What is the intrinsic value of a particular cryptocurrency? Is it a mere bubble or is their really a value?

A Zecoex counter on the noise that cryptocurrencies are mere bubbles and fiat currencies have intrinsic value.

Do cryptocurrencies really have a value? And if so, why are their valuations surging to astronomical heights, with the year 2017 being the highest grosser in most cases?

At the time I write this, Bitcoin had surged from around $1k from the beginning of the calander year to over $6k, after nearly touching $8k a few days back. Ethereum surged from around $10 to over $300 with a high of over $400 this year. Everyday we see posts from some respected and some not so opinionating that this is all a bubble. Everyone I speak to, who has never indulged in participating in the cryptocurrencies ecosystem in one way or the other, claims that they stay away as this is all a fad, a bubble, a ponzi pyramid, or something similar, again citing that they base their comments on their understanding that cryptocurrencies have no intrinsic value.

Fiat currencies, they argue, has value because they are backed by the state machinery, and the state has the capability to levy and collect taxes, and are able to guarantee store of value to the fiat currency they back.

A look at the definition of fiat in Investopedia.com “Fiat is the Latin word for “it shall be.””. Thus the basic

Wikepedia has a very thorough and well referenced note on fiat money, its origins, and use and specifically states in its opening paragraph that fiat money is a medium of exchange mandated by the government without any intrinsic value (https://en.wikipedia.org/wiki/Fiat_money).

A very interesting quote from the same page is reproduced below in verbatim:

“All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver… and indeed everybody takes them readily, for wheresoever a person may go throughout the Great Kaan’s dominions he shall find these pieces of paper current, and shall be able to transact all sales and purchases of goods by means of them just as well as if they were coins of pure gold.

Marco Polo, The Travels of Marco Polo

From 1944 to 1971, the Bretton Woods agreement ensured that fiat currency issued by Governments were backed by gold. Since the collapse of this agreement, fiat currencies are not bound by any underlying or commodity of value.

I invite you to take a look at the video, money as debt (https://www.youtube.com/watch?v=4AC6RSau7r8)

I came across this video a few years ago, and since they have prescribed this to be viewed to several of my friends and acquaintances. This, along with the above, probably should give us some sort of a confirmation that fiat, too, does not have any intrinsic value.

So why do we use a fiat currency at all? Probably because there is no alternative. One can transact in gold and silver, but they are not divisible easily, and are no longer easy to carry with all international border restrictions and immigrations, and also within the same state. Imagine carrying gold powder or small wisps of gold or silver, weighing them, and proving to the merchant that it is genuine, and then the merchant valuing it basis the international or local rates, and also using it as a means of exchange when he wishes to spend it. Definitely not a very encouraging thought in the present age of immediate transaction settlement.

For most, currency is a means of exchange and a store of value to be used in future for services one renders today. However, the biggest issue is that the moment one gets some currency either in crisp notes or in the bank, inflation is supposed to eat away a bit of it, starting the very next moment. Now we have read in our economics books that inflation occurs due to an increase in money supply. So why should the money supply be increased at all? Who gives the right to the government, to create an unlimited money supply, effectively reducing the value of the services provided today? So if someone has earned through hard work a million dollars, the Government, effectively, by printing more money, creates another few millionaires out of thin air, without any fairness to the value of service provided to the society, and without a corresponding demonstration that the new money created, provides commensurate benefit to the original millionaire, in lieu of my forgone exclusivity to the million he owns. Inflation on account of increase in money supply is precisely a format whereby the central bankers backed or mandated by the government create similar assets that others own out of thin air, thereby reducing the value of the asset they have created. Fiat currency is, thus, an inflationery currency with value eroding over time, without any intrinsic value per se since the value is solely dependent upon the issuer, i.e., the central banks/governments.

In old ages, barter system ensured that what you earned today was traded for value with some other commodity or promise of service immediately. Fiat money, which started of as a convinience as an easy medium of exchange backed by the gold standard, was pretty much the answer to all difficulties faced by mankind related to the barter system, and thus became the preferred, and later, mandated medium of exchange for commerce. While they were backed by gold, their value was intrinsic to the value of gold, which derived its value from the use in ornamental and indistrial uses. Once the backing from gold was removed, and the governments gave themselves power to print as much as they wanted, the intrinsic value dissolved quickly.

Now that we have arrived at an opinion, which can and should be challenged, that fiat currency has no intrinsic value by itself, let us look at whether Cryptocurrencies can be termed as having any intrinsic value.

Cryptocurrencies  are recorded in a public ledger where the ownership of the respective coins reside as a digital entry. For the purpose of this paragraph, allow me to use bitcoin as the cryptocurrency I refer to for simplicity, and ease of explaining. So I can earn a bitcoin by providing certain services or merchandise and accepting bitcoin in return, or buying thorugh the use of fiat currency. The bitcoin I have so procured, is recorded in a decentralised public ledger as an earned but unspent transaction which I can spend anytime later by sigining the transaction with my private key. It is decentralised because anyone in the network can pick up my signed transaction and validate that it is correct, and therefore does not require any one central agency to ensure its acceptability. Thus I can pass my bitcoin around for value of another service or merchandise, or as charity, or whichever manner I chose to.

So how do bitcoins I have so earned derived any value, and as the case is today, why should that be valued at a definite amount in terms of a fiat currency, say US dollars, or the Indian rupee?  The value of bitcoins arises from the system, same way as the value of a fiat currency. Except that, in case of the bitcoin system (Bitcoin with a capital B), the value is something which I have chosen to accept in lieu of services or merchandise I have traded it for. So if I, as an accountant, file your tax return and demand 0.2 bitcoins as my fee, it is the value of this service which is actually etched in the Bitcoin ledger for me. I can chose to redeem this value with any other services or merchandise in the future, say for buying bread for family, at a negotiated corresponding value with a seller. For me, the intrinsic value of my bitcoins is the value I ascribe to my sweat in providing my services as an accountant. And if I believe that this will hold value in the years to come, i.e., the Bitcoin system will stay and grow, then I have every reason to believe that my bitcoins hold intrinsic value of my sweat, which I can exchange later on. And since there will forever be a finite supply of bitcoins, 21 million to be precise, I know that there would be no one to earn similar without either paying for it is some manner, or earning it. This is the intrinsic value of the Bitcoin system for me. And I remember someone putting in the following in one of the forums I read, and am unable to give credit as I never noted down where I read:

“Trust in mathematics > Trust in gold > Trust in fiat issued by Government “.

Currency, by definition, will forever be a medium of exchange, and that is indeed what a currency is supposed to do. It is the system which defines an intrinsic value of a currency. Whether it derives its intrinsic value from gold, or another underlying commodity, or mathematics, the underlying trust in the system is what gives it any value. And as and when more and more people shift to a decentralised electronic medium of exchange, with no fear of limitless supply, perhaps the valuations might keep on soaring, till we reach a level of equilibrium. For now, cryptocurrencies are seeming more valuable to optimists like me, and I can see more and more people wanting to adopt a new medium of exchange, and move away from fiat currencies, for whatever it is worth, as a new emerging global mindset.

Remember, most technological innovations since times immemorial have had to fend off serious initial sceptism before they were accepted by society. Some of the brightest minds have dismissed pathbreaking inventions in the past, the telephone and the motor car being too very prominent inventions which the royalty laughed them off stating that no one in the right mind would use them and they are just a fad which would go away.

Crypto currencies, for the moment, appear to be an honest attempt to bring in legitimacy to an otherwise manipulative system of Fiat currencies. These are early days and surely, things will evolve. However, this seems to fit well with the overall direction of society from control to freedom as witnessed in almost all areas of our social life.

I would like to hear your comments and your solution to the problem. Do write

with your comments to the author at rajiv.tandon@zecox.com

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