The price of a single Bitcoin has seen a massive increase since the cryptocurrency was first introduced in 2008 — with big ups and downs along the way. It climbed to an all-time high of around $60,000 in April, and has continued fluctuating since.
Despite the volatility, Bitcoin continues to draw interest from investors for its long-term record of building and maintaining value. But unlike a stock, which has value because it represents part ownership of a company, or even a bond, which represents the value of a debt you’ll be repaid upon maturity, it can be harder to pinpoint the value created by a decentralized, digital currency with such a short history.
These swings can make investors wary, but also beg the question — why does Bitcoin have value in the first place?
Bitcoin as Currency, and Why Currencies Have Value
Currencies have value because people think they do, and societies or groups have decided they are going to be used as a medium of exchange.
Fiat currencies became widespread after the elimination of the gold standard (which mandated that every dollar be backed by a holding of physical gold). Fiats — like the U.S. dollar — aren’t backed by any commodity, and have value because a broader system or society accepts that they do.
For example, you can take a $20 bill to the store and purchase $20 worth of goods, time, and effort. But the physical piece of paper that you use to pay holds no inherent value.
Bitcoin, a cryptocurrency that was created and released by a pseudonymous figure by the name of Satoshi Nakomoto, has some characteristics of a store of value that resemble existing currencies like the U.S. dollar or Japanese yen:
- Limited supply: Bitcoin’s maximum supply is 21 million. There will never be any more than 21 million Bitcoin. To many experts, this limited supply, or scarcity, is a big contributor to Bitcoin’s value.
- Cannot be copied: Because Bitcoin operates on a blockchain ledger, no one can counterfeit a Bitcoin. The blockchain keeps track of the transactions and ensures the system continues to operate based on the original rules put forth by Satoshi Nakomoto.
- Transportable: Bitcoin is extremely transportable. You can easily move it from one exchange account or digital wallet to another.
- Transferable: Bitcoin is relatively easy to transfer to another user or merchant. You just need to know someone’s public key (wallet address) to send them Bitcoin.
All of these factors help establish Bitcoin as a type of currency, but they do not explain Bitcoin’s exponential price growth and unique appeal as a store of value. Cash savings aren’t considered a good investment strategy after all — typically, your U.S. dollars will see considerably more value growth in an investment vehicle than saved as cash. Even among cryptocurrencies, Bitcoin is unique for its value. Someone could make another type of digital asset, with all of the same properties, and it may not ever have any value (in fact many have tried and failed). So why Bitcoin?
Why Does Bitcoin Have Value?
In short, Bitcoin has value “because people think it does,” says Bryan Routledge, associate professor of finance at the Tepper School of Business at Carnegie Mellon University. “And if that sounds kind of unstable and goofy, it’s because it is.”
People believe Bitcoin will one day be worth more than it is today, which increases their demand for it, and its value continues to grow, similar to gold.
“Gold is just dirt that people decided that, OK, this dirt that is kind of shiny, it has value to people,” says Kiana Danial, author of “Cryptocurrency Investing for Dummies.” “Humans assign that value to gold, to your $100 bill. The $100 bill doesn’t itself have value. We assign that value to it.”
Like gold, you can’t (usually) walk into a store and transact directly with Bitcoin, but you can buy and hold it. But gold has one property that Bitcoin doesn’t — at least not yet: it’s been around much longer, so its lasting value has been proven time and again.
“What you want to know is, in a year from now, will your Bitcoin be recognized as a Bitcoin?” says Routledge. The answer to that, Routledge says, depends on the future of blockchain technology and a belief that that technology will continue to gain mainstream popularity.
What Do Investors Need to Know?
The price of Bitcoin fluctuates a lot, and it’s impossible to know whether it will continue to rise in value or fall into obscurity, which is why it’s smart to allocate only a small percentage of your overall assets to Bitcoin. Experts recommend keeping any cryptocurrency investments to less than 5% of your portfolio, just like any other speculative investment. And don’t invest in any cryptocurrency at the expense of other financial goals like having an emergency fund or saving for retirement.
Similar to gold, people buy Bitcoin “not because they expect to be able to go to the store and spend it, but because they expect it to hold its value,” Galen Moore, director of data and indexes at crypto news outlet Coindesk, told NextAdvisor recently.
But Bitcoin is only the most famous among thousands of different cryptocurrencies. Other cryptocurrencies come with different considerations for investors.
Bitcoin Value vs. Other Cryptocurrencies
If Bitcoin is digital gold, then Ethereum, the second-largest cryptocurrency by market cap, is more like oil. And like oil, its value is connected to its real-world uses — even if those uses haven’t quite made it the mainstream.
[READ MORE]: Ethereum: What You Should Know Before You Invest
Oil itself is valuable, but you can also invest in oil futures on the commodities market, or invest in stocks representing oil companies and energy technologies. Similarly, cryptocurrency investors might invest in Ethereum, which has a native currency called ether.
The Ethereum blockchain serves as a basis for innovation and development in the cryptocurrency space — from digital art sales using NFTs to decentralized peer-to-peer lending. So its currency, ether, has an inherent value: access to that network, says Routledge.
Ethereum may have a clearer inherent use case where Bitcoin does not, but that does not mean it’s guaranteed to maintain or increase its value. With thousands of different cryptocurrencies all claiming to address some unmet need or opportunity, experts recommend keeping your crypto investments to the main two cryptos— Bitcoin and Ethereum. Still, all cryptocurrency assets are unregulated and speculative, and there’s not enough data to make any sort of concrete predictions about how your investment may grow in the future.