Why do cryptocurrencies like Bitcoin and Ether have value anyway?
Why are cryptocurrencies “worth” anything?

This is not about why Bitcoin or any other cryptocurrency has a particularly high, or low value (depending on your point of view). Rather, it’s about why we can confer any value at all onto these digital arrivistes.
You will certainly be aware of the huge recent growth in attention that the cryptocoin economy has garnered.
Bitcoin has been around for roughly 8.5 years at the time of writing. In May 2010 Laszlo Hanyecz made what was one of the first exchanges of Bitcoin for physical goods when he exchanged 10,000 Bitcoin for 2 pizzas. It has had significant rises and falls in value since that point but over the last 6 months it’s been on somewhat of an upward tear. Indeed today, those 10,000 Bitcoins have a quoted exchange value of around $23,000,000.
In a similar vein, Ether, another cryptocurrency, which was launched in November 2014, has seen its growth in value rise by 4000% since January 2017. The total value of Ether in current circulation is approximately 16Bn USD at the time of writing.
Adding fuel to the fire are the recent and accelerating spate of ICOs (Initial Coin Offerings). An ICO is when a new cryptocurrency is launched and the organisation that launches the coin offers a portion of their newly minted coins in exchange for another currency (usually Bitcoin or Ether, which in turn can be deemed to have a value versus the US dollar). So, these brand new digital items, which are conjured into existence by a few lines of computer code, are immediately accorded real monetary value. And real monetary value at an astonishing level.
It’s the story we tell ourselves and each other
Regardless of whether you’re thinking about the more “mature” Bitcoin or Ether or one of the newly minted coins from an ICO sale, the same questions will be on your lips. How on Earth do these coins have value? They’re just made up. Who says they’re worth x US dollars per coin? Who says they’re worth anything at all?
The answer, without meaning to be trite, is that their value is whatever people perceive their value to be. They are valuable if at least two people agree that they have value. And they have greater value if the consensus of the global interested population is that they are valuable. They will go further up in value if the majority consensus is that they’ll be worth more in the future than they currently are.
To paraphrase, Yuval Noah Harari’s superb book, Sapiens, (If you haven’t read it, I urge you to buy it and do so. You will never look at the world the same again.) all money is just a made up story. But the key is that it is a shared story that we all know and we all believe in.
One of the primary threads from Mr Harari’s book is that as a species, we have managed to become successful because of our ability to hold shared belief in stories. Through shared beliefs we have been able to extend our social trust beyond our close tribes and to work alongside strangers.
All other species that accomplish coordinated work either depend on very limited hardwired instructions (e.g. bees) or a trust that comes from close tribal relations (e.g. wolves). Due to our shared stories, we Sapiens are able to coordinate complicated actions among many thousands of other Sapiens who may be complete strangers to each other. (It will be many millennia before wolfkind makes a rocketship to the moon and that’s not just due to their lack of opposable thumbs.)
Money is our greatest and most impactful shared story. Whether you’re thinking about Dollars, Yen, Euros or cowrie shells, the value attached to that currency is a made up fiction and it’s only because we all believe in the same fiction that we can consider these currencies as having any value at all.
There’s a long history leading up to the point where our species started to believe in the story of money. But money, or more correctly currency, is thought to have arisen much earlier in our prehistory than you might have imagined.
The inception of agreed value
The path to inception of currency as a shared story is covered in Mr Harari’s book and in a number of other places on the Internet so I won’t cover it here. We can quickly arrive at the salient points by considering what happens when our ancestors needed some good from an individual outside of their direct social trust group. (Their direct social trust group being their family or tribe who could be intrinsically trusted).
For example, consider a visiting stranger who has more beans than he needs and that I want some beans. The stranger will be keen to exchange me some of his beans for something of value. I’ll have a lamb I can trade him in a few weeks time but it hasn’t been born yet. We are at an impasse. We need a way to store the value of the beans so that he could come back for the lamb in a few weeks time. Let’s say we agree that I’ll give him a small stone with an identifying mark on it. When he returns the stone to me in a few weeks then I will give him the lamb.
As it turns out, the stranger has to go to distant lands so is not able to come back for the lamb. Instead he sends his brother, who I have never met. But because the brother presents me with the marked stone then I am happy to exchange it with the newly born lamb.
And so we can easily imagine how a currency can come into being. Each of the protagonists in my story trusted that the stone was “worth” the lamb even though it never was of the same intrinsic value to anyone as the lamb. What it was actually doing was being a temporary store of the value of the beans such that that value could be moved around in time and space.
Mutual trust
A currency’s value is a function of its level of trustworthiness as a medium of exchange for a different currency or for a good or service.
To unpack that a bit, for anyone to confer any value on a currency they must trust that they will be able to exchange that currency for a good or service, either directly or via an exchange with another currency either now or in the future.
Ability to validate
The first part of this trust mechanism is the ability to validate the unit of currency that you have been presented with. Here, as an example, we can say that diamonds, which are undoubtedly valued as a commodity, would make a poor currency. The average person has no way of validating the authenticity of a diamond and as such would not trust it as a medium of exchange.
In the currencies we are used to (USD, GBP, EUR, YEN, etc.), trust is generated by the many anti-counterfeiting measures applied to notes and coins for face to face transactions. For larger scale and electronic transactions trust in the validity of a currency is provided by a trusted third party such as a bank: when I wire you some funds the intermediary banks assure both you and I that the exchange took place in a validated amount of the given currency.
Exchangeability and fungibility
If there is a general trust among a population that a unit of a currency has a certain exchangeable value (one inscribed rock = 1kg of beans = 1 lamb = a newly smithed knife = etc.) then we can confer the critical characteristic of fungibility onto the currency. Ultimate fungibility means that the currency is capable of buying anything that is for sale because everyone who is selling something believes in the value of the currency and will accept it as payment.
A second element to exchangeability and fungibility is the requirement that the currency be liquid. Liquidity comes partly from a general consensus that the currency is a valid medium of exchange: that is, everyone accepts it. However, liquidity also requires divisibility and/or enough units of the currency to go around such that everyone who wants the currency can get it and everyone who wants to sell the currency can do that too.
Scaling
Furthermore, the currency must scale down far enough to buy low value items such as loaves of bread and scale up for large purchases like houses. This scaling can take place via both a relatively low value base unit of the currency and also a valid and easy divisibility of that unit. Here again, we can see that diamonds would make a poor currency as they are particularly indivisible.
Transportability
Finally regarding exchangeability, the currency must be transportable. That is, for a currency to be a useful store of value it must be easily possible to move it around and exchange it between people. Whilst there have been instances of immovable rocks being used as currency, they would certainly not carry much value in today’s globally connected world.
Assumed future value
The last part of the unpacking above refers to the future expected value of a currency. The function determining the currency’s value necessarily takes account of the likely future value of units of that currency. For a currency to have a future value it must not degrade and nor must its value significantly deflate versus the value of the goods and services that one may hope to buy with it.
There have been regular comparisons made between the current cryptocurrency boom and the tulip bubble of the early 1700s. Whilst there are some similarities, one certain difference is that tulips would never have made a good currency because they would degrade over time. Any tulip bulb is going to be worthless within a couple of years because it will rot.
Regarding a deflation of value, it is here where the oft-touted necessity for scarcity comes in. Gold has been used as currency in the past and its scarcity as a global resource is often given as its primary characteristic of why it makes a good currency. But, it’s not the scarcity in and of itself that provides the currency aptitude. Rather, the scarcity protects against deflating value. If we were using gold as a currency but then huge new caches of the stuff were discovered all over the world then any gold in circulation would immediately fall in value. It’d simply be easier to get hold of and therefore less valuable to everybody. It is the scarcity and unlikeliness of this scenario that allows gold to retain its value.
There have been a number of times in history when the increase in supply of a traditional sovereign currency has had a huge impact on the currency’s value. One of the most well known of these examples was in the Weimar Republic of Germany in 1922–23 when a 5 Million Mark coin would have been worth $714.29 in Jan 1923 but about 1 billion times less just eight months later. The very fact that they even had a 5 Million Mark coin should tell you all you need to know there!
So, why do cryptocurrencies have value?
So, now let’s go back and directly address the title question: crypto-coins have value because they carry all the necessary characteristics of a good currency and because of that a shared belief in their value has been established.
Crypto-coins are easily validated through software. The cryptographic algorithms and hashes from which they are made mean that they cannot be counterfeited or duplicated. In fact, this really is the key innovation of the blockchain system and technology. What’s more, the blockchain consensus mechanism means that we can trust electronic exchange of value without having to rely on middlemen like banks.
Next, these new cryptocurrencies, particularly Bitcoin, which is the most mature are starting to approach full exchangeability and fungibility.
There are numerous exchanges where you can exchange US dollars for Bitcoin and vice versa. So, whilst there remain few places where you can directly buy goods or services with Bitcoin, it has acquired fungibility by proxy through its known and exchangeable value with the US dollar.
Further, there is enough Bitcoin in the world and it is dispersed and divisible enough that it can be considered pretty liquid. If you want to go and buy some right now then you could do that. And if you want to sell some right now then you could do that too.
Cryptocurrencies are very transportable. They can be wired anywhere with an internet connection and can the exchange between owners can be validated by both parties almost immediately.
Cryptocurrencies are not going to degrade. Cryptocurrencies are simply stored bits on thousands of computers dotted around the world. Computer chips don’t really degrade in any meaningful sense and even if they did, the dispersed and decentralised power of the blockchain would mean that the information that makes up the currency would remain intact regardless of the degradation of any individual machine.
Finally, Bitcoins are not going to deflate in value due to an unexpected surge in their supply. The whole Bitcoin system has a hardwired process that manages the total amount of Bitcoins in circulation. At the time of writing there is a periodic controlled increase in the supply but eventually no further Bitcoins will be created.
Other cryptocurrencies have similar guards against supply related deflation in value but differ on the exact mechanisms.
So, to conclude, cryptocurrencies like Bitcoin and ether have value because enough people agree that they have value. And enough people agree that they have value because they carry all of the required characteristics for something to be a good currency. Indeed, in many aspects they have better currency characteristics than all of the sovereign currencies to which we happily ascribe value on a day to day basis.
It may seem outlandish to ascribe real world value to made up digital tokens but really it’s just another stage in the evolution of currency that started with inscribed rocks and moved through cowrie shells to gold coins to paper notes and now to cryptocurrencies.
