Since Bitcoin is an intangible currency, its value can sometimes be difficult to perceive. Some people then think that, unlike other forms of money, bitcoin is based on nothing.

While it is true that Bitcoin is not based on any physical asset, that is not a fluke. Like any other form of money, it is based on its intrinsic monetary properties. On the other hand, where it really differs from fiat currencies is in the way in which its properties are insured. That's what we're looking at in this short debunking article.

The monetary properties of Bitcoin

As I explained to you in A previous article, the search for an electronic cash system did not date from the invention of Bitcoin. This work was started at the end of the 1970s, when modern asymmetric cryptography methods were invented. The first system in this field of research is called “ecash”. It was created by cryptographer David Chaum in 1982. This protocol was still based on trusted third parties, since banks had to agree to represent money on the eCash system.

It was only partially with b-money (Wei Dai, 1998), then with RPOW (Hal Finney, 2004) and BitGold (Nick Szabo, 2005) that the idea of interpreting the solution to a mathematical problem as a valuable object emerged. Obviously, Bitcoin uses this concept, which makes it possible to put a monetary value on exclusively digital objects.

If all these researchers wanted to find a mechanism that makes it possible to decorrelate the value of a digital object from the value of tangible goods, it is because it was the only way to create a peer-to-peer system. In other words, it is at first impossible to create a truly decentralized monetary system, while basing the value of each unit on a physical asset. Satoshi Nakamoto explains this to us in a message posted on the P2Pfoundation forum February 18, 2009:

[...] I don't know any way for software to know the real value of things.

This is why Bitcoin does not rely on a physical asset such as gold for example. Instead, it derives its value from its unique monetary properties. These characteristics are similar to those that have historically supported various forms of money.

The first of these properties is, of course, rarity. Like some precious metals, which have long served as a store of value due to their natural scarcity, bitcoin is also limited in quantity. The protocol specifies that there will never be more than 21 million bitcoins. It also has other properties that encourage its use as money: its durability, its portability, its divisibility or even its fungibility.

➤ Learn more about the monetary characteristics of Bitcoin.

But beyond its monetary characteristics, bitcoin is certainly based on its protocol. It is a system that allows incensurable, private, irreversible and low-cost transactions to be carried out. All of this is allowed by its peer-to-peer nature. Its own users run and maintain the system. As a result, and unlike assets established on central entities, the characteristics of its protocol and the properties of its currency cannot be changed without reaching consensus among the users themselves.

Finally, while Bitcoin is not based on a physical asset or a government entity, it is based on its intrinsic monetary properties and on the unique characteristics of its protocol.

Consensus principle and proof of work

Proof of work obviously plays a critical role in ensuring Bitcoin's monetary properties. The Nakamoto consensus mechanism specifies that the blockchain that should be considered valid is the one that has the most accumulated work.

By establishing a marginal cost for multiplying the votes of each node, proof of work makes it possible, among other things, to secure an economic history. Gradually, transactions are buried under successive layers of work. To change this history, you must be able to redo all the calculations. Each block on top of transactions adds a new layer of security, globally and cumulatively.

This work is itself based on a real resource: energy. The right to vote on Bitcoin is based on the computing power of each processor, powered by electricity. Bitcoin therefore relies on a physical bulwark, available in finite quantities on Earth, namely energy. It is this principle that allows us to have a truly peer-to-peer electronic money system, without a trusted third party, while being able to interpret a value on its units.

What are fiat currencies based on?

A fiat currency is generally a currency issued by a state. Today, the majority of currencies in circulation in the world are fiat currencies.

It's important to understand that, unlike asset-backed currencies, a fiat currency is not backed by an underlying. Instead, it derives its value from its monetary properties, which are themselves guaranteed by the government that issues this currency. The value of a fiat currency is therefore ultimately based on the trust placed by users in the issuing state.

However, fiat currencies have almost natural flaws. Since governments have the power to create money out of nothing, they can give in to the temptation to increase the money supply to fund their spending. In other words, they're printing money. This increase in supply can lead to inflation or even hyperinflation if left unchecked. This causes the value of each currency unit to gradually dilute.. History shows us that this temptation to create money from scratch is deeply rooted in human nature.

Moreover, the stability of a fiat currency depends largely on the trust users have in the issuing government. This trust can quickly be lost in the event of economic mismanagement or a crisis. The recent examples of Venezuela, Argentina, and Turkey, where state currencies experienced a sudden drop in their purchasing power, illustrate this point well.

This is where Bitcoin presents an interesting alternative, since it does not depend on a central entity to impose its properties, especially in terms of the scarcity of the currency.

➤ Learn more about the usefulness of Bitcoin.

Conclusion

Finally, any form of money is based, directly or indirectly, on its monetary properties. When we talk about a currency that is based on an underlying, it is then the monetary properties of the underlying that determine the value of this currency.

Bitcoin cannot be based on a tangible asset. It is precisely this total independence that makes it possible to do without the intervention of a trusted third party in the system. It is then based solely on its monetary properties, and on the characteristics of its protocol.

Unlike fiat currencies, the properties of bitcoin are ensured by the users themselves through various governance mechanisms. In the case of fiat currencies, the issuing government must be trusted to maintain fair and efficient monetary properties. However, this trust has continued to be flouted throughout history, in particular through the dilution of the purchasing power of currencies, due to money creation ex-nihilo. This is why Bitcoin appears to be an obvious alternative to fiat currencies, especially in terms of long-term savings.