based on research and reporting by Sophie Bearman, CNBC.

IS BITCOIN INHERENTLY VALUABLE?

With bitcoin leading the charge, cryptocurrencies have generated a lot of wealth for a lot of people in a very short period of time. This rapid, exponential growth has left more than a few folks puzzled. Naturally, a market that moves as quickly as this one will create its share of skeptics.

At the time of writing this, bitcoin was trading at roughly $7,350, down from the recent high of close to $10,000.

Crypto-markets move up and down like any other market, but some people ask: Is this market unique? Is it a bubble? Should we be nervous?

How do we know that bitcoin, something that’s essentially invisible and intangible, has value?

WHAT MAKES SOMETHING ‘VALUABLE’?

In economics, something has value if it checks the following two boxes: scarcity and utility.

Scarcity just means that something has a finite supply. In the case of bitcoin, the cryptocurrency has a set cap of 21 million coins.

Let’s compare that to gold, which is also valued due to its scarcity. Analysts have noted that bitcoin’s set cap potentially makes the cryptocurrency even more desirable than gold. Why? Primarily because in the case of bitcoin, there’s no need to worry about a digital ‘gold rush’. In other words: a treasure trove of bitcoin won’t ever be discovered causing the price to crash due to an influx of supply.

Add to this the fact that we simply have no idea how much gold remains underground. As extraction technology improves, gold becomes cheaper and easier to mine. This can lead to more gold on the market and necessitates a constant revaluation of just how scarce the metal truly is.

With bitcoin: there is no such debate about scarcity or uncertainty in terms of supply.

UTILITY

Ok. So we can agree that bitcoin checks the ‘scarcity’ box. What about ‘utility’?

Bitcoin’s utility lies in its potential to be one of the most efficient commodities in existence. Here’s why:

  • Bitcoin is decentralized. No government, bank or single person has control over it. Meaning it can’t be toppled by corruption at the top. (This might not seem immediately compelling for participants of relatively static economies like the United States or Europe, but for developing super-economies like India or China, Bitcoin provides much needed stability and incorruptibility. Needless to say, these nations will be the major players in the future of global finance.)

  • It’s trivially divisible, meaning you can buy a small item like a doughnut as easily as you can buy a house.

  • Bitcoin’s code is open source, meaning that it’s available for anyone to look at, scrutinize and even modify. Bitcoin is constantly evolving and improving.

BUT WAIT A MINUTE… IS THIS ‘INTRINSIC VALUE’?

Do any of the above uses indicate ‘intrinsic value’? This is a question bitcoin skeptics often ask.

Gold, for example, 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, in a worst-case apocalyptic scenario, they could be used as kindling or something to write on.

But as you break down either of those claims, it becomes clear that gold and paper money don’t have that much intrinsic value either.

According to the World Gold Council, in 2016, only 15 percent of gold was used in industries. The majority went toward making jewelry and gold bars and coins — items that have value mainly because they’re trusted to be valuable.

With paper money, the Federal Reserve says it costs about 16 cents to create a $100 bill.

So the rest of that hundred bucks — the remaining $99.84 — comes from the trust people place in it.

 

SO HOW DO WE DETERMINE WHAT BITCOIN IS ACTUALLY WORTH?

If we know that bitcoin has value, it’s hard not to wonder how much a single bitcoin could end up being worth.

There are two main theories being used to calculate the potential value of one bitcoin.

The first theorizes that bitcoin, which some perceive to be a better asset than gold, could end up replacing either a portion of gold or replace gold entirely.

If bitcoin were to entirely displace gold, one coin could be worth $357,000. That’s calculated by taking the total value of all the gold ever mined in the world, which is about $7.5 trillion, and dividing that number by 21 million — the total number of bitcoins that can ever exist.

Tom Lee, from Fundstrat, told CNBC that it’s more realistic to assume bitcoin will replace 5% of gold, potentially driving the price of a single coin past $25,000 by the end of the year.

METCALFE’S LAW

Another theory is based on Metcalfe’s law, which says that the value of a network is proportional to the square of the number of users on the network.

For example, one phone is useless because you can’t call anyone else with it. But the value increases exponentially as other people get phones.

Studies have shown that Metcalfe’s law holds true for Facebook using 10 years of data. It also holds true for Tencent, China’s largest social media company.

Fundstrat looked at users on the Bitcoin network and found that the square of this value explained 94 percent of the variation in bitcoin prices since 2014.

THE VERDICT?

The belief that bitcoin and other cryptos are a “bubble” is based on the idea that bitcoin has no actual value. But it’s reasonably easy to prove that the theory just isn’t true.

By definition, bitcoin is scarce.
And the cryptocurrency has demonstrated its utility as a superior way to store and exchange wealth.

The value of bitcoin should be clear.