Lately in the headlines, Bitcoin has been causing quite a stir. As we mentioned in our video last week, people have been talking all about how the value has shot up, then crashed, and then recovered again. Aside from the stooges on CNBC, who else knows what a Bitcoin is, or how it works? Rest assured, Bitcoin is on our radar. While we neither recommend nor handle Bitcoin ourselves, we’re learning more and more about it and today we’d like to give a brief summary of what Bitcoin is and how it is valued, purely for informational purposes.
Back in 2009, Bitcoin was launched as the world’s first cryptocurrency. It is decentralized and private. No government has control over it, and there are no physical denominations or representations of it. It is an entirely digital currency. To really understand what this means, let’s take a brief moment to review some economics that relate to what currency is and how it is valued.
A currency can be loosely defined as “a generally accepted medium of exchange for goods or services.” In most cases, when we think of currency, we think of coins or banknotes. Money. While these are indeed currencies, commodities have also been used as currencies. Most commonly, we think of gold or silver here. Bear in mind though, anything could be used as a currency. In World War II POW camps, cigarettes were used as currency amongst the prisoners of war. In most cases, currency can be split into two categories; fiat money and commodity money. These two categories define how the money is valued. For our purposes of valuation and definition, we’ll be focusing on government-issued money as currency.
Look at a $100 bill. That little piece of paper is probably worth quite a bit to you, me, and many people around the globe. But why? After all, it’s just paper. There’s nothing really special about it, the paper itself isn’t worth very much to anyone. What is special, though, is what is written on the paper. This note is legal tender for all debts, public and private. The value of that paper lies in the power of the United States government. It has value because the government says it does. People accept United States Dollars because that currency has the full faith and backing of the United States government.
This type of money is called fiat money. The instruments (paper) themselves have no intrinsic value, but government decrees do. Many currencies around the world are fiat. The euro, yuan, Australian dollar… All have value because their respective governments say they do. Fiat differs from commodity money because, put very simply, commodity money needs no government backing to have value. If you took a solid gold coin, stamped a face on it, and offered it to someone as payment for a good or service (say, a sandwich), someone would take it. The same could not be said if you were to take some printer paper and write “$10” on it. The point here is that most all currencies either have intrinsic value as a commodity, or the backing of a government to give it value.
Bitcoin doesn’t fall into either category. It isn’t a tangible good, meaning you can’t go to an ATM and withdraw Bitcoins. You can’t touch them, feel them, or use them for anything practical. It has no value as a commodity. As we mentioned previously, it is also decentralized and private, meaning that it doesn’t have the backing of a powerful entity like the European Union or US government. Bitcoin is not widely accepted as legal tender. Why then, is Bitcoin valued so highly? Why is it valued at all?
For the answer, we have to look outside the usual means of valuing currency. To start, many people trade and use Bitcoin. Sheer popularity and volume of trades gives it some value. One of the reasons it is so popular is because Bitcoin transactions are incredibly difficult to trace. Bitcoin is used in many “dark” transactions concerning illegal goods or services because the government has an incredibly difficult time tracking these transactions. By this nature, there is another benefit; if the government can’t trace it to you, they can’t tax you for it. If someone seeks a degree of privacy that can’t be realized with traditional banking or trading methods, Bitcoin could be a fit. Another reason why it’s an attractive currency is because there is actually a cap on how many Bitcoins can be created. That cap is set at 21 million coins, and this serves as a natural defense against inflation. Once 21 million coins are in circulation, there will be no more. Finally, Bitcoin has value because it’s fun to some people. As many have seen, the value of Bitcoin has had incredible upswings and downswings lately, and to people who seek a thrill in investing, putting money into Bitcoin is only natural.
Our opinion at the moment? We simply don’t have one. Due to Bitcoin’s nature as an instrument whose value is seemingly derived simply from trading volume, popularity, and speculation (which cannot be proactively measured), it is not a security we can confidently recommend to anyone. It’s true that there are possible gains to be found with investing in Bitcoin. Beware, though, because there are losses to be found as well.
Again, we’d like to iterate that we do not recommend nor handle Bitcoin. We do think that it’s incredibly interesting to watch and learn about, which is why we’ve posted this article purely for informational purposes. This Bitcoin buzz has a lot of people interested, we’ll see how it all pans out!