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Why is Bitcoin so valuable?

Why is Bitcoin so valuable? How is it possible, that one bitcoin costs tens of thousands of dollars? The biggest obstacle in Bitcoin investing is the failure to understand its value drivers. This article gives multiple answers and views to this dilemma. It’s a beginner’s guide to understanding Bitcoin’s value.

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Bitcoin wasn’t always valuable

Let’s have a quick overview of Bitcoin’s history. As you might already know, Bitcoin was founded by Satoshi Nakamoto. The identity of this person is yet to be revealed. Satoshi Nakamoto is just a pseudonym used by an individual or a group of people.

Satoshi introduced the Bitcoin whitepaper on the 31st of October 2008. The Bitcoin blockchain was started on the 3rd of January 2009. This is the date generally considered Bitcoin’s birthday.

The first transaction was made in block number 170. Satoshi Nakamoto sent bitcoins to Hal Finney, who was one of the early participants in Bitcoin’s development. The word started to spread slowly in the cypherpunk community. In 2010, Bitcoin started to get traction among a wider audience.

Bitcoin began as an experiment. When Satoshi published the white paper in 2008, a handful of people had an interest in it. Many were skeptical due to dozens of failed digital money attempts done in the 90s and early 2000s. It wasn’t easy to believe that Satoshi’s idea was actually going to work.

Bitcoins were also worthless. It was like play money, and people used to send thousands of bitcoins for fun. There was no global market price defined in the early years.

Laszlo Hanyecz made history in 2010 by purchasing two pizzas with 10.000 bitcoins. This was the first time when bitcoins were used to purchase real-world items. It gave each bitcoin a value of 0.004 dollars.

There used to be even faucets, where anyone could earn free bitcoins. Faucets were browser-based games that gave you free bitcoins every x hour.

It’s estimated that two to three million bitcoins have been lost due to various reasons. Hard drives and USB sticks have been searched even from the dumping grounds. Many people regret the way they treated bitcoins in the early days. Now those coins could be worth hundreds of millions of dollars.

Bitcoin didn’t become valuable because of some magic trick. There wasn’t a government or central bank making it legal tender either, as it is with fiat currencies. Bitcoin has been traded in the free market since day one. It has value because millions of people believe it does.

What are the features making Bitcoin so valuable? Let’s find out!

Satoshi Nakamoto created digital scarcity

One of the most intriguing features is that everyone sees Bitcoin differently. A person living in the slums of Venezuela values different features than a Wall Street trader. Bitcoin is like a digital organism that changes and adapts to the surrounding world.

This is what makes the value debate so difficult. Bitcoin is valuable to different people for different reasons. However, there are some cornerstone features we can all agree on.

The most important value driver is scarcity. To be more precise, digital scarcity. This is a feature Satoshi Nakamoto was able to create for the first time in history.

It’s best understood by people, who are familiar with the history of digital currencies. Many newcomers think Bitcoin was the first digital currency. This is not true at all.

Satoshi Nakamoto created Bitcoin by combining existing technologies. He is not the inventor of blockchain or Proof of Work. For example, public-key cryptography dates back about 50 years. Merkle tree was patented in 1979.

One of the pioneers, David Chaum, developed DigiCash in the late 1980s. Different digital currencies were developed in the 1990s due to the rise of the internet. They all failed due to various reasons. One of them was that nobody figured out how to get rid of a central entity controlling the network.

Satoshi Nakamoto managed to combine existing information with technology, which fixed the errors of the past. The use of blockchain and Proof of Work mining made it possible to create a distributed ecosystem, where nobody was in control.

Satoshi is the one who set Bitcoin’s monetary policy. He made sure that Bitcoin would always be a store of value by creating a fixed supply. This was the first time in history a digitally scarce asset was created.

Bitcoin is the opposite of debt-based fiat money, which is designed to lose value over time.

It’s important to comprehend that Bitcoin isn’t just scarce. It will soon become the scarcest asset in history! Even gold will be left behind. The problem with gold is that the mining capacity can be increased when the price goes up. It’s all about allocating money and resources.

This is not possible with Bitcoin. Even if every computer in the world would begin mining, new coins were minted only every 10 minutes. The mining difficulty is automatically adjusted accordingly.

All this is secured by the Bitcoin network. It guarantees that nobody can mint bitcoins out of nowhere or manipulate the contents of wallets. Data in the Bitcoin blockchain is set in stone and it’s monitored by tens of thousands of nodes.

Bitcoin’s network effect

Many would agree that the network effect is one of the biggest value drivers of Bitcoin. What does it mean? Investopedia uses the following description:

The network effect is a phenomenon whereby increased numbers of people or participants improve the value of a good or service.

Think about a phone, for example. If you were the only person with a phone, it would have no value. Phones became valuable when there was one in every household. Suddenly, you could contact anyone in a matter of seconds.

Millennials can easily understand the network effect via WhatsApp. This app was created in 2009, just like Bitcoin. Nobody is sending traditional SMS anymore thanks to WhatsApp. Some of us can still remember the time when we tried to get our friends & family to download it.

whatsapp

WhatsApp is a free application, but worth tens of billions of dollars. Why? There are no monthly fees and it’s not even unique. You can easily find dozens of alternative messaging apps.

The value comes from its network of users. Facebook paid 16 billion dollars for WhatsApp in 2014. Facebook.com is also a free-to-use website with an almost trillion-dollar valuation. They are both immensely valuable because of the network effect.

If nobody was running Bitcoin miners or nodes, the technology would be worthless. That’s why there was little or no value in Bitcoin at the beginning. The network was small, and it was also vulnerable to attacks.

Now there are more than 100 million people, who have bought bitcoins. It’s no surprise that the value of Bitcoin has increased hand-in-hand with the number of Bitcoin wallets. The network hash rate (mining power) keeps also increasing year after year.

The power of the network effect can also be seen in the cryptocurrency market. There are over 10,000 publicly traded cryptocurrencies. Yet, Bitcoin’s market share has stayed strong.

Past years have proven, that it’s not possible to create a “better Bitcoin” by copying its program code and changing a couple of parameters. There have been numerous forks of Bitcoin, but they have all failed miserably in terms of network valuation.

Bitcoin’s distributed network

There is no way Bitcoin could have reached the network effect it has without exceptional technical qualities. Digital scarcity and network effect are the core value drivers of Bitcoin. Still, there has to be solid technology behind them.

One of the most important properties of Bitcoin is its censorship resistance. Anyone can download a Bitcoin wallet and send (or receive) coins using a mobile wallet. There is no entity that can stop you or block the transaction.

This is not the biggest selling point for a European or U.S. citizen in the 2020s. However, the world is full of countries where censorship resistance is extremely valuable.

The network is operated by tens of thousands of nodes, which are running the Bitcoin program code. This network is also permissionless. Anyone can download the open-source program and run a node.

bitcoin-nodes

The map shows the concentration of Bitcoin nodes globally. See the live data at bitnodes.io.

The permissionless and distributed nature of the Bitcoin network has made it so strong. There is no way Bitcoin could be hacked or destroyed. There is no central server or CEO to attack. Nowadays, Bitcoin transactions are even broadcasted in space!

Nodes are the ultimate controllers of the Bitcoin protocol. Miners are also important. They are the ones doing the blockchain maintenance work and minting new transactions to blocks. The price of one Bitcoin has increased hand-in-hand with the mining power.

If successful VCs are willing to invest hundreds of millions of dollars in Bitcoin mining farms, it should tell you something. This development has made Bitcoin’s network the world’s most powerful supercomputer. There is no other entity in the world, which possesses such computing power.

All this is run independently without central governance. Bitcoin blocks have been created for 10 years with amazing precision. The network keeps on running and creating blocks, day and night. The massive hash rate makes the blockchain virtually indestructible.

How can anyone look at this kind of infrastructure and see no value in it?

Bitcoin is a currency and a payment network

Bitcoin (cryptocurrencies) is a new asset class compared to alternatives. Gold has been used for thousands of years. Stocks have been traded for hundreds of years. Bitcoin is just taking its first steps as an asset. We don’t know the role it’s going to take over time.

Investors try to categorize Bitcoin, which is quite difficult. During the boom of 2017, Bitcoin was treated as currency. Its rivals tried to make the case of faster & cheaper transactions. This debate has disappeared. The narrative of Bitcoin has transformed into digital gold.

Publicly traded companies, hedge funds, and other institutions have started put bitcoin into their balance sheets. The most famous is Microstrategy with its CEO, Michael Saylor. He invested $175 million in his own money and $425 million in his company’s money in August 2020.

Today, Microstrategy owns more than 100,000 bitcoins.

If you want to understand the thought process of investing gurus, check the interview below.

The problem in categorizing Bitcoin is that people don’t understand what Bitcoin really is. It’s not just a currency or digital gold. Bitcoin is both an asset and a payment network. These two features cannot be separated.

Euros and dollars exist in bills and coins. A gold coin has value in the central park of New York and in the Amazon jungle. Euros, dollars, and gold can also be traded digitally on dozens of different platforms.

This is not the case with Bitcoin. It’s only valuable as the native currency of the Bitcoin payment network. You cannot print out bitcoins as bills like euros and dollars. You cannot mint it to coins and use them as payments. Bitcoin and the payment network are intertwined.

Earlier, you learned why the Bitcoin network is so valuable. This is what makes bitcoins (the currency) so valuable. You could compare Bitcoin to the HTTP protocol, which is the backbone of the internet. Or think of the SMTP protocol, which is delivering all your e-mails.

Bitcoin is the money protocol of the internet.

It’s difficult to categorize Bitcoin as an asset class because it’s both technological innovation and hard money. Bitcoin is like a golden ticket, which opens the doors to the internet of money. It gives everyone an opportunity to be their own bank and store their wealth in a scarce, digital asset. Many would argue that such a ticket is extremely valuable.

Money Printer Go Brrrr

Bitcoin was given birth on the ruins of the 2008 financial crisis. The timing is no coincidence. The financial crisis revealed painfully all the flaws that exist in our debt-based monetary system. Over 10 years have passed, but nothing has been fixed. Every “too big to fail bank” has become even bigger.

Central banks have created a zombie economy, where companies are kept alive with zero interest rates and endless debt. Manipulation of interest rates and money printing have destroyed the most important part of the free market: price discovery.

Gold has been a great investment since the year 2000. An increasing number of wealthy individuals have converted fiat wealth to gold, which has been a safe haven & inflation hedge for thousands of years. Some of this wealth is now diverting into Bitcoin.

As we mentioned earlier, all-digital currency experiments failed before Bitcoin. No one managed to create digital scarcity before Satoshi Nakamoto. Now we have entered a new world. Bitcoin is an asset that has never existed before in human history.

This is a fact that many investors have failed to understand. Even today, just a couple of percent of investors have realized it.

The year 2020 changed many minds, though. Massive money printing emerged after the covid crash, and it shows no signs of stopping. Investors have finally woken up to the fact that their fiat-based purchasing power is destroyed.

There are dozens of different memes created on social media. They are titled ‘Money Printer Go Brrr’.

money printer go brrr

This GIF is another popular version.

The crypto boom of 2017 was fueled by ICOs and retail investors. These are individuals making investments a size of $100 to $1000. The boom of 2020-2021 was boosted by institutional investors, such as Michael Saylor.

More and more investment gurus have come out and publicly praised Bitcoin. They are all shouting the same message: Bitcoin is 10x better store of value than gold.

The current macro situation couldn’t be better for Bitcoin. It’s also favorable for gold, but Bitcoin’s historical performance is so much better. It attracts more young investors, who appreciate the digital form. Bitcoins are much easier to buy and sell compared to physical gold coins.

Even a billion-dollar BTC transfer can be done like snapping fingers with a cost of $2. Try moving the same amount of wealth around the world in gold bars.

Bitcoin’s price potential

This article has listed different reasons for Bitcoin being valuable. The next question is: how valuable? How do you price Bitcoin? This is a question no one can answer with a high level of certainty.

Even if you would understand the value drivers, technology, and history of Bitcoin, it is not enough to give a fair price. How do you know if Bitcoin should be worth $100,000 or $10,000 or $1,000 per coin? Is it possible, that one bitcoin is eventually worth one million dollars?

We think there are two basic methods for estimating Bitcoin’s fair price. One is the Stock-To-Flow model, which has become extremely popular in the past years. It was developed by the pseudonym Plan B in early 2019.

Stock-To-Flow is not a perfect model of Bitcoin’s price development, but it is the best we have so far. The model is based on the increasing scarcity of Bitcoin, which is a result of halvings. These events occur every fourth year and they reduce the supply of new bitcoins by 50 percent.

There are dozens of videos about Bitcoin halving on Youtube if you want to learn more. Here’s one.

The point is that the Stock-To-Flow model has been right about Bitcoin’s price development in its entire history. Even when the model was backtested with old data, it would have been right about the price movements in the early 2010s. S2F predicts Bitcoin to reach $100,000 during the bull run of 2021/2022 and $1,000,000 four years later.

The second way to price Bitcoin is by measuring its market value against other asset classes. You’ll find a great visual overview from this article.

Bitcoin’s market cap is currently 600 billion dollars. Gold is about 10 trillion asset class. The value of all stock markets in the world is 100 trillion, the global debt is 250 trillion, and so on.

Many investors are comparing Bitcoin and gold. If Bitcoin would get even near gold in terms of market cap, the price of one BTC would go 10-15x from the current ~35,000 dollars. This means a price range of 350,000 to 500,000 dollars for one bitcoin (or even higher).

Final words

This article presented different reasons for Bitcoin to have value. It’s not a black and white case. Different people value different features.

There are many countries suffering from hyperinflation. For those people, Bitcoin could be literally a lifeline. It will be something else for a hedge fund manager on Wall Street.

Narratives also change over time. Nobody cares anymore if Litecoin and Bitcoin Cash are faster to do transactions with. Anyone, who sees Bitcoin as “outdated technology”, doesn’t understand its value drivers at all. Besides, the Lightning Network has already solved the micropayment problem for Bitcoin.

Even if opinions and narratives change, there are some things that remain constant. Bitcoin’s architecture and monetary policies have been set in stone. The fact that Bitcoin is so difficult to change is a particularly important feature for many investors.

Image by tom bark from Pixabay, Image by Thomas Ulrich from Pixabay

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