Cyptocurrency and "Value"

"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident. " - Arthur Schopenhauer

A lot of times when people get into Crypto, or are told about it by others, they gravitate to the question of value. "Why does it have the value that it does?"; "Where does its value come from?"; "Who decides the price?"; "Isn't the value arbitrary?" To answer these types of questions, we first need to examine the intrinsic value of fiat, or currencies as most of you know them, e.g. Dollars, Euros, Pounds, etc.

Prior to 1976 and the Bretton Woods Agreement, most of the world's currencies were pegged to gold or silver, and this was the established standard for thousands of years. Without getting into the full history of currency as we know it, and the whole concept behind the gold standard, I will direct you, should you wish to really delve into the topic, here: https://en.wikipedia.org/wiki/Gold_standard

But we do need to scratch the surface of it a bit should we wish to understand the value of cryptocurrencies. Most people still think that fiat currency is "tied to something", as in it derives its value from something other than itself. Currencies in contemporary times float, in other words, they derive their value from the currency markets themselves and are subject to the forces of supply and demand. They typically gain or lose value based on large scale fundamental factors affecting the nation(s) that utilize the currency in question. You see frequent references to unemployment or payroll reports, gross domestic product, trade surpluses or deficits, important socio-political events, and other indicators that denote the direction a country is headed based on macroeconomic events.

These indicators allow centralized forces, typically central banks, to steer the country’s economy, and their currency by proxy, to better respond to whether or not an economy is “overheating” as in growing too quickly, which could cause inflation, or "decelerating" as in growing too slowly, which would cause deflation. The central banks use a variety of tools to help steer the ship, but, in contemporary times, they use interest rate increases/decreases or quantitative easing.

These forces, coupled with the other indicators that I previously mentioned, account for the value of fiat currencies in the market. But, what you have probably realized from a moment of introspection, is that ultimately the market actors themselves decide the value based off of these circumstances. While interest rates do have a direct affect in terms of a carry trade, for instance, most market actors utilize these macroeconomic indicators to predict the currency's valuation and a trajectory or direction that it is headed.

It is important to note, however, that these techniques are mainly reserved for longer term speculation and that short term speculation depends on technical factors (support and resistance, for instance), news reports, and other short term predictive elements that when "zoomed" out, help inform more fundamental market actors as to the direction of a trend over a longer time frame.

So now that we have all of that out the way, how does this relate to cryptocurrencies? It is, after all, relatively easy to understand fiat currencies in the context of our lives as we are accustomed to earning them (hopefully), spending them, and perceiving the causal link between their worth and use in our daily lives.

When most people, myself included, originally get interested in cryptocurrencies, there is an initial perception that they are created ex nihilo or from nothing. They are literally spawned from the ether. A person or group of people are taking something that has no worth and through the sheer act of creating it, they are assigning it its worth. There is some truth to this, but their intrinsic value derives from a few factors: supply, means and difficulty of acquisition, differentiation, and utilization.

Let's unpack these terms for a moment before we proceed. Supply is pretty self-explanatory. How much of the currency exists? If there is 300 billion of them in circulation, chances are that the second factor, acquisition, would indicate they are pretty easy to acquire. Maybe, maybe not. Maybe the creators simply created a lot from the onset (known as pre-mining), which, in turn, would also lead to a perception, namely, that their worth is probably not very high or should not be very high. There are recent examples that defy this observation, most notably in Ripple and Stellar, but it is a relatively straightforward method of helping to determine the intrinsic value of a crypto coin.

Acquisition or the means and difficulty of acquisition, typically examines how they are created. Are they "mined" using a Proof of Work, Proof of Stake, Proof of Capacity, Proof of Importance, Proof of Something, algorithm? What are the computing resources required to earn these coins through utilizing these methods? There is a degree of effort or resources that goes into their creation, it could be electricity, computing power, or something other than their mere creation that helps to better inform their initial valuation. Understanding how these coins are mined is essential to understand the nature of acquisition and supply. In addition, there is an element of atrophy inherent in the production of these coins, which, in turn, serves to or attempts to increase their value by limiting supply over time. This is essentially a decentralized way of controlling interest rates. You are making it more difficult to "create" them over time.

The third element is differentiation. You will see this as more and more of these coins hit the street. Is a relative newcomer simply a clone of a previous coin or does it offer something new, something innovative that distinguishes it from others? This may compel the auspicious investor to favor one coin over another.

The last factor is utilization. Do certain stores actually allow you to use this coin? Is it just a hypothetical currency that floats in the market or does it have some tie-in to a real world market? Put simply, will people accept this currency as legal tender or is it still perceived as some fluctuating online token?

These four factors help to define, in similar respect to the macroeconomic factors of fiat, the direction and valuation of a cryptocurrency. Cryptocurrencies, and blockchain technology in particular, are still relatively new to the world scene and the worth of the technology, to those who understand it, could be perceived as a precursor to the either the replacement of fiat (unlikely in the near future), or, better yet, an alternative to be utilized alongside it.

Ultimately, what gives them their value is, again, like market actors with fiat, a determination on the part of market actors to speculate using a series of four factors on something's worth. If the world were to end tomorrow and we lived in some Mad Max apocalyptic wasteland, would paper money really be worth anything? Or would water, food, fuel, and other factors of survival suddenly increase in value? Something's value is often either a product of the time we live in, or based on a legal perception that the money you use to purchase goods and services has a perceived value in the minds of citizens or the government that (hopefully) represents them.

Cryptocurrencies ultimately spawned in the wake of the 2008 financial crisis as a means of putting ordinary people in control of a form of digital fiat where they can control the means of production, they can control the boundaries and difficulty of acquisition, they can control what features differentiate it from others, and they can control what it is ultimately used for.

It could be argued that the factors that govern its worth: supply, acquisition, differentiation, and utilization are simply nothing but speculation, especially at the moment, and perhaps they would be correct in saying so. But it is speculation on a forward-thinking time scale as these four factors continue to be better realized through the introduction of new cryptocurrencies.

Perhaps in the near future, questions over the definition of their worth will change to a valuation of what they are actually worth.

I guess only time will tell. Here's to the future in all of its wonderment and worry, implied potential destruction and possible new beginnings...