The argument that bitcoin (BTC) has no value because it is not backed by anything physical remains one of the biggest misconceptions.
It’s an opinion perpetuated by the likes of billionaire tycoon Warren Buffet and former US president. Donald Trump — both of whom have already been quoted as saying that bitcoin has no value.
But now that bitcoin is among the world’s largest currencies in terms of market capitalization, the question remains: What is bitcoin’s backing?
What is the difference between bitcoin and national currencies?
Until quite recently (in the last century), most paper money and coinage could be directly exchanged for gold. That’s because many of the richest countries followed the gold standard, a currency system in which governments linked a fixed exchange rate for national currencies to gold.
As part of this system, countries maintained sufficient reserves of money in their vaults to back 100% their supply in circulation, ensuring that exchanges between currencies for gold were always possible.
But this also limited the economy in the midst of the Great Depression, as governments were not able to simply provide more gold to expand their supply and stimulate spending.
The system was abandoned by Australia and New Zealand between 1929 and 1930; by Canada, Germany and the United Kingdom in 1931; and the United States partially got rid of the standard in 1933.
However, it was not until 1971 that the United States really got off the gold standard after President Richard Nixon finalized the interconvertibility of the US dollar into gold, thus nullifying the Bretton Woods system and ending the gold standard era.
Instead, countries migrated to a fiat model, in which a national currency would not be backed by a commodity such as gold, allowing central banks to print more money when needed. Despite having no intrinsic value, the value of fiat money is defined by changes in supply and demand, as well as the strength of the government responsible for it.
Since governments only accept payment of fees in fiat currencies and tax evasion is illegal, their value is also partially maintained by the requirement to pay fees.
Although fiat currencies are not formally backed not at all, we tend to buy our fiat currencies with the confidence that they will be accepted elsewhere in exchange for goods and services. Basically, our reliance on fiat currencies generates purchasing power — and thus value — for fiat currencies.
But our reliance on fiat currencies suffers from an induction problem. In other words, we assume that a sequence of events will occur, as it always has, based on our previous experience.
We cannot say with certainty what will come next for the value of our fiat currencies. Without a currency being formally linked to a commodity such as gold, value becomes an uncertainty rather than a guarantee.
Is bitcoin backed by math?
Like the US dollar, bitcoin is not backed by a physical commodity, but derives its value in other ways.
Since bitcoin does not have a centralized entity that enforces its value and is not backed by a commodity, many people mistakenly believe that bitcoin is worthless.
But currently, bitcoin has an individual unit of value of around $21,000 and a total market capitalization — defined as the unit of value multiplied by the number of coins in circulation — of $400 billion, clearly demonstrating that it is regarded as valuable by a huge number of people.
But bitcoin is not backed by anything physical — only by complicated mathematical equations that underpin its blockchain technology and controlled supply. They ensure that bitcoin’s supply remains limited and resistant to censorship — which permeates part of its value.
As explained by Anthony Pompliano, a big supporter of bitcoin: “If you don’t believe in bitcoin, you’re basically saying you don’t believe in cryptography.” For Pompliano, blockchain technology provides an inherent value to bitcoin, almost like a gold standard for crypto.
The remainder of bitcoin’s value can be attributed to the fact that it was the first currency system to be successfully operated without the need for a centralized entity, i.e. its supply cannot be forcibly inflated, confiscated easily (as gold was in the 1930s) and offers a level of financial freedom that few (if any) national currencies can offer.
Bitcoin has always been shown to have utility value; thousands of merchants accept it as payment for goods and services. In two countries — El Salvador and the Central African Republic — bitcoin has been adopted as a currency, meaning traders have to accept it (although, in El Salvador, uptake was uneven).
The level of trust that exists in a currency can be indicated or preserved by its level of use around the world. If it’s performing well against other fiat currencies, the US dollar is — and will be, for the foreseeable future — a currency that can be spent almost anywhere. As a result, people have confidence in the dollar.
Purchasing power and practicality are valuable commodities.
On the other hand, bitcoin is still, in some ways, far from widespread adoption. The crypto community has come a long way since the first bitcoin transaction was spent to buy a pizza, but until mass adoption takes place, trust in bitcoin will not be as large or widespread as trust in national currencies.
Despite the obvious differences, bitcoin ends up being similar to a fiat currency because of the wide confidence of those who use it. As trust in the crypto sector increases, trust in bitcoin will also increase.
*Translated by Daniela Pereira do Nascimento with permission from decrypt.co.