bitcoin and the Value of Money

Island of Yap

Have you ever thought about why our money has value?  Is it composition?  I am pretty sure that a blank piece of cotton paper would not get you much, if anything, at the grocery store, but artfully print Benjamin Franklin on that same cotton paper with some numbers on there and you have money.  So why does a $100 bill have value?  If you are thinking gold standard, don’t, we stopped using it in the 1930s.  For that matter, why does gold have value?  It is pretty, but you can’t eat it.  Gold has very little utility unless you fashion it into some kind of useful tool (not jewelry).  The answer is that money and gold have value because we give them value.

The above picture of the grass skirt clad Micronesian citizens of the Island of Yap has meaning.  If you look closely you can see a couple of very large stones in the background.  These stones are their money.  Hundreds of years ago the people of the Island of Yap found large limestone deposits at a neighboring island.  They carved these limestones into huge stone discs and viola they had money.  Now their money is particularly interesting because it doesn’t actually have to “change hands” in order for the value of their money to be transferred.  In fact, according to the Island’s verbal tradition there was once a boat that was returning to the Island of Yap carrying one of these giant stones and before arrival they passed through a storm forcing the hulking carved limestone off the boat and into the sea.  Well, the Islanders decided that the owners of the stone still owned it regardless of its location, so, this stone is currently in circulation on the Island even though it resides on the ocean floor.  Why do these giant limestones have value you may ask?  Because the islanders give the stones value.

Understanding why money has value is fundamental to understanding the value of bitcoin.  I was late to the story of bitcoin and unfortunately so because if I were early I might have a nice bitcoin nest egg.  1 bitcoin is worth $449.02 as of the time of this writing.  There are roughly 15,500,000 bitcoins in circulation for a total estimated value of $6,959,810,000.  Almost $7b dollars.  Why is this cryptocurrency worth a whopping $7b?  Because we gave it that value!

In 2008 a paper was published by Satoshi Nakamoto (widely believed as a moniker for the anonymous creator) titled, “bitcoin:  A Peer-to-Peer Electronic Cash System.”  The basic concept behind the cryptocurrency was that this store of value (money) did not rely on trust (like the Micronesians having to trust that one of their limestones was on the bottom of the ocean but still in circulation) rather, bitcoins in circulation could only be transferred with verifications coming from each block in the blockchain.  Let’s back up.  Early adopters of bitcoin used their computers to “mine” bitcoins.  This mining process meant that they downloaded a piece of software and used their computer’s CPU (Central Processing Unit) to solve math problems and were issued bitcoins as a reward for solving these problems.  Since the early days hardware manufacturers have designed specific computer chips that perform this mining function (solving math problems) at roughly 100x the speed of your computer’s CPU.  Miners mine until they complete a block (a number of bitcoins) and then they start to mine a new block.  As of this writing there are 67,168 blocks in the blockchain.  (Check out a high level video on the mining process here).  Transactions are checked against the existing blocks by the miners at distributed computer terminals performing a decentralized fraud protection measure.

For bitcoin purists the allure of the technology is that it does not require a national central bank (like the Federal Reserve in the U.S.) to be the governing body for the currency, rather, its decentralized authentication process, described above, allows the users of the currency to all have a share in a secure peer-to-peer value exchange.

Forget what you have heard about bitcoin and the dark web.  If you haven’t heard about this, disregard the comment.  The true value of bitcoin and the movement of digital currencies, popularized in large part by bitcoin, is that in some cases the exchange of value doesn’t require any transaction costs.  Many readers might be saying to themselves that when they pay with their credit card there aren’t transaction fees either.  Well, while you might not think you are paying transaction fees as a consumer, you are actually paying roughly 3% every time you swipe.  Visa and MasterCard impose these fees for card usage on retailers and retailers pass the charge on to the consumer.  Additionally when you think about making cross-border payments from country to country it would seem that there are significant benefits to employing bitcoin to reduce transaction costs that can be over 10%.

Generally speaking innovating on universally accepted payment systems is long over due.  As I type the Federal Reserve is entertaining 12 final proposals from various companies to be the faster payment solution for the Federal Reserve.  Change is coming.


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