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?

  • if there are only 21,000,000 bitcoins where/who do the mined bitcoins copme from? – user9947 Dec 2 '13 at 22:05
  • @Jonah There will only ever be around 21 million Bitcoins. Right now, there are fewer than that. The mined Bitcoins come from the mining process. Bitcoins are basically just numbers and the process of mining is the process of generating numbers. – David Schwartz Jan 10 '14 at 22:35
up vote 44 down vote accepted

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.

  • As we could see over the last days and weeks the Bitcoin protocol DOES NOT prevent theft. It is as easy to steal BTC as it is to steal cash. – Steffen Roller Mar 5 '14 at 15:29
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    The Bitcoin protocol certainly prevents theft in that it has stronger built-in security mechanisms than cash. Of course, if someone doesn't use those mechanisms properly (i.e. by securing their private keys), then the built-in mechanisms don't really help. Cash basically has no built-in anti-theft mechanisms except physicality. Bitcoin done properly is much more theft-resistant than physicality. Bitcoin done poorly is much, much less theft-resistant. – eMansipater Aug 9 '14 at 20:16

That is basically it. They have value because they are scarce, fungible (one Bitcoin is as good as another), easily transferred, and easily verified.

The only other component they need to have value is a general agreement that they will be used as a medium of exchange or a prevailing belief that they will be in the future. It is the variation in these two factors that accounts for most of the volatility in the value of Bitcoins today.

They aren't backed by anything because they're a commodity. What is gold backed by?

  • +1 it might be worth formatting the above as a list to ease quick scanning later – Gary Rowe Sep 7 '11 at 13:01
  • Gold is backed by having uses other than just as money. If gold was being used as money, but then it fell out of favor, it would still be useful for its industrial purposes and use as jewelry (which would limit how low gold could go.) – DJG Mar 9 '14 at 20:18
  • @dg123 Right, but that limit is so low as to be of no practical value. It's also creates two disadvantages to using gold as a currency. First, if those uses change in popularity, the value of the currency will change. Second, the cost of gold for those uses is artificially inflated by the use of gold as a currency, which discourages economically efficient uses of gold. – David Schwartz Mar 9 '14 at 20:18
  • This answer has been moved to this question through merging an exact duplicate question into this one. It might need slight editing to fit here. – Murch Oct 31 '14 at 9:43

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.

  • "The primary purpose of a backing is to ensure scarcity." good! – osmosis Dec 9 '11 at 19:47
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    Gold backing a currency does more than just ensure scarcity. It also sets a floor value for how low a unit of currency can go. If $1 is backed by 1 oz. of silver, and the value of the $1 went under an oz. of silver, people could exchange their dollars for the more valuable silver until the value of the dollar was brought back up to the value of what was backing it (the oz. of silver.) – DJG Mar 9 '14 at 20:15

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.

From my research the best short answer is that they have use value as a medium of value exchange. Their use value comes from having properties of gold (limited supply), and digitally transferable over the internet so can be called digital cash. There is no central authority, so you can trust the wisdom of the crowd. Another good described is a digital distributed notary system.

Also see this larger discussion: http://bitcoinweekly.com/articles/bitcoin-what-is-it

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:

Hypothesis 1:
 * All people in USA has equal savings and all savings are in BC. BC is used only in USA
 * Average Savings Amount for Americans is 3,800$. 
 * USA population is 317,161,000

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:

1 BC = 3,800/15.10 = 251.66 $

Let estimate another hypothesis.

Hypothesis 2:
    * Bitcoin will replace all gold.
    * There is 171,300 tons of gold in the world.
    * The price of gold is 1,245.5 USD/Troy ounce.

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:

1BC =  6,859,335,922,500 $ / 21,000,000 BC = 326,635 $

Another hypothesis:

Hypothesis 3:
 * All people in the world has it's savings only in BC.
 * World population is 7,127,000,000

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?"


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