Have you ever thought about why we hand people little pieces of green paper when we want to buy something? Or why we swipe a little plastic card across a black electronic device? Or why we write checks to landlords or babysitters? It’s really weird when you think about it long enough. None of these things has any value on its own. Something else allows buyer and seller to both agree that this ritual of giving and taking of non-valuable objects entails a concrete and objective value exchange. So what is it?
At its root, the government promises that the money we exchange is the value printed on it, and that it won’t ever change, and it is divisible (down to a fraction!), and there is a limited supply of it in circulation. And because we trust the government, we trust the promise on the paper. (Even if we don’t have any trust in the government.)
It’s really a shared delusion, a collective belief that something that has no intrinsic value has inherent value bestowed on it by a large, abstract entity that is itself made up of…us. Kinda freaky, right?
So how does cryptocurrency fit into all this?
I’m about to get into some monetary theory, which was not the original intent of this issue, but I think anyone who is interested in cryptocurrency ought to also be interested in what gives cryptocurrency its value, because if cryptocurrency does have value as both a store of wealth and a utility for conducting transactions, then it has incredible implications for society. And if it doesn’t, that would be good knowledge to have before deciding whether to invest in it.
But determining all that is a little like mapping an undiscovered country by first checking an existing map. It can be somewhat reductive, as the question which prompted this little detour demonstrates.
Someone asked me the following: “I want I know where the original amount of money that people used to "transact” came from… chicken and egg?“
The first Bitcoin was mined by its creator, Satoshi Nakamoto. That Bitcoin was initially worth practically nothing. Indeed, it was worth nothing until other users began to see the possible utility of the protocol, began using it themselves, at first to mine but later to also transact exchanges, and convinced others to do the same. Once the protocol and its currency began to be used widely, it gained utility, which drove its perceived value.
But you have to remember that Bitcoin is really just a encrypted public ledger. Each transaction is just a note in the ledger, and everyone on the network has a copy of the ledger. When a user sends Bitcoin to another user, they are not physically exchanging Bitcoins (no more than banks today send physical dollars from one account to another). Instead, a note in the ledger is made, indicating a deduction from one account and an increase in another account. Like all modern currencies, these ledger entries are backed by the community’s shared use of the protocol as measured against the total supply.
This exposes the challenges that cryptocurrencies have in overcoming institutional understanding of market value exchange. We are all used to asking, "What does this cost?” and think of the answer in terms of dollars, or euros, or yuan, or ruble, or some other national fiat currency. Because we see cryptocurrencies also valued in terms of fiat currency we expect their value is also somehow tied to that currency. But that’s misleading at best. Yes, we do place a dollar value on a particular cryptocurrency since, like any commodity or asset, we believe that it has value within the existing monetary system.
But, cryptocurrency has its own stored, inherent value, which is that it is worth what the people who use it believe it is worth. With Bitcoin specifically, 21 million coins will have been “mined” once the last block is sealed (sometime next century). This limit is called scarcity, and is one of the underlying characteristics of money.
Since bitcoins are just mathematical tokens, controlled by the network against counterfeit and theft, and are limited to a set supply, the Bitcoin community, in using them for transactions to exchange value, asserted that the value of the coin could be found in its utility, its scarcity, its fungibility and its divisibility. Because of these factors and the fact that it can be exchanged nearly instantaneously across the globe, Bitcoin carries its own internal value.
On an open exchange you can see Bitcoin’s value in terms of itself when measured against other cryptocurrencies, but you could just as easily compare the dollar’s value against a Bitcoin, instead of the other way around. We don’t normally do this only because of institutional inertia and the fact that in terms of lifespan, Bitcoin is still an infant compared to the dollar.
Because Bitcoins (and other cryptocurrencies) are ascribed value by their users, they only need to be accepted by anyone else who agrees to that same system of value or backed by an authority (central or decentralized) to succeed as a “currency,” in much the same way bartering or local currencies work.
But, this may not be the answer to the original question posed. Allow me to rephrase the question to bring to mind a different answer.
“How did Bitcoin first come to have value as a medium of exchange if no one was using it as a medium of exchange?”
This is the chicken/egg problem implied by the original question, and this is a well-known problem in money theory. There is a response to this, known as Misesian Regression Theorem of Money, which states:
We can trace the purchasing power of money back through time, until we reach the point at which people first emerged from a state of barter. And at that point, the purchasing power of the money commodity can be explained in just the same way that the exchange value of any commodity is explained. People valued gold for its own sake before it became a money, and thus a satisfactory theory of the current market value of gold must trace back its development until the point when gold was not a medium of exchange.
In short, the price of money (value) is determined by utility of money today, and the utility of money is determined by yesterday’s prices. This seems circular, until you introduce the element of time.
In order for money to emerge from a barter economy, it must have a pre-existing commodity value, either as a good or service, or–and this is important–as a means of money.
This arises from demand for the potential money in terms of direct consumption. This value seeds future estimates of the value of money as a medium of exchange.
Once an economy has been monetized and the pricing ratio for goods and services has been established (and the original memory of those goods and services barter exchange has been eliminated), money can lose its direct market commodity value and still be used as a medium of exchange. In other words, once the medium of exchange has been set, first from barter, then from memory of the barter value, then money prices continue to be set as long as that value holds for its users.
This is the principle that underlies all fiat currencies. Bitcoin initially served (and still can serve) as an intermediary for any national fiat currency, but with the perceived utility (anonymity, decentralization, cryptographic trust and encrypted transactions, predetermined rate of growth, built-in deflation, and low transaction fees (in theory!) inherent to the network, it’s easy to see why it can serve as its own currency, since it provides a common medium of exchange with its own internal value separate and distinct from any national fiat currency.
There’s lots of great books on the history and utility of money, its underlying mechanisms, and monetary theory (which I’ve only touched on here). I encourage you to check them out. Some good ones below: