has no use for fish at the moment, so you need to arrange a complex series of exchanges to end up with something the egg seller actually wants. You’ll probably lose a percentage of your fish’s value with each trade, and you also must know the exchange rate of everything with respect to everything else. What a mess.
This is where money saves the day. By agreeing on one interme- diate commodity, say, silver coins, two is the maximum number of exchanges anyone has to make. And there’s only one exchange rate for every other commodity that matters: its cost in silver coins.
In truth there is more complexity involved—some things, like your fish, would make very poor money indeed. Fish don’t stay good for very long, they’re not particularly divisible, and depending on the exchange rate, you might have to carry a truly absurd amount of them to make your day’s purchases.
On the other hand, silver coins have their inherent problems too, when traded on extremely large or extremely small scales. This is what is truly valuable about Bitcoin: It’s better money.
The Evolution to Bitcoin
It’s been a long time since those first “hard” moneys were developed, and today we transact primarily with digital representations of paper currency. We imagine bank vaults filled with stacks of cash, but that’s almost never the case these days— most money exists merely as numbers in a database. There’s nothing wrong with this type of system, either; it works fantastically well in an age where physical presence during a transaction is not a given. The problem is that the system is aging and far too often plagued by incompetence or greed.
Every IT guy knows that from time to time you have to take a drastic step: throw the old system in the trash and build a new one from scratch. Old systems, such as our current monetary system, have been patched so many times they are no longer functioning as efficiently as they should.
We previously patched our problems with gold and silver by introducing paper banknotes. We patched further problems by removing the precious metal backing those banknotes, then patched them again and again to allow wire transfers, credit cards, debit cards, direct deposit and online billpay. All the cornerstones of modern life are just patches on this ancient system.
But what would you do if you had the chance to start over? What if you could make purely digital money based on modern technologies to solve modern needs? What if we didn’t need those dusty old systems or the people making absurd profits maintaining them? This is Bitcoin.
Replacement, Not Repair
Bitcoin isn’t another patch, another layer of abstraction added on top of an aging and over-complex system. Bitcoin isn’t another bank or payment processor coming up with new ways to move old dollars. Bitcoin is instead a simple, elegant and modern replacement for the entire concept of money. It has value for exactly the same reason as the paper money in your wallet: It simplifies the exchange of goods and services, not in the antique setting of a barter system bazaar, but in the current setting of modern Internet-enabled life.
“But that’s only why it’s useful,” I hear some of you saying. “Why does it actually have value?” The two-word answer is one most economists are familiar with: Network effect. The network effect is a lovely piece of jargon that refers to the quite commonsense statement that networked products and services tend to have more value when more people use them. The most common example is the telephone: During its early days when few people had access to telephones their utility, and therefore their value, were minimal. Today practically everyone has a phone, so their utility and value is so high as to be unquestionable. In this way the value of Bitcoin is directly tied to the number of its users and the frequency of their use.
Of course Bitcoin’s value stemming from the network effect is not without its own unique difficulties. When the network is still relatively small, each new group’s entry or egress can create massive price fluctuations, resulting in huge profits for early adopters. Unfortunately, this makes Bitcoin look, on the surface, too good to be true—a bit like a Ponzi or pyramid scheme.
Ponzis and pyramids are distinct and different forms of fraud, but they share one thing in common: The first ones in make a lot of money while the last ones in foot the bill. Both feature initial “investors” being paid out directly from new investors’ money. The return is always too good to be true and the gains (for those who actually get gains) are exponential.
Because Bitcoin’s value has risen so dramatically since its 2011 debut, it seems to fit this sort of a profile at first glance, but then so does every new technology. It’s just not normally the case that we get to invest in this sort of technology and profit as it’s adopted. Imagine being able to invest in the concept of email back in 1965 when some clever hacker at MIT found a way to use primitive multi-user computer systems to pass messages. It might have seemed like a silly waste then, but owning even a tiny percentage of the rights to email today would make one wealthy beyond imagining.
Technologies follow a known adoption curve, which tends to include a period of exponential rise. Bitcoin is no exception. Ponzis and pyramids both create value for their oldest investors by stealing from the new. There’s no economics involved—just theft.
Bitcoin creates value for the old investors and the new by splitting a finite currency supply more ways. That’s not trickery or theft, just good-old-fashioned supply and demand at work— a basic and ancient economic principle applied to the world’s newest currency system.
Originally published in yBitcoin Magazine.
David Perry is the author of the popular Bitcoin blog, “Coding In My Sleep.” When he's not breaking (or making) Bitcoin news, he can often be found moderating the Bitcoin StackExchange Q&A site, attending Bitcoin meetups and conventions, or tending to his Bitcoin mining operation.