Why Bitcoin has Value

Get a foundation in why investors from all sorts of backgrounds value Bitcoin.

Ian LeViness

2021-05-14 6 min read

With the dizzying amount of opinions that exist on cryptocurrencies today, it can be truly difficult to get down to the truth. If you're just diving into the crypto-sphere, then it's best to kick-off your journey with understanding why Bitcoin has value because through that lens, you'll find it easier to grasp all of the intricacies of other cryptocurrencies and projects that came after it. 

With that being said, if you're ready to take the plunge, read on!

Bitcoin: The Genesis

Traditional money is flawed. All it really represents is a government's debt to us and we never really own the money we earn. Don't believe me? Look up how the banking system works. Whether you live in the USA, Europe, or elsewhere, it's all the same. You deposit money and the bank lends out most of it. In the USA, this amounts to 90 or even 100% of what you put in. Additionally, you don't really own the money you leave with a bank, it does, because it's your "custodian." That means they're authorized by law to hold your money for you and keep it safe.

Without getting too lost in the weeds for now, this sort of system is called "fractional reserve banking" and it's broken, not only because of the above, but because if enough people go to a bank at once and close out their accounts, then there won't be enough cash on hand to do that. 

Bitcoin started us on the road towards fixing both banking and money.

Back in 2009, a pseudonymous developer named Satoshi Nakamoto launched the Bitcoin network, which you can think of as a mini-internet for money run by a group of computers owned by all sorts of different individuals. In other words, as it's said in crypto circles, Bitcoin is a peer-to-peer, decentralized, currency network. To me, the easiest way to understand why Bitcoin matters is to think of it like a bank, transfer system, and currency mint, all rolled into one and all run by a group of people living all around the world with no shared relationship except that of keeping Bitcoin going. Hence, the "peer-to-peer" aspect of crypto's pioneer, since Bitcoin isn't controlled by any single company. 

To get the basics of how Bitcoin works, it's enough to understand two things. First, all of the network's data is stored on a special shared database called a blockchain. A blockchain only accepts data as valid if a special subset of users solve a highly complex mathematical problem to prove it is so. In Bitcoin's case, these users are called miners because they race to be the first to group transactions on the Bitcoin network into "blocks," which refers to the fact that only one group of up to 1 megabyte of transactions can be added to the network's database at a time. The first miner to run transactional data through what's called a "hashing algorithm" correctly wins 6.25 bitcoins, which is called the block reward. All in all, the block reward has always been the only way that new bitcoins are created. If you think of the hashing algorithm as a machine that turns normal transactional data like the date, origin account, and amount into a secret code, then you've got the gist of it. Now imagine that to transform that data correctly and record it on Bitcoin's blockchain, you have to solve a very complicated math problem, in fact, so complicated that expensive, specialized computers are required to do so. So, with this improved understanding, we can circle back to the block reward, which is really just an incentive for miners to keep validating transactions and in turn, keep the network secure. 

But, I don't get it. Why does this block reward have any value?

I like to put bitcoins into a four-fold model:

1. When a transaction is pushed through from one cryptocurrency wallet to another, it goes into something called the "mempool." From here, miners pick out the transactions they want to try to put into a block first, based on those that offer them the highest fees. Yes, you heard that right. The Bitcoin network has transaction fees and they're paid solely to miners, since they're the ones keeping the lights on. Because the mining process also creates all new bitcoins, it can be said that bitcoins gain their first, foundational value through "mining difficulty," i.e., the perceived energy spent to mine a block. 

2. As Bitcoin grew in popularity, businesses called "crypto exchanges" began to populate around it. Think of them like the stock-trading apps for cryptocurrencies. You make an account, then start trading Bitcoin and other cryptocurrencies with other people all around the world. Because of the spread of these trading venues, Bitcoin has become more and more driven by simple behavioral factors, i.e., supply-and-demand. One added framework you can use to understand this is if more people that buy and HODL bitcoins and less people sell them, their value tends to grow(like stocks, to an extent). 

3. Bitcoin's event-driven. Historically, when a lot of positive news comes out about Bitcoin, it tends to do well, whereas when negative events surface (even false ones from time-to-time), it tends to experience price dips that can last for hours, days, or even months. This is because, all in all, it's early yet and the Bitcoin market is still thinly-traded, despite the fact that its market cap continues to hover at/around $1 trillion. Generally, the consensus is, amongst most experts, that the more institutions that buy into its value, the less it will drastically move based on market news.

4. The fourth pillar of our model leads us into today. The more it has persisted, the more Bitcoin has demonstrated a powerful level of potential as a store-of-value. To find out what that means, read on below! 

Where We Are Today

Today, the digital gold narrative drives Bitcoin adoption, above all. Like gold, Bitcoin is scarce and has demonstrated a high annualized return-on-investment over the course of its' history, in spite of the movements of more traditional assets like stocks and bonds. From May 2018-May 2021, for example, Bitcoin maintained a 74.21% annualized return, adjusted for inflation. If you're not familiar with what annualized means here, just think: "the average added money earned over each year of a specific time period." Now compare that 74.21% average to the S&P500's historical yearly average ROI, which is 10%, and you'll begin to see where Bitcoin's status as "digital gold" comes in. 

Still, digital gold suggests a better, or at least, more internet-native form of gold and to determine Bitcoin's status in that respect, we need to bring "analog" gold into the picture. For centuries, people have used gold to store value, especially when times got tough. Between 1971 and 2019, gold posted an average ROI just north of 10%. Over the last two years, however, especially since COVID-19 surfaced, gold's posted an annualized ROI of 19.91%, adjusted for inflation. 

Circle back to Bitcoin's above and you get the picture. Despite its relatively short life-span, it has demonstrated a consistent ability over the long-term of being the world's best store of value and institutions are just starting to notice, with Square, MicroStrategy, Blackrock, MassMutual, and more than 40 other companies and even governments deciding that Bitcoin's worth at least a bit of risk. What's most interesting about this institutional adoption, in my mind, is that it has largely all occurred over the past year as Bitcoin reached closer and closer to a $1 trillion market cap. So, to me, even though the first 11+ years of Bitcoin's existence saw it rise from $0 to just north of $50,000(today), it's the next decade that will be even more exciting. Whatever changes come, there's no indication that Bitcoin's driving value proposition as "digital gold" will change at all.

It's just too perfect a moniker for an asset that lives in its' own financial system and has the potential to insulate people from financial difficulties in other markets for years to come. As time goes on, I'll share more and more to paint as detailed a picture I can of Bitcoin's value. For now, however, through keeping in mind all of the above plus the fact that only 21 million bitcoins will ever exist, you've got a good baseline in what makes Bitcoin valuable to people from all walks of life.

With all I do here, I'm aiming to bridge the gap between those who are already crypto-native and the rest of the world. Think of me as the sherpa, leading the masses through to a wide understanding of all things crypto through all of the different perspectives I've gathered and continue to gather. If that interests you, reach out to me on Twitter with any thoughts, any time and stay tuned for much, much more!

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