Knut Svanholm

@knut.svanholm

“But, it’s not backed by anything?”

One of the most common arguments against Bitcoin is that it is not backed by anything. That it’s price is just speculation. But what does it mean for an asset or a currency to be backed by something in the first place? To find this out, we first need to defy what it means for something to have value. After all, if something is to be backed by something else, that something else better be something of value. Like gold. Why does gold have value? Is it valuable because you can make jewelry out of it or is jewelry made out of it because it’s valuable? You can’t eat it and it’s not very good for any other basic human need. So what makes it valuable?

A fundamental thing that people miss when thinking about value is that value is always subjective. Not a single thing is of the same value to one person as it is to another whether the price is the same or not. A price means one thing to a wealthy person and another to a poor person since the amount of time and effort they have to sacrifice in order to acquire that thing differs between the two. Things like debt and compound interest also play a huge role here. In addition to this, the value of something priced in any fiat currency changes over time since the value of the currency is constantly being diluted through inflation. The value of something boils down to two distinct variables, supply and demand. Supply is always objective to the buyer and demand is always subjective. This is also true for the medium of exchange or type of money that is being used to carry out the transaction. Money is simply the language we use to express how we subjectively value things to each other.

So what does “being backed” by something mean? Basically it’s a guarantee that the token being used will be redeemable for some other thing that have proven to keep its value over time, at a later point in time. Currencies around the world used to be redeemable for a certain amount of gold but this isn’t true for any fiat currency at this point. It has not been true for the world’s current reserve currency, the U.S. Dollar, since 1971 when president Nixon decided to unpeg the dollar from gold. Ever since that day, the value of the dollar has been backed by nothing but the good word of of the Federal Reserve Bank and the U.S. government whose current president is Donald Trump.

Gold has shown to be a good store of value for around 5000 years. It is valuable because it is hard to produce more of it, period. When the price of an asset goes up, producing more of it becomes more profitable. This in turn leads more of the asset being produced, increasing the supply hence lowering the price again until an equilibrium is reached. In the case of gold, the amount of it already extracted from the ground is high in comparison to that which is still yet to be found. This means that an increased gold price does not lead to any significant increase of the total supply of gold available for sale despite the increased production efforts. It is this high stock-to-flow ratio of gold that has led it to such a good store of value over time. The demand for gold is ever changing but its supply stays relatively scarce.

Bitcoin is absolute scarcity. Even though you can’t make jewelry or anything else out of Bitcoin, its total supply is fixed. After the year 2140, after the last Bitcoin has been mined, the total amount of Bitcoins in circulation can only go down. This limited supply is what the gold standards of the past were there for in the first place. Bitcoins are a lot more limited though as they will be lost as time goes by. Since the supply is so limited it doesn’t matter what the current demand is. The potential upside to its value is literally limitless due to this relationship between supply and demand. The “backing” that other currencies have is only there to ensure people that the currency will keep its value over time and the only way of ensuring this is to limit the supply. Bitcoin does this better than any other thing before it. Leonardo da Vinci’s original paintings are extremely valuable since there’s only about 13 of them left. One day there’ll be less than one Bitcoin left.

Bitcoin doesn’t need to be backed by anything. On the contrary, the best thing anything can be backed by is Bitcoin, since Bitcoins are absolutely scarce and completely programmable at the same time.

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