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Why Are Cryptocurrencies Valuable?

There is a question that kept me awake at night since the first time I heard about Bitcoin: How is it possible that something so abstract, with no existence in the real world, can have monetary value? How can it be possible that those virtual coins are trading at such high prices at times – why are people willing to give a lot of money to get such virtual currencies?

In this post I don't want to address technical details, nor discuss what value 1 bitcoin (or any other cryptocurrency) should have as this is decided day by day by the multiple cryptocurrency marketplaces, but share what I learned searching for the answer to this question.

To answer my question, the first thing I did was to question what I knew (or thought I knew) about money. The concept of money is deeply ingrained in our societies, we grow up knowing it exists and we accept its value, but we rarely think deeply about what it really means.

What is the Origin of Money?

One of the driving forces for the advancement of human societies has been the diversification of activities, that is, that each individual can dedicate himself to what he likes, instead of everyone producing everything he needs to consume. For this to be possible, it is necessary to have mechanisms that allow the exchange of goods.

Barter fulfilled this function in primitive societies. However, it is a very limited mechanism, because it requires a coincidence of needs. That is, if you are a bricklayer and you need to get food, you have to find someone who produces food and needs the services of a bricklayer. On the other hand, it is very difficult to value each activity (how much masonry work would you have to do to get the food you need).

Money appeared as a common means of payment to overcome these limitations and allow societies to become more and more diversified. In this way, a mason could provide his services in exchange for money, and then exchange the money for goods he wished to purchase.

What characteristics should Money have?

  • scarcity
  • interchangeability
  • divisibility
  • durability
  • easy transportability

Money has taken different forms throughout history, being represented by stones, grains, metals or papers, among other objects. These forms have been changing with the evolution of society's needs, but there are some basic characteristics that any object must fulfill to be a representation of money.

First, it must be a scarce resource, difficult to obtain. If money were represented by an easily obtainable resource, no one would be willing to offer their labor for it. On the other hand, it must be interchangeable, that is, one piece must have the same properties as another, so that it functions as a scale for valuing goods and services.

It is also important that it be divisible, so that different types of goods and services can be paid for with it. Additionally, it must be durable, so that it maintains its value over time (a fruit could not represent money because in a few days it loses its properties). Finally, it must be easy to transport, so that it can be used by all individuals in daily life activities.

Fulfilling these conditions is necessary for an object to function as money, however, it does not automatically mean that it will do so, or that it has value.

What is the Value of Money?

We already know what characteristics an object must have in order to represent money in a society. However, what is it that gives money its value?

None of the different representations that money has had has value because of its practical utility. None of them is capable of covering basic needs, so if you were in the middle of the jungle with a lot of money it would be useless.

Money is an illusion in any of its forms, and its value lies in the consensus of society around it. If a society accepts a representation of money, and all the individuals in it agree to give their labor or goods in exchange for it, then this representation has value.

Usually, the consensus is based on the trust of the individuals in the administrators of the society, and that is why it is usual that the issuance of money is a monopoly of the latter. In modern societies, the state defines the legal tender, and is the only one who has the right to issue it, so that it is generally accepted by the citizens.

So how can Cryptocurrencies have Value?

Digital information fulfills all the characteristics that money needs to have, except for the most important one: scarcity. From a technological point of view, one of the great achievements of bitcoin (inherited by the cryptocurrencies that emerged later) was to create digital scarcity, giving rise to a "digital object" capable of representing money.

But as we know, this is not enough. Bitcoin also achieved an unprecedented social achievement, by creating a consensus of value around a form of money that was not issued by any state or institution.

One of the first documented transactions of bitcoin as money was when someone paid 10000 bitcoins for two pizzas. Many things have changed since that day but the principle is the same, we share the illusion that these curious 'digital objects' have value and we are willing to exchange our labor or our goods for them.