What Gives Cryptocurrencies Value?
Crypto critics often claim that digital coins such as Bitcoin, Ethereum, Litecoin, among others have no real value. The argument is that since these coins do not exist in the real world, and a government or central bank does not back them, they cannot be valuable as currencies.
But how true is this? Do cryptocurrencies really have value? If they do, how is this value determined? Here we seek to answer these questions, so read on to find out.
First, what gives any Currency Value?
A successful currency must meet the following qualities:
• Store of Value
Money is only useful if it can be relied upon to maintain its value over time without depreciating. In the past, items like shells and precious metals were used as currency due to their relatively stable value.
Currently, most currencies are known as fiat currencies (e.g. NZD, USD). A commodity does not back fiat currency, and the government issues it. Most societies accept fiat currencies because they are durable and less likely to lose their value or deteriorate over time.
Supply is key to the maintenance of the value of a currency. Anything that is considered a currency needs to be scarce; otherwise, it will have no value.
An excellent example of a scarce currency is gold. There's a small amount of gold worldwide, which is why this metal has been a means of exchange for tens of decades. The supply of fiat currencies such as the NZ Dollar is controlled by central banks and organisations such as the Federal Reserve hence ensuring that they retain their value.
Currencies were developed to enable people to trade units of the currency for goods and services. Utility is, therefore, a vital requirement for any effective currency.
Utility requires that it be possible for individuals to exchange a unit of currency for goods or services and that the currency be easy to carry from one point to another. Cumbersomeness is one of the reasons why people prefer fiat money and cryptocurrencies to coins minted from metals.
A successful currency must be divisible into smaller units for it to work as a medium of exchange across different types of goods and values in an economy. A divisible currency can accurately reflect the value of all the products available in the marketplace.
For currencies to be useful, it must be easy to transfer them between the participants in the economy.
Now that we know what it takes for something to be classified as a currency let us look at what cryptocurrencies are and what gives them value.
What are Cryptocurrencies, and What Gives them Value?
A cryptocurrency is a digital currency that is not governed by a central authority. Unlike fiat currencies which are minted by central banks, crypto coins are (usually) decentralised, making it difficult for them to be controlled by any one individual.
The value of a cryptocurrency is influenced by a variety of factors that relate to its supply, demand, usage, mass adoption, the strength of the coin's blockchain network, among other factors.
Let’s explore each factor in details:
• Supply and Demand
The prices of cryptocurrencies are governed by laws of supply and demand which cannot be influenced by authorities such as price-setting monopolies and governments. Digital currencies represent a form of a free-market economy in which the forces of supply and demand determine the prices of different coins.
These forces drive the value of a coin towards a point of equilibrium where any authority cannot influence it. However, cryptocurrencies are still relatively young, and they are yet to reach this point of balance. Also, since the crypto market does not have a central body that regulates it, it is still suffering from chaotic fluctuations.
• Security of the cryptocurrency’s network
The other significant factor that influences the value of a cryptocurrency is the level of security of its underlying system. The security of a network is determined by the number of decentralised nodes, among other factors.
Networks that have many nodes that are owned by many different entities or individuals are more secure, and their coins are more valuable than those from networks with a few nodes.
The overall hash rate of the network also affects the security of a crypto coin. The network’s hash rate is an indication of the number of computer resources used in confirming the transactions in the network and ensuring its security.
For instance, the Bitcoin network has the largest hash rate out of all other cryptocurrencies. This is one of the reasons why Bitcoin is the most expensive cryptocurrency.
• Mass Adoption and Regulation
The value of a cryptocurrency rises once it begins to be used as a payment method. As more businesses accept payments made using a particular cryptocurrency, more people will start using that digital asset. This is especially so because the transaction fees of digital currencies are way more affordable than those of fiat currencies.
Increased use means increased demand which leads to an increased value of the cryptocurrency, especially in the face of fixed supply.
Regulation by governments is also a factor that can significantly increase the value of cryptocurrencies. The law will play a significant role in driving cryptocurrencies into the mainstream, which will further enhance their value.
• Production Cost
The direct and opportunity costs involved in the production of a cryptocurrency also influence its value. For instance, the cost of producing bitcoin is very high. Bitcoin’s value is a result of the number of resources and energy that is invested in mining the coin. These costs include the costs of manufacturing the specialised hardware required for mining such as GPUs, CPUs, and servers as well as cooling systems for such equipment.
Additionally, these systems require significant amounts of energy for them to operate. Previous research has shown that it costs between 400 million dollars and 600 million dollars in electricity to mine Bitcoin every year.
Although such energy usage might seem wasteful, it is the only way to protect the bitcoin blockchain from being shut down by institutions such as the government, hence making the blockchain safe. Programmers are, however, looking for ways in which they can make the process more energy-efficient.
What makes Cryptocurrencies Better than Fiat Currencies?
• Protection Against Fraud
Cryptocurrencies cannot be counterfeited due to the robust underlying technology. What’s more, unlike credit card chargebacks, with cryptocurrencies a transaction cannot be reversed to the sender.
• Open to Anyone
Today there are about 2.2 billion people who have no access to traditional currency exchange services. Since cryptocurrencies are digital, and almost everyone owns a smartphone, they enable you to access financial services regardless of your location.
• Lower Transaction Costs
Cryptocurrency transaction costs are meagre when compared to average bank transfers. It costs about US$40 for an outgoing wire transfer. There is hardly any fee for crypto exchanges since the network compensates miners.
Instead of relying on one main system hosted in one location, cryptocurrencies are decentralised using blockchain technology. This means that there is no one central authority that can be hacked or manipulated.
Final Word on What Gives Cryptocurrencies Value?
All said and done, cryptocurrencies present a unique economic model designed to resist manipulation by any entity.
The long term value of cryptocurrencies will be affected by factors such as mass adoption and the values that they bring to our everyday lives.
Whether governments and central banks accept the new technology or fight against it will also be a great factor in determining the value of cryptocurrencies. Usability and safety will also play a role.
All these factors make it difficult to predict the future value of cryptocurrency, but it brings an exciting twist for investors and crypto traders.
About the author:
Jay Jackson is a blockchain enthusiast and a freelance writer at topcryptowriter.com. He works closely with brands (people, businesses and startups) in the crypto sphere. He currently writes Blog posts, Guides, Press releases, ICO reviews, eBooks & Whitepapers. You can find him on LinkedIn.
The above references an opinion and is for informational purposes only. Do not take this as personalised financial advice or investment advice. The views expressed by the author do not necessarily represent the opinion of BitPrime.
Last updated: 25/01/2020