Where do bitcoins come from? From the WeUseCoins.com video it appears they are just being produced by "miners" and sold to people. So who backs Bitcoin or gives it its value?
Although individual bitcoins enter the Bitcoin economy as miners are rewarded for processing transactions, it's much more helpful to think of all 21 million bitcoins as having been created when Satoshi Nakamoto defined the Bitcoin protocol and launched the Bitcoin network in 2009.
The reason for this is that the Bitcoin protocol specifically defines and controls when and how a limited total number of coins are rewarded to miners for the job of securing the Bitcoin network. These "bitcoins" are really just mathematical tokens which are very carefully controlled by the network protocol to prevent counterfeiting, theft, etc.
By agreeing to use these mathematical tokens as money, the larger Bitcoin community is essentially "backing" their value and turning them into a currency in the same way traditional African and Asian societies used the money cowry despite the absence of any central bank. Unlike the money cowry:
Presumably, the members of the Bitcoin community who choose to accept them as money consider these features to be worth something, and value the bitcoin accordingly based on supply and demand on open currency exchanges.
Because bitcoins are given their value by the community, they don't need to be accepted by anyone else or backed by any authority to succeed. They are like a local currency except much, much more effective and local to the whole world.
So to sum up, bitcoins come from the Bitcoin community's agreement to follow a set protocol, and are backed by everyone who uses them as money.
The value comes from their scarcity. To use something as a medium of exchange, it only has to have a certain set of properties. Bitcoins have these properties, so they can be used as a medium of exchange.
They are fungible. That is, 10 bitcoins is 10 bitcoins. This makes Bitcoins more useful as a medium of exchange than, say, apples, which vary widely in quality, size, and so on.
They are scarce. The number of bitcoins is predictable over time.
They are easily transferred. They are not easily counterfeited.
That's pretty much all you need. Nothing needs to back them just like nothing backs gold. The primary purpose of a backing is to ensure scarcity. But the block generation algorithm does that for Bitcoins.
Bitcoins are just ledger entries. Like all modern currencies they are not backed by anything, but have value based only on their usefulness and their supply.
The addition of bitcoins into the money supply is controlled by the bitcoin software and is limited to a pre determined amount and rate of distribution.
The reason mining causes new bitcoins to be created is two-fold. On the one hand it's a mechanism to introduce bitcoins into the money supply that is controllable and essentially random (like winning little lotteries). On the other hand it motivates people to run the mining software which helps to secure the entire system.
Like fiat money, the valuation of BitCoin stems from its changing share per unit of world GDP transacting in it - the share of world economic activity expected to transact in BitCoin vs. the supply of BitCoin. Consider what gives fiat money value: is it the “faith in and credit of” the issuing government or its quantity relationship to real GDP? The CPI or purchasing power (valuation) of fiat money is clearly determined by its supply relationship to real GDP wherein excess money vs. production of goods and services determines the CPI. Figure 1: U.S. M3/Real GDP vs. CPI 1981-2006 (latest date for M3 available data from Fed)
The period of CPI trending above the ratio of M3/real GDP coincided with massive (in relation to GDP) increase in foreign investment in the U.S. A broader measure would look at the world stock of dollars vs. world transactional share of GDP in dollars. This can be done for gold during the pure world gold standard. When gold was the money supply under the pure Gold Standard, and CPI was measured in relation to gold, the same determinant of the CPI held. The world above ground gold stock/world real GDP vs. World CPI relationship demonstrates this in Figure 2. Figure 2: World Gold Stock/World Real GDP vs. World CPI 1820 – 1913 Pure Gold Standard
This article does not deal with the effects of political agendas as they may aid or impede transactions in BitCoin or technical issues relating to the security of either BitCoins themselves or the code generating them; but rather strictly with the economics of BitCoin valuation. The former most certainly can in a moment remove large swaths of GDP from BitCoin transaction and thus move its price in relation to the share of GDP change – as China recently did. The U.S. dollar, gold, and BitCoin are world media of exchange since, in fact, transactions are taking place denominated in each of these media globally. The fundamental economic differences are that the growth rate of the stock of gold and BitCoin (the latter having a finite future maximum quantity) are less than the growth rate of world real GDP and are thus deflationary (inherently grow in purchasing power). Some may question this assertion about gold in view of its historic price swings and may choose to read my Seeking Alpha articles on gold and published academic journal papers to see why. BitCoin has a further economic distinction from both fiat money and gold: its global acceptance curve as a medium of exchange is just beginning. Thus, its price is mostly a function of the share of world GDP accepting it in relation to supply. Fait money and gold in contrast have reached acceptance maturity. At a current market cap of $7.1 billion (see www.bitcoinwatch.com) and an estimated world GDP of about $88 trillion, its share of world GDP acceptance may be in the range of .000081. A simple model of the potential value of BitCoin, other factors (which are crucial and beyond scope here) aside, may be built as shown below where if the world GDP acceptance share of BitCoin was 1%, its price per unit would be about $40,000 if its supply was also at its maximum 21 million units. Of course, by the time the maximum is reached, world GDP is likely to be much greater and the transaction share may be greater.
While there are other factors affecting the valuation of BitCoin, which factors also affect the price of gold, they are minor in relation to its global acceptance growth curve. Those other factors include the real yield, fiat exchange rates, the expected world inflation rate and the cumulative world inflation rate. Other digital currencies may affect BitCoin valuation to the extent they compete for world transactional acceptance by offering attributes such as superior technical, security and transactional ease features or compliance with regulatory requirements.
Although a simple question, "What gives Bitcoin value?", the answer is not as simple as the question. What gives Bitcoin it’s value, can best be answer by the formula
PB = (SW + TX) / BC
The value of a Bitcoin is derived from the total value of the Bitcoin used for storage of wealth (SW) plus the total amount of the Bitcoin required for concurrently transacting in it (TX). The sum of these two numbers divided by the amount of Bitcoins in circulation (BC) (currently 12.2 million, ultimately 21 million), will give you the price of Bitcoin (PB).
There are estimates of the total amount of gold in existence (mined) in the $10-13 Trillion range. If $1 Trillion (10%) of the amount of wealth that would have gone into gold, instead lands in Bitcoin, that would increase the price of Bitcoin to ($1Trillion + TX) / 12.2 million, or by $83,000 per Bitcoin. Remember, this leaves out the TX component, which will further increase the price of Bitcoin. Over time, funds will shift from other asset classes being used for wealth storage to Bitcoin.
There are many advantages to storing wealth in Bitcoin as opposed to specifically gold, for example, as you can divide Bitcoin into very tiny pieces (difficult with gold) and you can send Bitcoin to someone on the other side of the planet within minutes (impossible with physical gold). These use cases illustrate why Bitcoin is a good alternative for gold (and other assets) for storage of wealth.
From a transaction perspective, as more citizens, businesses, and governments transact in Bitcoin, the amount of ‘wealth’ that must be placed into Bitcoin must be large enough to allow these transactions to happen.
For example, if it becomes common place for real-estate purchase payments to be processed via Bitcoin, then the amount of value in Bitcoin required to allow this to happen will need to be as large as the current working set of real estate transactions in progress. This logic applies to online sales and brick and mortar sales. If, on a daily basis, $250 Billion is required to allow all Bitcoin transactions to occur, the Bitcoin price only in terms of TX requirements, is $20,500.
The price of Bitcoin (PB) = (SW + TX) / BC. SW and TX will both change as time passes. In geek terms, SW, TX, and BC are functions of time f(t). Therefore to more accurately predict the price of Bitcoin, you need to estimate these two components for a given time, and then divide by the number of Bitcoins in circulation. BC can easily be obtained from many websites and is updated live.
Bitcoin works well as a storage of value and for financial transactions, therefore it will often be used as a substitute for both currency as well as common wealth storage assets (e.g., gold). Bitcoins utility (global register – the block chain) is what makes this possible. The worth of Bitcoin comes into play because of this utility, wealth storage and transactions will happen ontop of this platform. And using the formula above, the price of Bitcoin (PB) can be computed by estimates of these two quantities.
The value of bitcoin is created by demand and offer by the need of market.
If you want deeper estimation let assume two hypothetical examples:
Because the number of bitcoins is restricted, let divide the bitcoins equally among people.
317,161,000 / 21,000,000 = 15.10 BC. In this hypothetical example has every American 15.10 BC and it correpsond to 3800$ of saving. It implies:
Let estimate another hypothesis.
1245.5$/Troy ounce = 40042.825 $/kg
Price of all gold in the world is 40,042.825* 171,300,000 = 6,859,335,922,500$
If we replace the gold with the bitcoin, we get price:
21,000,000 / 7,127,000,000 = 0.0029BC
It means that median saving amount of people is only 0.0029BC. It includes babies and poor people in Africa, India..
With three different (unreal) hypothesis and very simple estimate and we can get three different prices.
The question is not very well worded, but I this article is the best response to the question of "What backs Bitcoins?"
protected by Community♦ Mar 18 at 7:07
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