What is a Cryptocurrency Backed by?
Any currency’s strength and stability depend on the backing it receives. However, cryptocurrencies are different. They are unregulated and work in a trustless environment. Here is an examination of the question that lingers in the minds of new crypto investors- what is a cryptocurrency backed by?
Making digital payments has become more of a norm than an exception in today’s digital environment. Consequently, people are discovering new ways of making digital payments. One of the emerging modes of payment is using cryptocurrency. However, cryptocurrency is still in an early adoption phase globally because of its uncertainties. Many people do not know what cryptocurrencies are, how they get their value, their backing assets, and who controls and regulates them. Platforms such as Pokket are taking the initiative to bridge this knowledge gap for traditional investors who want to get started with investing in cryptocurrencies. This article will help you understand the aspects that back cryptocurrencies.
Understanding the Nature of Cryptocurrency
Before looking into what factors back cryptocurrencies, it is essential to understand what cryptocurrency is. Cryptocurrency is a digital and decentralized currency. While people can buy and sell things using cryptocurrency, they do not own any physical coin or currency bills. Instead, owners hold their cryptocurrencies in online/offline wallets and trade them or make transactions through an online exchange.
Cryptocurrency’s primary trait is its decentralization, unlike fiat currency. For instance, the US dollar is regulated by the nation’s monetary policies decided by the US Government. On the other hand, cryptocurrencies do not have any centralized authority to control their use. The transactions are recorded on a decentralized ledger known as the blockchain. While anyone can join the blockchain, the data concerning the transactions and the people involved are secured using cryptography. Thus, the currency gets its name, cryptocurrency.
How Does Cryptocurrency Value Increase?
Now the question is that if it is decentralized, how does cryptocurrency value increase?. The cryptocurrency concept is similar to stocks you trade on stock exchanges. Its value varies depending on the demand and supply position. For example, Bitcoin, the most popular cryptocurrency, crossed the $1 mark in February 2011. Today, Bitcoin trades at more than $38k. It peaked at $65k in February 2021, April 2021, and November 2021. The following graph should give you an idea of how Bitcoin’s value increased over the years.
Besides the demand and supply situation, various other factors influence cryptocurrency values. They include trustworthiness, cost of production, influencer intervention, competition amongst different cryptos, regulatory developments, and internal governance.
What Makes Cryptocurrency Valuable?
Cryptocurrencies like Bitcoin do not have government support and a proper banking system to propagate their use. It depends on a decentralized network without any monetary or regulatory authority to respond to the risks involved. However, cryptocurrency is protected by blockchain security and hence cannot be counterfeited. This feature of not being duplicable is what makes cryptocurrency valuable as it preserves its scarcity.
Apart from the lack of regulatory control, cryptocurrency has all the virtues of fiat currency. It is fungible, non-consumable, portable, and transactions with it are easy. Simultaneously, it is better than regular currency because of its durability, high divisibility, and security. Besides, cryptocurrency is scarce, decentralized, and easily programmable.
All these factors make cryptocurrency valuable.
What Backs Bitcoin?
When you accept that cryptocurrencies like Bitcoin are valuable, you should also understand what backs Bitcoin. However, before learning what cryptocurrency is backed by, you should know why currencies require backing.
Currencies require backing or support to ensure their value. A backed currency guarantees exchange for a pre-determined amount of an alternative asset. Many countries back their currencies with gold. For example, 100 units of the specific currency can be traded for one ounce of gold. Generally, countries choose gold or silver because they have characteristics similar to money. Besides precious metals like gold, currencies can also be pegged to other currencies. A backed currency protects against inflation, but it requires credible backing to assure its citizens that it retains its value.
Cryptocurrencies are different from regular currencies because a central authority does not regulate them. Therefore, questions arise as to what cryptocurrency is backed by. Bitcoin draws its support from its decentralized network, blockchain. The public blockchain ledger has evidence of all the transactions conducted on the network. In addition, it operates on a secure network that enhances security levels daily, depending on its unbreakable, unchangeable, and incorruptible math. These features prevent Bitcoin from being compromised by malicious actors.
Thus, one can be sure that the value of the cryptocurrency cannot change by anyone’s tampering. Also, the total number of a cryptocurrency to be released into circulation is fixed. It increases its scarcity over time, raising its value rather than decreasing. The security of the blockchain network is what backs any cryptocurrency and guarantees its value.
Why Are Bitcoins Worth So Much?
Bitcoins do not have any materialistic backing like gold or silver. Therefore, they do not have intrinsic value. So, it is natural for people to ask if Bitcoins have any inherent value or why are Bitcoins worth so much? Furthermore, despite operating in a completely trustless environment, millions of people trust the blockchain ledger and Bitcoin. These factors are crucial in determining Bitcoin’s value, depending on its demand and supply. Bitcoins are valuable because of their finiteness and scarcity. The total quantity of Bitcoins available is 21 million. More than 18 million have already been mined. This scarcity increases its desirability and makes it more valuable.
Other critical factors that enhance Bitcoins’ worth are the transaction time and cost. Generally, there are two parties to a Bitcoin transaction. Hence, it is equivalent to a digital cash transaction between two entities, which reduces transaction costs. Besides, the security layer provided by the blockchain makes it the safest way to transfer value digitally. These factors make Bitcoin valuable.
Why Does Cryptocurrency Value Change?
Compared to a few years back, the number of people investing and trading in cryptocurrencies today has increased exponentially. And its popularity has increased its demand. These changes in the demand and supply position cause the cryptocurrency value to vary. Utility and scarcity are two primary characteristics that cause changes in cryptocurrency value. For example, some believe that Bitcoin’s finiteness makes it more desirable than gold.
One can argue that gold has a limited supply. But no one can guarantee that a large gold cache will not become available anytime soon. A sudden influx can cause gold prices to crash, affecting the pricing of the currencies that have their backing in gold. Besides finiteness, features like security, divisibility, transaction costs, and time cause variations in cryptocurrency value. These factors also provide the necessary backing for cryptocurrencies.
Final Words
Cryptocurrencies have been gaining popularity in recent times. While they do not have any tangible backing, the decentralized environment in which they work provides the support required for cryptocurrencies to gain prominence. Besides, the demand-supply situation, production cost, influencer intervention, internal governance, regulatory developments, and competition among similar cryptocurrencies decide their value. With increased adoption, the popularity is expected to increase further, enabling cryptocurrencies to even compete with regular currencies in the global financial market very soon. Pokket is one platform that realizes the value of cryptocurrencies and offers products that can help traditional investors jump onto the crypto bandwagon. Suppose you’re a conservative investor but look forward to beginning your crypto journey. In that case, you can simply invest and hold one of the more popular crypto assets, such as Bitcoin (BTC) or Ether (ETH), and get regular income on your holding. One can experience the best of both worlds, traditional investing and cryptocurrencies.
References
- Little, K. (2021, August 30). What is Cryptocurrency? NextAdvisor. https://time.com/nextadvisor/investing/cryptocurrency/what-is-cryptocurrency/
- Best, R. (2022, January 27). Bitcoin BTC/USD price history up until January 27, 2022. https://www.statista.com/statistics/326707/bitcoin-price-index/
- River Financial. What Is Backing Bitcoin? https://river.com/learn/what-is-backing-bitcoin/
- Kelleher, J. (2021, December 25). Why Do Bitcoins Have Value? https://www.investopedia.com/ask/answers/100314/why-do-bitcoins-have-value.asp
