The inherent value of cryptocurrencies

01 February 2019 | Fri

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People who oppose cryptocurrencies say that cryptocurrencies have no inherent value. One can refute this by stating that, conventional assets like gold, silver also don’t possess any inherent value and the price of gold is derived from the people’s belief in it. Let me explain this with a simple example. If given a choice between a bottle of water and a bag full of gold, a person struggling to survive in the desert would choose the bottle of water. On the other hand, a poor person living in a city would choose the gold without a question. The person struggling in the desert needs water more than gold to survive, so he believes that water is more valuable than gold. This example illustrated us that value of something comes from the belief and need.

Value of an asset come from people perception?

Price of an asset is the reflection of consumers’ willingness to pay for it. Top brands in the world charge premium for their products and some people are willing to pay this high price for these premium products because they believe that those premium products are valuable.

Let us investigate a case study to understand this better. Many people around the world perceive Apple products as best in the market. This high regard for the Apple products among people made Apple a top brand in the world. The total cost to make an iPhone XS max 256GB variant is 750 US dollars, but Apple sells this model for 1249 US dollars. The price of iPhone XS max 256 variant is 60% more than the total cost of production (750 US dollars). Why do you think apple is confidently setting this high price for their iPhones? It’s because Apple understands that people are ready to pay a high price for their products. Many people are willing to pay this high price because they perceive that iPhone has that value in it.

Why do we value gold?

People value gold because it has some unique properties that no other asset class possess. There are 3 unique properties that gold possesses.

  1. Scarcity: Gold is a precious metal and it’s present in limited quantity on earth. Also, gold is very hard to mine from inside the earth surface.
  2. Durability: Durability is the ability to withstand pressure and damage. Gold will stay for centuries without any damage. This property will attract people to buy gold and store it for a long period of time.
  3. Impossible to fake: The dollars you hold can be faked. As the dollar is made of paper, it’s not impossible to fake them. Unlike paper money, gold is impossible to fake. It is easy to detect when the gold is fake.

These unique features make the gold a valuable asset. Features like scarcity and durability have made gold very popular among investors. We must note that gold is not the only product which is rare and durable. Let us see below why cryptocurrencies can be considered as “digital gold”.

Similarities between gold and cryptocurrency

As we have seen above, gold is valued because of its unique properties. Like gold, cryptocurrencies also have unique properties. The similarities between cryptocurrencies and gold made many perceive cryptocurrencies as “digital gold”.

  1. Limited supply: Like gold, the quantity of cryptocurrencies is limited. For example, Bitcoin has a fixed quantity of 21 million bitcoins.
  2. Durability: Cryptocurrencies are durable. We can store them in a wallet for long periods of time without any worry of damage. This is not true with paper money as they are prone to damages in long term.
  3. Hard to fake: As cryptocurrencies are the digital form of currencies, it is very easy to identify fake cryptocurrencies. It’s impossible to generate a fake cryptocurrency. This feature is like gold as gold is also very hard to fake.

As we have seen above, cryptocurrencies have all the important features that gold possess. These features make cryptocurrencies valuable. Same as gold derives its value from its unique features, cryptocurrencies also derive its value from their unique features.

Replacing gold with cryptocurrencies

We have seen above that, cryptocurrencies have a lot of similarities with gold. Some even say that cryptocurrencies are better than gold.

Below features make cryptocurrencies better than gold:

  1. Ease of storing: Gold is a physical asset. This makes it hard to find a place to store it. Especially if have a large amount of gold then it’s very hard to store it. Cryptocurrencies don’t have this problem because it’s a digital form of asset and you can store it easily in a digital wallet.
  2. Security: In many countries like India where security is not so high as in developed countries, people cannot store gold safely in their houses as there is a risk of robbery. It’s much easier and convenient to secure cryptocurrencies as they are securely stored in digital wallets.

Though cryptocurrencies are easy to store and secure than gold, many people are still not replacing their gold investments into cryptocurrencies. There are a few reasons why people are apprehensive about cryptocurrencies

  1. Fear of price fluctuations: many are worried about the price fluctuations in cryptocurrencies. If these price fluctuations stabilize many will be willing to convert their gold investment into cryptocurrencies. It is important to note that in recent days bitcoin price fluctuation has reduced, and this is encouraging many to purchase bitcoins.
  2. Unawareness: As we have seen above, cryptocurrencies have many advantages over gold. However, very few know about the advantages that cryptocurrencies have over gold. We can change this by educating people about cryptocurrencies.

Gold and paper currency have any inherent value?

Gold and paper currency don’t have intrinsic value, the value they derive come from people’s belief. Let us understand this with an example. Gold is thought to have intrinsic value because of its applications in industries like dentistry and electronics. Some people even argue that dollar bills have intrinsic value since they are backed by the government. But as you break down either of those claims, it becomes clear that gold and paper money also don’t have any intrinsic value. According to the World Gold Council, in 2016, only 15 percent of gold was used in industries like dentistry and electronics. The other 85% of gold went toward making jewelry and to gold-bars and coins. The gold which is used to make jewelry and gold-bars have value mainly because they’re trusted to be valuable by people holding them. Like gold, there is no intrinsic value for gold. It takes 16 cents to make a $100 bill. So, all the remaining $99.84 value is coming from the trust people place in the dollar.

If you could believe in gold and paper currency, why not in cryptocurrency?

For some, it may be hard to see the cryptocurrency as having value because you can’t hold it in your hands like you hold a gold coin, or a 100 dollar note. Something which is not physical should not be considered as worthless.

Let us understand how much it takes to produce one bitcoin. Bitcoin is produced with the help of computing power; this production of bitcoins is referred to as mining. The amount of electricity required to operate this computing power is very high, and this high electricity requirement will result in high electricity costs. For example, it will cost 5,936 US dollars to produce one bitcoin in Singapore. However, in China, it only cost 3,172 US dollars to produce one bitcoin. This huge difference in cost is because of the lower cost of electricity in China when compared with Singapore.

The current price of bitcoin is 6,200 US dollars, and it takes around 4000 US dollars to produce one bitcoin (varies based on the country of production). As we have seen above, it takes 16 cents to make a $100 bill. If you could justify $100 value to a paper currency that is produced for just 16 cents, why can’t you justify the 6,200 US dollar price for bitcoin that is produced for 4,000 US dollar?

Paper currency is controlled by government bodies. In past, many central governments have used their influence to manipulate their national currency. If we can trust these centralized government systems, why not trust a decentralized network like Bitcoin network? As more people come into a cryptocurrency network, the belief in the network will increase. This increased belief will translate into a higher value of cryptocurrency.

Conclusion

As we have seen above, people’s belief is the primary reason for the high price of assets like gold. Presently various cryptocurrencies are trying to develop the belief in digital currencies. Cryptocurrencies like Bitcoin, Ripple, and Ethereum are currently leading this mission of increasing the belief of people in digital currencies. However still many are unaware of how cryptocurrencies operate and the underlying technology behind it. This unawareness makes it hard to appreciate the unique features of the new “digital gold”. As more and more people understand the features of cryptocurrencies, the more value it will derive from the people’s belief. Therefore, educating people about cryptocurrencies is very essential.

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