Overview

What Gives Cryptocurrencies Value?

Within this episode, we take a deeper dive into understanding what actually gives cryptocurrencies their value. There’s a lot of talk about how Bitcoin is “magical internet money” and many critics of cryptocurrencies like to bring up the fact that cryptocurrencies “aren’t real currencies”… well, that couldn’t be further from the truth.

To understand how cryptocurrencies get their value, you need to take a step back and look at how any currency gets it value, and what even enables something to be defined as a “currency”. This is exactly what we do during the third episode of series 1.

Here are the main talking points from the episode:

  1. Which characteristics define a currency?
  2. How does a cryptocurrency like Bitcoin compare to a precious metal, like gold?
  3. How does Bitcoin compare to a more traditional fiat currency, and what factors impact the value of each.

As always, all of the resources mentioned in the episode as listed below, under the “Extra Reading” section.

Episode Transcription

What Gives Cryptocurrencies Value? Transcription

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Matthew Howells-Barby: Hello. Welcome to the Decrypting Crypto podcast. This is series one, episode three. We’re going to be talking all about what gives cryptocurrencies value. I’m Matthew Howells-Barby here today, as ever, with my co-host, the ever-reliable Austin Knight.

Austin Knight: Hey Matt. Hey everyone. Today we’re going to start out by defining what actually makes something a currency on a fundamental level. It may seem a little intricate, but it’s really important to understanding the broader context of cryptocurrency and how it works, and then to make it more tangible for you, we’re going to walk through some comparisons that you can relate to. Like how Bitcoin compares to gold, the actual metal, not… And then finally, we’re going to put to rest some of the myths around this discussion. Of course, you’ve probably seen on TV, and in articles, things saying, “Oh, you know, it’s not backed by anything. It doesn’t have any real value.” And it actually turns out that it could, very well could be, depending on how you view it, back by more than any of the currencies that we actually today, which is very compelling.

Matthew Howells-Barby: It’s provocative. All right, let’s jump into it. The first thing we want to cover of this, what actually makes something a currency? This is a very top-level thought and something that monetary theorists have tried to really drill down and make very clear definitions around, and one of the best ways I’ve seen this broken down is with these five core pillars of what defines a currency. When I talk about currency I’m not talking about a cryptocurrency or Athena currency. I’m talking about one layer above that, like what is money. So the first pillar here is fundability. And this it the ability to exchange one unit of the currency for another. So they have to be completely identical in value to do this. So if I have a five pound sterling note, and I swap that five pound sterling note for someone else’s five pound sterling note, their five pound sterling note has to be exactly five pound sterling. There can’t be differences in this because they’re not able to be exchanged completely equivalent values. That’s the first one.

Austin Knight: The second principle is scarcity. So there has to a limited supply of the currency. And as we described a little bit earlier, this is actually the case for things like gold and things like Bitcoin.

Matthew Howells-Barby: Right.

Austin Knight: As well. There is a limited supply in the world of actual gold, and there is also a limited supply of Bitcoin, about 21 million.

Matthew Howells-Barby: Both need to be mined.

Austin Knight: That is true. And what’s interesting is you also have things that feel like currencies that actually are currencies like the US dollar, but there isn’t completely a limited supply of that. So you get into some weird situations where it’s like, wait, is Bitcoin more of a currency that some the currencies that we currently have today.

Matthew Howells-Barby: And then the third one is durability. This, in short, is basically the currency itself must stand the test of time and weather. Like Bitcoin can’t just get rained on and then it’s gone. The same with gold. It has to be able to stand harsh weather conditions. And the same with any dollar notes. They can’t just get wet and disintegrate. They have to be durable.

Austin Knight: The fourth principal is transferability. You need to be able to take one unit of that currency and transfer it to another owner. So I take my physical dollar, and I give it to Matt. That dollar now belongs to Matt. This is a fundamental aspect of any currency. And crypto actually makes this easier than ever. In that tangible example that I gave, I take one dollar, and I give it to Matt. He now has that dollar. In tech, and with digital assets, sometimes this can get really complex and convoluted. For example, a lot of people might not know this, but when you send an email with attachment, that file that you’re attaching to that email, when you send that somebody and they receive that file, they’re not actually receiving the original file that you sent, they are receiving a copy of that file.

Matthew Howells-Barby: Yep.

Austin Knight: With Bitcoin, though, when you send somebody a Bitcoin, they are receiving that actual Bitcoin, even though it was a digital transfer, it is fully transferable. You’re taking that one Bitcoin, not copying it, it’s that one Bitcoin, and you’re giving that to your recipient.

Matthew Howells-Barby: Oh yeah. If we could send copies of Bitcoin, I would be way richer, that would be great. But, unfortunately, alas, we cannot. So the final and fifth pillar here is divisibility. This is the currency itself should be able to be divided into smaller fractions. So let’s use the Euro, or let’s use the US dollar. You can take one Euro and you can break it up into 100 cent, the same as the dollar. Same with pound sterling. You can break that up into 100 pennies. And with Bitcoin you can do the exact same, and I’m using Bitcoin as an example here, but this is for cryptocurrency as a whole. As it stands, the cent version of Bitcoin is Satoshis. So, the cool thing about Bitcoin is you can have up to eight decimal places of a bit coin. So you can have .00000001 and that’s one Satoshi, and that’s of a Bitcoin. Right? Here’s where it gets even more interesting. A simple change of a line of code, would increase that, and it would have no impact. So when you start thing about, we can actually do super micro transactions here, so that eighth decimal place of a Bitcoin I can send that money to someone else. That shows how divisible it is. Way more divisible than other fiat currencies.

Austin Knight: Fun little fact that you brought up there, and sort of went right past, is that the eight decimal point of a Bitcoin is a Satoshi. What’s the significance of that?

Matthew Howells-Barby: Yeah, that is an interesting point. This is something that we didn’t even touch on really, when we talked about what Bitcoin was, but Bitcoin was created by a woman, man, group of people, that went under the pseudonym of Satoshi Nakamoto. This was a made up pseudonym, and we actually, to this day, have no idea who the real person or persons behind the original code that was created for Bitcoin is. And that’s where the original Satoshi name came from. This is like one thing that adds a lot of mystery to Bitcoin, which is super interesting. But is also, probably, the core reason for its sustained success. It’s because it became truly decentralized. No one owned, Satoshi went into darkness, after three or four years of running Bitcoin, and it now runs on its own, and there is no one sitting at the head of the table anymore. That’s something that’s incredibly interesting. Probably another rabbit hole we could fall into and start discussing. Very fun story to think about, and there’s all kinds of articles trying to figure out who Satoshi Nakamoto is. I think my favorite one was, there was a story broke in 2017 that Elon Musk was Satoshi Nakamoto. Highly believable. It really is.

Austin Knight: He invented literally everything that comes up. You know there’s also nobody at the helm of gold. There’s nobody that controls gold the mineral.

Matthew Howells-Barby: Mr. Gold does not exist? I feel it’s like the Monopoly man who just owns…

Austin Knight: Exactly. So that makes an interesting sort of parallel, in a weird way. Even though decentralization sounds like a new thing, if you think about it, our oldest currencies, in a lot of ways, were decentralized and not controlled by a single entity, while some people may have tried. And so you get some interesting comparisons between how Bitcoin is valued and how gold is valued. How does that work?

Matthew Howells-Barby: Yeah, I think that’s like so much more accurate to compare Bitcoin to gold, the precious metal, than the US dollar in all honesty, even when we look at things like divisibility. You can break up gold into tiny fractions, and you can sell that. It’s used in jewelry and all sorts, and that’s what gives it value. Right?

Austin Knight: And for those that don’t know, the US dollar used to be backed by real gold.

Matthew Howells-Barby: Right. Exactly.

Austin Knight: There’s some logic to this.

Matthew Howells-Barby: There is for sure. And I think Bitcoin itself is valued in a similar way. In fact, a lot people call Bitcoin “digital gold.” And that’s primiarly because one of the core utilities, that’s the main use case that people associate with Bitcoin, as being a store of wealth. People buy gold to preserve their wealth and store it for a period of time because rather unlike Bitcoin, the valuation of gold is relatively stable, and doesn’t fluctuate a whole lot. However, it’s ultimately determined by the price the last person is willing to pay for it, which is exactly how Bitcoin is valued. And that’s also another thing where during times of economic, political crisis, in particular, times of war, things like gold surges. You look at the price of gold, and basically put some key milestones around things like, 9-11 when Iraq was invaded, the many different Syrian wars, gold surged. Because people wanted to lock their wealth up into something that wasn’t ultimately backed just by a state, but it is something that they can hold and transfer a lot easier and store wealth in for a longer period of time.

Austin Knight: We feel safer when we don’t trust our government, or the people that are at the helm of these currencies, by putting our wealth into something that they can’t control. As another modern example that hits really close to home for myself and for a good deal of my friends, who happen to be from Venezuela, is the recent political situations with Nicolas Maduro, and how they have suffered from extreme inflation, total collapse of industry. And people can’t get out of the country. They can’t get out of the situation, because their wealth is tied up in a currency that has no value at this point.

Matthew Howells-Barby: Yeah. And I think people are running towards cryptocurrencies as a potential solution to some of this. Interestingly enough, there was a new story in January 2018 broke, around actually Nicolas Maduro, who has launched a cryptocurrency that is back by oil, on of the assets that Venezuela has in abundance, and is trying to have this adopted by several different countries, even though Venezuela’s own parliament has declared the cryptocurrencies trading and possession as illegal. Interesting as that develops, and coming, not to get off on a tangent too much, but more and more states and countries, I think are looking at potentially adopting their own blockchain solution cryptocurrency. Maybe not in the ethos of cryptocurrency being so decentralized, but also having like a state-backed version of a digital currency. I know India, we’re looking at that, Estonia at one point looking to do a similar thing, so all of things are contributing towards more adoption, which creates more news stories, which creates more interest, which ultimately fuels an increase in price.

Austin Knight: And for that matter, speculation of price, which is a lot of what drives that value of gold. It’s people speculating, “Oh, I think the value of gold is going to go up, so I’m going to buy gold,” so that becomes a self-fulfilling prophecy. And that’s what we’ve seen, especially in recent months happen with Bitcoin. There’s speculation that it’s going to go up, and thus the value goes up.

Matthew Howells-Barby: Yeah, I remember a number of years ago now, Mt Gox, in the earlier days of Bitcoin. This was the largest exchange, cryptocurrency exchange, that existed. And it was where a lot of people stored a large amount of their Bitcoins. This is a lot more trust in the exchanges back in those days. And Mt. Gox, without going into all the details, was ultimately shut down. Lots of people lost a ton of Bitcoin. Off the back of this, Bitcoin’s price actually dropped over 23%, almost overnight. People were losing their minds at this point. And panic selling, which again, fuels this drop in price. Fortunately for anyone who did hold out that storm, they’ve ended up pretty well. But, it’s another huge piece that clearly shows the impact of speculation and news stories, et cetera, are having.

Austin Knight: This is one of the cool things about investing in crypto. While it is good to understand on an intimate level how crypt works, and what’s happening in these inner circles of devs that are working on the blockchain itself, you can also pay attention to more obvious things that will be indicators of the value of the crypto. Like its use cases, how easy it is to obtain. For example, hypothetically, if in 2018 Amazon were to start running, or accepting transactions in Bitcoin, this would dramatically increase the value of Bitcoin because now its use case has expanded. It can also be impacted by legislation. When China made moves to shut down cryptocurrency within their border, we saw the value of cryptocurrency all across the board.

Matthew Howells-Barby: In particular Neo, which was a cryptocurrency that was basically branded as being the Chinese version of ethereum, and ethereum is another big cryptocurrency that we’re going to come onto in episode eight, but, a lot of the Asian cryptocurrencies really suffered around that time. But completely recovered when China kind of reversed some of the statements that they made. I think one of the things amongst this, while we talk about it, is to always to think about when you read news stories around cryptocurrencies. What are the vested interests in the people that are making the decisions? And I’m not saying there is an evil conspiracy behind every single thing. I’ll just take my tinfoil hat off for a moment. But, there are a lot of things that you can do at this early stage, to create speculation, which can spread fear and doubt around the markets. Definitely spook people. And for newer cryptocurrencies, where they are a little bit more volatile in their earlier stages. That can be a big thing.

Austin Knight: It can kill them.

Matthew Howells-Barby: It can. And we were talking earlier, for relatively newer cryptocurrencies, especially in 2016, 2017, just simply having a cryptocurrency added onto an exchange, was an enormous thing that boosted the price, just because people could access it easier. Or even when, for example, Vertcoin, when they got added into being able to be stored within a Ledger Nano wallet. That spiked the price, because people could now store it easier. That’s the level that we’re out with some of the speculation, right?

Austin Knight: We’re so early at this point. I liken it to like being in the early nineties of the Internet. We’ll dive into this when we talk about the block chain in more depth. But arguably, the blockchain, which is the technology which cryptocurrency runs on, is the most important innovation since the Internet. But we’re still in the dial-up days. At best. You can buy domains, or this case, you can buy coins. Tokens for small amounts of money. But the use case isn’t totally there, in the same way that in the early dot com days, the use case for domains wasn’t totally there. There’s non-believers and entire governments that felt that the Internet was a threat or something that didn’t belong. Corporations of course had vested interests in going against that, until eventually there was no going back. And it was very much happening. The entire infrastructure of the Internet changed to be more accessible and usable. A lot of these were just design problems.

Matthew Howells-Barby: Right.

Austin Knight: And then all the sudden you have dot com millionaires.

Matthew Howells-Barby: Yep. Pets.com. I wish I bought it. And that is some of the level that we’re at. To kind of reign this back in before we go off on too much of a tangent. I think one of the other things to think about when we talk about Bitcoin and gold, is also probably the most striking resemblance between one and another, or similarity should I say, is it’s scarcity. I saw a stat where, if you took the entire amount of gold that exists in the world, it will fill three and a half Olympic-sized swimming pools, and that’s it. That’s wild.

Austin Knight: Well that is bizarre.

Matthew Howells-Barby: Yep. It’s crazy. Right? And that is actually how much gold exists in the world. Any similarly with Bitcoin, you only ever have 21 million Bitcoins that are ever going to exist. Now if we get to the point where it’s the year 2140, roughly when all of Bitcoins will be released into circulation, there’s a lot more than 21 million people in the world. And I would say, the added scarcity of Bitcoins will probably influence its value. I mean, when all the gold is mined in the world, it’s definitely going to become way, way more precious. And that’s where mining operations for solid gold can create huge amounts of wealth. You just talk about the gold rush days, right? And it’s all driven by scarcity, and that’s a key thing here. Now, the only other thing here, when we talk about scarcity, we’re ultimately talking about demand that’s attached to that. One of the big criticisms that I hear around … things like Bitcoin as an example, but a lot of cryptocurrencies is “What purpose do they serve?” Is this just a store of wealth? Why is it better than gold? Is there no other utility?

Is it going to be used as a payment method. Some people are saying, “Well, you know Bitcoin’s transactions fees are too high.” We’ll come onto that in a separate episode. So it can never be used completely as a payment method. And if that’s the case, what is its use case? And for a long time I kind of rationalized this. What’s the utility of gold? And actually had a really interesting discussion with someone on this, on Reddit, where the person in question said to me, “Well Matt you know, there is a use case for gold. It’s used in manufacturing, it’s used in jewelry. There are actually reasons why you need gold as a manufacturing application. I guess the question that we need to find out is, okay maybe Bitcoin doesn’t need to be the defacto payments method digitally. Is a store of wealth enough to create enough value and demand for it.

Austin Knight: And I think there are a lot of other cryptocurrencies that are saying no, it’s not enough. And they’re developing use case that go much further beyond being a store of wealth. I think that Bitcoin became the defacto store of wealth because it was first.

Matthew Howells-Barby: Yep.

Austin Knight: And also because it is worst. It is old an old technology. The transactions are slow.

Matthew Howells-Barby: I love that we say a Bitcoin is an old technology.

Austin Knight: 2009.

Matthew Howells-Barby: God. But I think the thing that’s attached to that is one of the key things, without going too deep into blockchain technology, is that the longer that a blockchain has been running, the more transactions that its been processing, and the longer its existed, the more secure it becomes. Because, in short, to hack a blockchain, let’s say it is possible, you need to change all of the transactions histories from the beginning of when it happened. Now, the longer it’s been around, the more difficult that becomes. So this is another piece in here that, yeah, Bitcoin has become the defacto store of wealth digitally because it’s the most trusted technology. Will that last forever? I don’t know. Because in 30, 40 years, having something that was started in 2009 versus 2011, kind of pales into insignificance.

Austin Knight: Yeah. These technologies, the newer more recent blockchains, a lot of them are built off of the Bitcoin blockchain as an iteration. They’re forks, which we’ll discuss in our…

Matthew Howells-Barby: There’s a can of worms.

Austin Knight: That’s a can of worms. So, one of the questions to be asking yourself, is how do you balance the inherent value of Bitcoin, because it was the first, and it has the most media coverage, and it checks off a lot of those core boxes for a currency that we discuss, with the underlying technology, and reconciling yourself with the fact that Bitcoin’s underlying technology probably isn’t the best, and there are competitors that have much better underlying technology. What’s ultimately going to win out? There probably won’t be a single winner. It’s going to be a shared market. With a lot of different use cases.

Matthew Howells-Barby: I believe so.

Austin Knight: Yeah.

Matthew Howells-Barby: One debate is like, which cryptocurrency will win the cryptocurrency war? I don’t really like to think in absolutes like that, with the cryptocurrency markets. Yeah, that kind of shaped out with the search engine market with Google. For a long time we had a ton of disruption that comes in and, I would imagine if we were talking in 2005, everyone would be like, “Well, you know, no one can kill Yahoo.” That’s changed a lot. But I think there is a lot of space multiple different cryptocurrency. And the reason why we say many more cryptocurrencies and blockchains have come in that are better than Bitcoin is cause, Bitcoin was like V1, and people have looked at Bitcoin, and either built on top of it, or created whole new things that, basically add new features to this. Ethereum being a big one that we’re going to chat about. But, to bring this back a little bit, what I find quite interesting, is that there a lot of parallels with gold. And when we talked about those five key pillars of what makes something a currency: fundability, scarcity, durability, transferability, divisibility. You kind of tick a lot of boxes with gold and also with cryptocurrencies there.

But when you compare that with fear currencies, you do this with the US dollar, right? Let’s look at scarcity. You can’t just print more Bitcoins, but you can do that with the US dollar. You can’t tear up a Bitcoin, but you can do that with a US dollar. Bitcoins can be passed with ease across borders. In fact, Bitcoin’s ultimately a borderless technology. It doesn’t matter whether you’re in Ethiopia, or whether you’re in England, or USA, or within Brazil. You transfer it in the same way. Very different with the US dollar.

And the last piece there is divisibility. Cryptocurrencies are so much more divisible, and it makes in my opinion, fear currencies seem so much more inferior, when you start to think how much it can be divided down into ultimately two decimal places versus Bitcoin which is eight, and other cryptocurrencies which are way, way more divisible. Creates a pretty compelling argument when you just look at how Bitcoin should be justified, and other cryptocurrencies should be justified as a currency versus fear currencies, which are probably the only other differentiating factor being one is controlled by the state. Which I’m not a massive fan of.

Austin Knight: Neither am I, and I think that history would agree with us.

Matthew Howells-Barby: Absolutely. So hopefully within this we’ve given you at least some idea to what actually gives a cryptocurrency a value, and one thing to bear in mind amongst all of this is, this space is going to change, evolve. There’s going to be 100% more dips in the prices across the board. There’ll probably be another crash at some point. There’ll probably be another crazy period where there’s 100X gains. But in amongst all of this, the thing as an investor or someone that’s interested in cryptocurrency needs to understand, why is the price moving. And my best advice is to just really stay up to date on the news. Probably my best advice would be to keep listening to this specific podcast. And there are a bunch of other great podcasts out there. Some good news websites. But just question the motives of any news you’re actually listening to.

Austin Knight: I would also bear in mind that as you build faith in this technology and come to understand it, you can get a better sense for why it’s moving, what the determining factors are there. And you start to remember that there was also a dot com bubble. A lot of people lost money in that. That was not a reflection on the extreme importance of the Internet as an innovation. And in the same way that there will be fluctuations in cryptocurrencies, and maybe even a bubble. Who knows?

Matthew Howells-Barby: Right.

Austin Knight: It is in no way a reflection on the extreme importance and significance of the blockchain as an innovation.

Matthew Howells-Barby: 100 percent. Very well put. I think that’s the key thing, for a lot of tech enthusiasts, and people that ultimately as well want to reshape the world of politics and how economies are run, is this is not about Bitcoin, this is about blockchain and distributed ledgering, all of which is the collective term for blockchain and surrounding technologies. That is the innovation. And with that, what we’re going to touch on in the next episode is how to understand mining itself. In episode two, we taught you about how you could actually go in and own your cryptocurrencies. This episode, now you can understand how it’s valued. And then the next one is going to be understanding how the whole network itself is powered.

Austin Knight: Thanks for listening. If you love this episode and want to show your appreciation to myself and Matt, give us a review on iTunes, or your favorite podcasting platform. We really appreciate that. You can also visit thecoinoffering.com to learn more about cryptocurrencies, get caught up on some news, see how your currency is performing. And you can follow us on Twitter at The Coin Offering, as well as email us at podcast@thecoinoffering.com if you’d like to get in touch.

 

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