The worth of currency used to be stipulated by precious metals. From 1879 until 1933, for example, Americans could trade the federal government $20.67 for an ounce of gold. For the United States, that all changed at the height of the Great Depression when America faced mounting unemployment rates and spiraling deflation. In 1933, President Franklin D. Roosevelt decided to cut the United States’ ties to gold, effectively allowing the Federal Reserve to pump more money into the economy than the federal government had the gold to back.
The United States now has what is called a “fiat” money system, meaning the dollar’s value is determined by faith, rather than a physical asset. The dollar, for example, is worth far more than the value of the ink and paper that it’s printed on.
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. 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 in the event 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 type of currency value?
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 methods of payment because they were seen as having relatively stable value. Rather than require individuals to carry around cumbersome quantities of cocoa beans, gold or other early forms of currency, however, societies eventually turned to minted currency as an alternative. Still, the reason many examples of minted currency were usable was because they were reliable stores of value, having been made out of metals with long shelf lives and little risk of depreciation.
In the modern age, minted currencies often take the form of paper money which does not have the same intrinsic value as coins made from precious metals. Perhaps even more likely, though, individuals utilize electronic currency and payment methods. Some types of currencies rely on the fact that they are “representative,” meaning that each coin or note can be directly exchanged for a specified amount of a commodity. However, as countries left the gold standard in an effort to curb concerns about runs on federal gold supplies, many global currencies are now classified as fiat. Fiat currency is issued by a government and not backed by any commodity, but rather by the faith that individuals and governments have that parties will accept that currency. Today, most major global currencies are fiat. Many governments and societies have found that fiat currency is the most durable and least likely to be susceptible to deterioration or loss of value over time.
Scarcity, Divisibility, Utility and Transferability
Aside from the question of whether it is a store of value, a successful currency must also meet qualifications related to scarcity, divisibility, utility and transferability. Let’s look at these qualities one at a time.
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 which aims to address the role of the money supply in the health and growth (or lack thereof) in an economy.
Successful currencies are divisible into smaller incremental units. In order 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 so as to accurately reflect the value of every good or service available throughout the economy.
A currency must have utility in order to be effective. Individuals must be able to reliably trade units of the currency for goods and services. This is a primary reason why currencies developed in the first place: so that participants in a market could avoid having to barter directly for goods. Utility also requires that currencies be easily moved from one location to another. Burdensome precious metals and commodities don’t easily meet this stipulation.
Currencies must be easily transferred between participants in an economy in order to be useful. In fiat currency terms, this means that units of currency must be transferable within a particular country’s economy as well as between nations via exchange.
To assess Bitcoin’s value as a currency, we’ll compare it against fiat currencies in each of the above categories.
Bitcoin Compared Against Fiat Currencies
When Bitcoin was launched in 2009, its developer(s) stipulated in the protocol that the supply of tokens would be capped at 21 million. To give some context, the current supply of bitcoin is around 18 million, the rate at which Bitcoin is released decreases by half roughly every four years, and the supply should get past 19 million in the year 2022. This assumes that the protocol will not be changed. Note that changing the protocol would require the concurrence of a majority of the computing power engaged in Bitcoin mining, meaning that it is unlikely.
21 million Bitcoins is vastly smaller than the circulation of most fiat currencies in the world. Fortunately, Bitcoin is divisible up to 8 decimal points. The smallest unit, equal to 0.00000001 Bitcoin, is called a “Satoshi” after the pseudonymous developer behind the cryptocurrency. This allows for quadrillions of individual units of Satoshis to be distributed throughout a global economy.
One of the biggest selling points of Bitcoin has been its use of blockchain technology. Blockchain is a distributed ledger system which is decentralized and trustless, meaning that no parties participating in the Bitcoin market need to establish trust in one another in order for the system to work properly. This is possible thanks to an elaborate system of checks and verifications which is central to the maintenance of the ledger and to the mining of new Bitcoins. Best of all, the flexibility of blockchain technology means that it has utility outside of the cryptocurrency space as well.
Generally, Bitcoin holds up fairly well in the above categories when compared against fiat currencies. So what are the challenges facing Bitcoin as a currency?
How Much Would Bitcoin Have to Be Worth to Rival Fiat Currencies?
In order to place a value on Bitcoin we need to project what market penetration it will achieve in each sphere. This article will not make a case for what the market penetration will be, but for the sake of the evaluation, we’ll pick a rather arbitrary value of 15 percent, both for bitcoin as a currency and bitcoin as a store of value. You are encouraged to form your own opinion for this projection and adjust the valuation accordingly.