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Ever wondered why Rs 100 is worth the amount we assume it is? A few years ago, when the government demonetized a few currency units, 500 and 1,000 became worthless overnight. So what gives 2,000 its value today?

Of course, theres the intricate relationship in supply-demand metrics, but it boils down to trust! The trust we place in the government and the monetary system in place. Bitcoin (BTC) is not issued by a central bank or backed by a government, so where does its intrinsic value come from?

When we talk about Bitcoins value, aspects such as decentralization, distribution, scarcity, security and systems of trust simultaneously play a role.

No single entity can make decisions on everyones behalf. Distributed ledger technology (DLT) is non restrictive and permission-less. They are transparent and secure. DLT's does not store information in any one place. Instead, it distributes information across a peer-to-peer network. All network participants have access to the distributed ledger technology (DLT) and its immutable record of transactions.

Scarcity & TrustA Bitcoin's main source of value is its restricted supply and increasing demand. Its supply is programmed to be limited. Unlike traditional money, Bitcoins aren't printed out. Instead, they are mined out of the system. Bitcoin relies on a decentralized network of independent nodes to approve consensus-based transactions.

In simple terms, a miner has computers (or nodes) running the mining program. Only 21 million BTCs can ever exist.

An asset that is scarce can command a high price, while one that is plentiful will have a lower price. There has been a decrease in Bitcoin supply since its inception. There is a fixed rate at which Bitcoins can be created, and that rate is designed to slow down over time.

After every 210,000 blocks, or roughly every four years, the number of Bitcoins minted per block is reduced by 50%.

Miners solve transaction-related algorithms that verify Bitcoin transactions with software.

As a reward, miners receive a certain amount of Bitcoin per block. This way they are provided an economic incentive to continue solving transaction-related algorithms, thereby supporting the overall system. Miners not only verify and validate transactions but also ensure that new Bitcoins are added to the system at a predictable and constant rate. This is where trust comes into play again.

Bitcoin users need not trust each other but just need to trust the token's technology and the level of security. There is a cost of production for Bitcoin, it depends on the block reward, cost of electricity, mining difficulty and energy efficiency of miners.

As there will be only 21 million BTC, what happens when all of them are mined? Since these tokens are issued per block at a decreasing rate approximately every four years, it is expected that the last Bitcoin will be issued in 2140.

Around 2140, the amount of BTC in circulation will remain fixed at that level. This number was arrived at taking into consideration the average time taken to verify and create blocks, which is supposed to be ten minutes.

So every 10 minutes, a certain amount of BTCs are introduced into the supply, but this supply is designed to be reduced by 50% every 4 years.

Whats driving the economics behind BTC right now is the supply limitation, which makes it scarce. Once all the BTCs are mined, the underlying economics is bound to change. What miners will rely on then is transaction fees.

Bitcoin was originally conceptualised as a medium of exchange, but is more often than not used as a store of value.

This ecosystem is still developing, so its underlying narrative could undergo another transformation between now and when the last BTC is mined. So what will the economic incentive for the miners be when all BTCs are mined? They will be rewarded through transaction fees.

When it comes to any asset of value, the price one agrees to pay for the asset is generally socially agreed upon and based on supply and demand metrics. As BTC is digital currency, one that is not tangible, many have criticised its actual value, failing to grasp the scarcity and cost of production metrics.

BTC is often equated to monopoly money - fake. But those who understand the scarcity and intricacies of the protocol see value in this.

(The author, Darshan Bathija, is CEO and Co-Founder, Vauld. Views are personal)

Read the original here:
What determines the value of Bitcoins? - Economic Times