To answer this question one needs to understand the concept of bitcoin and mining process. Let’s begin with the first question: what is bitcoin? Bitcoin is a cost value of any unique information. In fact, this value can be referred to as bitcoin, or called in any other way; its meaning will remain unchanged. What does unique information stand for? It is a web-based information that is not available in the public domain yet, therefore, it has some value. What is bitcoin mining? Mining is the process of finding blocks of unique information whose value is programmatically expressed in bitcoins. There is a number of various articles and reviews on mining, both for dummies and tech-savvy users, consequently, the following article will not focus on this topic. So how the value of bitcoin is created? People with economic education or those related to currency or stock exchanges would formulate the question in the following way – what is bitcoin backed by? The answer may seem quite surprising – it is backed by nothing. The cryptocurrency is not gold-based as it happened with all traditional national currencies at the end of the last century, it does not depend on a country’s GDP or is governed by any state within its monetary policy. Moreover, bitcoin is not printable, so the value of paper cannot be declared.
And still it remains unclear – how the price of 1BTC can reach nearly a thousand dollars? Usually this is another subject worth discussing. In order to understand the formation of the bitcoin value, real bitcoin price, it is important to look into the value of any currency. Why one can buy a certain quantity of goods and services for a piece of paper marked by $100? Isn’t it just paper?! Yes, it is absolutely right, and so far the world has not run out of paper, but… still, what does the cost mean? In simple words, price is the amount of any benefits available that a person is willing to pay for the privilege of owning a certain item. More explicit definition can be found in the economic literature and textbooks. Value by itself is subjective or evaluative in relation to each individual. If we look into history, initially value was expressed in the amount of any benefits in return for a number of other goods (barter or exchange), then money as such came into the existence launching the process of commodity-money turnover. Further information on different types of money can be found also in the literature on the history of money. Throughout history money subjectivity has remained unchanged. Though, when digging into the subject answers to the questions like “what is money?” and “how its value is built up?” may appear quite philosophical.
Consequently, so far the general meaning of money is more or less covered. Let’s move further to the formation of money value. Addressing once again the question of paper shortage worldwide, in fact anything can be referred to as money, even orange plastic boxes. In general, that is possible, but if one decides that a particular product is worth 1,000,000 of such kind of money, it will be extremely inconvenient for the potential buyer to transfer or bring such an amount, as well as store it. Therefore, paper is a practical tool for circulation. Why in return for a certain piece of paper one can get, for example, a house in Spain located on the shores of the Adriatic Sea, but for another piece of paper – a loaf of bread? The value depends on many factors, but as it is important to give a simple explanation now, let’s keep it plain.
For instance, there are, hypothetically, two states. One country has natural resources, but poor economy, so residents have no job to apply for in order to earn money to pay for their own needs. There are no companies that could provide inhabitants with essential goods and meet their demands in exchange for money. This particular state has its own hypothetical currency – called “unfortunate”. The second made-up country has a developed economy but lacks natural resources and owns its national currency – named “efficient”. Within these countries the currencies are in circulation, i.e. it is possible to buy or pay for something within the states, but the two do not have any contacts. At one point the country No 2 finds itself in the need of natural resources, since it does not have its own, so there is one possible option to purchase those from country No 1. The problem lies in having different currencies, so how to make it work? Hence, we are approaching the basic principle of currency value formation. The currency of one state is worth nothing for the second, as they lack contacts. The same situation applies to country No 2, since they want to have something that only state No 1 has, so their currency acquires a particular value for the second country.
When considering a possible cooperation, the first state sees merit in using the currency of the second state, but the value of it will be lower than that of their own currency. Hereby, both countries are ready to start a kind of dialogue about the exchange of resources for money. However, taking into account that currencies differ and circulate only within a particular state, both parties have to understand what their currencies will be worth of for each of them. In the process of negotiation the two countries should agree upon the price on the basis of objective factors. This is the way the price formation principle works for any currency, and in this particular case – for bitcoin. What is the source behind the bitcoin value formation – the question still remains. It is completely subjective. Here is when the public opinion matters. As the community believing in the currency’s viability and profitability expands, the demand continues to grow. Given a limited number of blocks of unique information generated by mining, the bitcoin price is likely to rise monthly and yearly, though, it is difficult to predict the pace of such development.
Indeed, for many people there is a difference between philosophy and reality, as well as between economy or money that allow one to purchase something and contemplation of the sublime. Let’s presume that if someone has improved the paper clip and at least one person in the world is willing to have it, this super paper clip will become of a value for both the developer and buyer. Once the transaction is completed, the clip will be highly demanded and reach a certain price, provoking the domino effect in the future. With time the paper clip will attract more people, which will result in the increasing number of potential buyers and, consequently, the rise of the product’s price. The first bitcoin transaction has provoked the chain reaction, encouraging further development of infrastructure and bitcoin operations that can no longer be stopped, causing the continuous price growth.
Another example of value formation is as follows: while going by train from one city to another a passenger decides to buy bottled water. The real price of this water is just some cents, but taking into account the value added, the final consumer price is around $1.75. However, in a train water would cost almost twice more. For sure, in case the buyer doesn’t agree with the price considering it too expensive, he can turn down the offer. If at that time the passenger buys water in the train, he accepts this kind of pricing policy. The domino effect starts with the first purchase of the water for the higher price.
There are different views on the bitcoin price and its formation. However, the fact that the cryptocurrency – which has been accepted as such – is viable and a million people uses it as a mean of transaction, demonstrates that the number of potential users is likely to grow exponentially.
So how is the bitcoin price formed? With the help of society. The more efficient crypto-payments, the higher the price and exchange rate of bitcoin.