Dollars, pounds, yen, and all other currencies are “fiat currencies,” which means they have no intrinsic value other than that a government has decreed that they’re legal tender.
Fiat is Latin for “let it be done.” United States dollars have value because the United States government declares that they have value, and people have enough faith in the stability of that declaration to go along with it.
Fiat currencies are convenient, but not without risks. When a government fails, its fiat currency typically hyper-inflates into being worthless. Most fiat currencies ever created have eventually become worthless; the ones that exist now are all relatively recent.
Bitcoin was invented to be like a new, modern form of gold and silver. Like some libertarian sci-fi form of money.
It’s digital and can be used for both in-person transactions and online transactions, assuming both the buyer and seller have the technology and willingness to use it.
It’s decentralized, meaning its existence and value isn’t tied to any agency, government, corporation, or bank.
It’s able to be broken into tiny fractions. You can send someone 0.008235 Bitcoins, for example.
It’s relatively secure, as long as you protect your private key. Bitcoin uses a level of standardized encryption for which even the top supercomputers would take far longer than the current age of the universe to break.
Today, cryptocurrencies are one of the hottest asset classes to invest in. Bitcoin, in particular, has soared in price from pennies to thousands of dollars per unit in just a few years.
Price is what an investor pays, but value is what an investor gets. It’s easy to look up the current price of Bitcoin, but it’s harder to determine what a realistic value is.
This article provides a framework to help you think about how to determine the worth of Bitcoin for yourself, and the value of other cryptocurrencies, including explaining a lot of the risks involved.
Read more: The History of Bitcoin
Cryptocurrencies: a blockchain overview
The first cryptocurrency, Bitcoin, was invented by an anonymous person or group named Satoshi Nakamoto and released publicly online in 2009 as open-source software and a white paper that explains the concept.
Satoshi claimed to be a Japanese man in his thirties, but his identity has never been verified because all of his communication was via the Internet. He wrote with influences of British English and had sleep/wake cycles according to his online activity that would presumably place him in North America, leading many to believe that he’s not Japanese. Or maybe he’s multi-ethnic.
It might not even be a man. It could conceivably be a woman or a group of people. But most likely, it’s a man using a pseudonym. And wherever he is, he has about a million Bitcoins, worth billions of dollars now, which he has never spent. And he has gone dark; after having invented the concept, he no longer leads it, and his whereabouts and identity are unknown.
A decentralized currency
Anyway, Bitcoin was invented to be a decentralized currency and method of payment. It doesn’t rely on any central authority like a government or bank or Satoshi himself and is instead wholly distributed on numerous clients running open-source Bitcoin software.
Blockchain technology is at the core of most cryptocurrencies, which now has applications outside of just cryptocurrencies.
Blockchain is a new foundational technology which uses decentralized encryption to record events publicly. The technology was conceptualized in the 1990s, but not implemented until Satoshi applied the idea to his Bitcoin software, creating a digital currency that relies not on governments or banks, but encryption.
With Bitcoin, each user has a private key, which is a giant integer number that acts as a digital signature and is kept a secret, known only to that user. Users then have public addresses (more numbers), that people can send money to for the purpose of a transaction.
Storage and Mining
You don’t actually “store” Bitcoins anywhere. It’s just a public ledger that attributes a certain number of Bitcoins to addresses that you control with your private key.
Bitcoins can be “mined” by verifying the transactions of third parties. Miners contribute computing power to verifying Bitcoin transactions, and in exchange, the algorithm allows them to create a certain number of Bitcoins for themselves. The total number of Bitcoins will max out at 21 million, at which point they can no longer be mined.
Since Bitcoin technology is open-source and not proprietary, other cryptocurrencies can be and have been created, and many of them like Litecoin even have certain advantages over Bitcoin itself, like faster processing times.
Another big blockchain application is for software. Ethereum, which is the second-largest cryptocurrency, was developed to be broader than Bitcoin in terms of using blockchain technology to transfer various types of value. It’s like a decentralized app platform with a built-in currency in units of ether.
Typical app platforms have a central authority like Google or Apple, and developers can request to put apps on those networks to sell to consumers. Ethereum can do that without the central authority, without the middleman.
The difficulty in valuing cryptocurrency
Most buyers and sellers of cryptocurrencies are speculating, meaning they’re just looking at price charts and guessing that it may go up or down with technical analysis.
Fundamental investing, on the other hand, uses a bottom-up approach to find the inherent value of something. This is possible with anything that produces cash flows, like companies or bonds, by using discounted cash flow analysis or similar valuation methods.
But when something doesn’t produce cash flows, like commodities, it gets trickier.
Every individual cryptocurrency is scarce. For example:Bitcoin’s algorithm is limited to 21 million Bitcoins totalBitcoin Cash’s algorithm is limited to 21 million Bitcoins totalLitecoin’s algorithm is limited to 84 million litecoins totalEthereum’s algorithm is limited to 18 million new ether per yearRipple’s algorithm is limited to 100 million ripples total
The problem is that although the units of any individual cryptocurrency are scarce. Any programmer can make his or her own cryptocurrency, with the hard part being that it’s worthless until enough people recognize it, adopt it, and begin to trade it around.
Currently, three cryptocurrencies have over a $10 billion market capitalization. Bitcoin, Ethereum, and Ripple are the three that are far in the lead in terms of adoption. Bitcoin, in particular, has a 66% market share of the entire cryptocurrency market capitalization.
Bitcoin went on to increase to over $19,000 only to come back down to just over $3,000, and since then, it has popped back up to over $8,000.
Cryptocurrencies will only be worth serious money over the long term if they take off as a method of spending or store of value, and a handful of cryptocurrencies continue to make up most of the market share, rather than all cryptocurrencies becoming extremely diluted. So far, that is happening; Bitcoin is maintaining market share among the growing number of coins.
A big debate right now is what the block size should be. Small block sizes significantly slow down the network and make a currency unscalable, while big block sizes require bigger data centers to process, meaning the currency’s network can become highly centralized, which is exactly what users don’t want to happen. A solution in development is to process transactions off the blockchain and then reconcile them with the blockchain, like batching multiple transactions into one big transaction.
All that debate around block sizes and off-chain scaling solutions, plus all the other features of certain currencies, makes it challenging to predict which coins will end up with dominant market share. Which ones will solve all the primary problems in the best way, and achieve the widest adoption?
Cryptocurrencies are volatile, their market share is fickle, and updates can result in split currencies, which has happened to both Ethereum and Bitcoin.
Read more: Where to Buy Bitcoin with credit Card?
How to determine Bitcoin Value and other cryptocurrencies
Bitcoin began to receive press – both good and bad. TIME Magazine published an article on the cryptocurrency for the first time, but the same year there was also an article on Gawker detailing Silk Road, the dark web drug market where Bitcoin was frequently used as payment. The publicity got lots of people talking Bitcoin, and by June, it was worth over $30. Soon after, it crashed back down to about $10.
Also, in June, Mt. Gox dealt with a severe security breach that compromised tens of thousands of accounts and their Bitcoins. That wouldn’t be the last security issue Mt. Gox would have to deal with.
Still, Bitcoin was generating lots of different opinions in the public and interest in the cryptocurrency grew. This led to a rise in altcoins, other forms of cryptocurrency whose developers were either trying to improve upon Bitcoin or had created the digital coin for a different purpose.
While 2011 was a choppy year for Bitcoin, 2012 was smoother sailing. Among noteworthy moments on its way to becoming the world’s top digital coin was its crossing the $100 threshold in April.
Bitcoin reaches it’s peak
Now that we’ve established what cryptocurrencies are and why they are difficult to value, we can finally get into a few methods to approach how to determine their value.
Remember, price is what you pay, while value is what you get. A stock can have a higher or lower price than what its value is truly worth, and a cryptocurrency can as well. What is a realistic Bitcoin value?
There’s no way to determine a precise inherent worth of Bitcoin, but there are certain back-of-the-envelope calculations that can give us a reasonable magnitude estimate for the value of Bitcoins or other cryptocurrencies based on certain assumptions.
The trick, of course, is coming up with reasonable assumptions.
Bitcoin values could go up by a lot, or they could fall to nothing, and it mostly comes down to how much and how fast Bitcoin or any of these cryptocurrencies can maintain and grow their network effect to be seen as either a permanent store of value or a medium of exchange. As a medium of exchange, they’re failing to take off. As a store of value, the top three and especially Bitcoin seem to be succeeding.
Right now, there’s already a lot of optimism backed in; Bitcoins and other major cryptocurrencies are extremely expensive compared to their estimated current usage. Investors are assuming that they will achieve widespread adoption for spending or storing of value and are paying up accordingly.
Now that you know what Bitcoin is worth, you’re ready to get in the Bitcoin game. Get started with NordikCoin today; one of the easiest, cheapest, and safest places to go for all your Bitcoin needs.