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Beauty is in the eye of the beholder. These will probably be the most accurate words to answer a question on the value of something.
The flow of cheap cash has led us to distrust fiat currencies and look for safe assets. However, interestingly, investors choose to explore not only precious metals, but also risky cryptocurrencies.
Many people know how modern cryptocurrencies are, but rarely will anyone be able to answer the question – what gives value to cryptocurrencies and what – to commodity goods?
What is Value?
For each person, value can mean different things. It can be a standard or principle of behaviour, and it can also convey how much a person is emotionally attached to something. Often, we talk about value simply as the value of some property.
Why does money have value?
Money, be it coins, banknotes, digital tokens, etc., is an unusual object because people tend to, although not always, exchange it for goods that they will eventually consume.
Today, money comes in the form of paper banknotes or base metals with a face value that significantly exceeds their fair or market value. The value of Fiat money (currency) comes from people’s faith in their government or central bank.
Why does gold have value?
Gold has been used as money for thousands of years, and some consider it “free market money.” It is long-lasting, rare enough not to lose its value over time, and has been a reliable unit of account throughout its life.
Perhaps more importantly, gold has become a hedge against inflation over the last hundred years. While governments have pursued a policy of withdrawing gold from circulation and the economy, its value has only grown.
How is gold valued?
As gold is mainly traded rather than consumed, it is not valued in the same way as a consumer good. Like any investment asset, the price of gold is either derived or valued. It is based on the views of entrepreneurs (anyone who takes any kind of economic risk) on how gold will do in the future. Its value can go down if they believe its price will go down and rise if they expect it to go up. The demand for production, which has a life of its own and does not depend on investor sentiment, also plays a significant role in shaping the price of gold.
Why does bitcoin have value?
Bitcoin and gold have some common features. The cryptocurrency was created by those who have observed the devaluation of the world currency.
Like gold, the amount of bitcoins is limited. The supply of newly mined Bitcoin is kept constant by its algorithm, for this reason only 21 million bitcoins will ever be obtained.
Decentralization (independence from any institutions) has been a major driver of the increase in the value of bitcoin, especially as government policy has focused on increasing the money supply and reducing its purchasing power. It also eliminates any risk for third parties.
Decentralization is also a feature pertaining to gold, as many private companies are involved in gold mining. Even at the beginning of the 20th century, there were many private mints producing coins for general circulation.
Gold and bitcoins are easy to transport, although transporting large amounts of gold can be cumbersome (we’re talking huge here). High conversion fees can increase the cost of transferring bitcoins between wallets.
Both assets are endless, but although gold is a tangible commodity, the lifespan of bitcoin lies in its secure mathematical coding, known as the “blockchain.” It is a publicly accessible register that allows you to create a “digital paper path” for all your transactions.
Why do fiat currencies have value?
Gold beetles and cryptocurrency enthusiasts may seem to be in a constant Cold War, but there is one thing that unites many of them: their dislike and distrust of world currencies.
The Latin word “fiat” roughly means “let it be done!” It can be defined as money that has been declared legal tender without having collateral for raw materials.
Fiat currencies have been used for centuries, but they have rarely existed for as long as other valuable assets such as gold or silver.
Since the end of the gold standard (a currency backed by gold) and The Bretton Woods Agreement (a pseudo-gold standard in which currencies are backed by US dollars rather than gold), most world currencies have relied on a paper standard in which public trust is the only guarantee. However, the public’s confidence in government and their currencies is clearly declining.
Inflation around the world is reaching or has already reached record highs in recent decades. Due to Fiat currency inflation, investors and the public have begun to hedge against high inflation, but some against the risk of devaluation.
Both gold and bitcoin have a limited supply advantage. Both assets are free market means of settlement. History still stands by gold, whereas Bitcoin is considered the “future of money”.
However, none of them are used in everyday transactions. Even gold and silver coins, which are legal tender, are rarely used (with one notable exception) because their fair value greatly exceeds their face value.
Value is subjective. Even staunch supporters of cryptocurrencies and gold beetles can see the value in currency by keeping small amounts of pounds, euros, and dollar to pay bills and taxes.
Can gold, bitcoins and fiat currencies coexist? We shall see that in the future. If inflation continues its course, how soon will people completely lose faith? Gold has served as means of exchange for thousands of years; will it stay the same in the future? Bitcoin is an unimaginable innovation that has huge advantages, but it is still very new with a very uncertain nature. In addition, bitcoins today are still too volatile to compete seriously with gold.
For the time being, one thing is clear: splitting risk into several asset classes is a sensible move. As regards the proportions – it depends on what is most valuable to you!
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Source: interview with John Clark, cryptocurrency and blockchain specialist
Bitcoin, Currencies, and Fragility https://arxiv.org
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