There has been a lot of talk about how to price Bitcoin, and we set out here to explore what the cryptocurrency's price might look like if it achieves further widespread adoption. First, however, it is useful to back up a step. Bitcoin and other digital currencies have been touted as alternatives to fiat money. But what gives any currency value? Bitcoin offers an efficient means of transferring money over the internet and is controlled by a decentralized network with a transparent set of rules, thus presenting an alternative to central bank-controlled fiat money.
KEY TAKEAWAYS
- Currencies have value because they can be used as a store of value and a unit of exchange.
- Successful currencies have six key attributes—scarcity, divisibility, utility, transportability, durability, and counterfeit ability.
- The cryptocurrency bitcoin has value because it holds up very well when it comes to these six characteristics. However, its biggest issue is its status as a unit of exchange, as most businesses have yet to accept it as payment.
- Bitcoin's utility and transferability are challenged by difficulties surrounding the cryptocurrency storage and exchange spaces.
- However, if bitcoin gains scale and captures 15% of the global currency market (assuming all 21 million bitcoins in circulation), the total price per bitcoin would be roughly $514,000.
Why Currencies Have Value
Currency is usable if it is a store of value, or, put differently, if it can reliably be counted on to maintain its relative value over time and without depreciating. In many societies throughout history, commodities or precious metals were used as payment methods because they were seen as having a relatively stable value. Rather than requiring individuals to carry around cumbersome quantities of cocoa beans, gold, or other early forms of currency, societies eventually turned to minted currency as an alternative. Still, many examples of minted currency were usable because they were reliable stores of value, having been made out of metals with long shelf lives and little risk of depreciation.
Aside from whether it is a store of value, a successful currency must also meet qualifications related to scarcity, divisibility, utility, transportability, durability, and counterfeit ability. Let's look at these qualities one at a time.
1. Scarcity
The key to the maintenance of a currency's value is its supply. A money supply that is too large could cause prices of goods to spike, resulting in economic collapse. A money supply that is too small can also cause economic problems. Monetarism is the macroeconomic concept that aims to address the role of the money supply in an economy's health and growth (or lack thereof).
In the case of fiat currencies, most governments worldwide continue to print money as a means of controlling scarcity. Many governments operate with a preset amount of inflation, which drives the value of the fiat currency down. In the U.S., for instance, this rate has historically hovered around 2%.4 This is different from bitcoin, which has a flexible issuance rate that changes over time.5
2. Divisibility
Successful currencies are divisible into smaller incremental units. For a single currency system to function as a medium of exchange across all types of goods and values within an economy, it must have the flexibility associated with this divisibility. The currency must be sufficiently divisible to accurately reflect the value of every good or service available throughout the economy.
3. Utility
A currency must-have utility to be effective. Individuals must be able to trade units of the currency for goods and services reliably. This is a primary reason why currencies developed first: so that participants in a market could avoid having to barter directly for goods. The utility also requires that currencies be easily moved from one location to another. Burdensome precious metals and commodities don't easily meet this stipulation.
4. Transportability
Currencies must be easily transferred between participants in an economy to be useful. In fiat currency terms, this means that units of currency must be transferable within a particular country's economy and between nations via exchange.
5. Durability
To be effective, a currency must be at least reasonably durable. Coins or notes made out of materials that can easily be mutilated, damaged, or destroyed, or which degrade over time to the point of being unusable, are not sufficient.
6. Counterfeitability
Just as a currency must be durable, it must also be difficult to counterfeit to remain effective. If not, malicious parties could easily disrupt the currency system by flooding it with fake bills, negatively impacting its value.
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