Where The Value of Bitcoin Really Comes From
The secret of Bitcoin’s price swings.
I got into an argument yesterday with a co-worker — the argument, you guessed it, is the ‘value’ of Bitcoin. He argues that Bitcoin isn’t backed by anything; he argues that there’s “nothing behind it” because it’s not tied to anything per se, and Its price can never be justified pragmatically.
This is an open letter to anyone in his camp — anyone who believes that a digital currency doesn’t have intrinsic value.
Enter: The Network Effect
… the phenomenon by which the value or utility a user derives from a good or service depends on the number of users of compatible products.
We can observe the Network Effect with social network-oriented businesses like Facebook, Uber, and Airbnb. These services gain exponential value from Network Effects. However, they are not the only entities that benefit.
A currency's value is proportional to the number of individuals who hold said currency.
So with Bitcoin, as more individuals buy it (irrespective of purchase amount), its value increases.
It’s sort of common sense. If no one accepts your currency, then you can’t buy anything with it, and thus it’s completely useless. As more people accept the currency, what you can buy with the currency and who you can buy it from increases.
Another illustration of this phenomenon can be seen within the language. The utility you get out of speaking Spanish is incredibly high because millions of people worldwide speak Spanish. The same can be said of Arabic, (Mandarin) Chinese, French, and, oh yeah, English.
When we’re talking about language, it’s even easier to see how the utility of a language is directly proportional to the number of individuals who speak it.
Well, money talks and Bitcoin is just speaking its first words. In essence, network effects increase the demand for Bitcoin. While network effects increase demand, systematically increasing network difficulty reduces supply. Once we see the larger framework at play, the question begins to shift from “Why is Bitcoin’s price going up?” to “Why wouldn’t it?”.
I concede this explanation is sort of a Catch-22, in that it essentially asserts that the price of Bitcoin goes up because more people hold Bitcoin. You’ll logically ask yourself, “Okay, then why are more people buying Bitcoin then?” You might be satisfied to hear that “[u]pon critical mass” the network effect can often catalyze the bandwagon effect:
As the network continues to become more valuable with each new adopter, more people are incentivised to adopt, resulting in a positive feedback loop
So next time someone asks why Bitcoin’s price just shot up, show them this graph, then this one.
