How did bitcoin get monetary value

March 22 February 23 January 25 December 24 November Digging into fiat vs. By design, the total number of Bitcoins in existence will never exceed 21 million. It is a fundamental top limit on their possible issue. About This strict upper limit is a design reaction to an ongoing problem we have with our existing western money systems. These have all fallen under the control of governments, which are abusing their position to create money out of thin air by so called 'fiat', to spend as they choose. Many people, and the large majority of Bitcoin users, believe the uncontrolled issue of fiat currency will in the long run render them worthless.

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So Bitcoin and Pounds or Dollars differ in that one absolutely cannot be further issued by fiat decree, and the other routinely is. Yet the outright control and steady fiat corruption of monetary systems by western governments is a relatively modern phenomenon. If you go back to the s and before, you will find government's role in the money system was much smaller. The traditional creation of money. Back then, the creation of money was done by private institutions — ordinary banks — and the money they created had a value basis resting in real capital.

As the Victorians were building Britain's capital stock the wealth bound up in it could be mobilised — through a private bank — by creating money. It was perfectly sound money, not like the fiat currency we see our governments granting themselves today. The way it worked was that someone who had property rights over something of value, for example a factory, would persuade a bank that against a promise of this property as collateral he could safely be extended a credit balance in a bank account, alongside a matching debit balance for his loan, secured on his property.

The debit side, together with its parallel collateral agreement, connected newly created money to tangible assets, whose genuine value could be recognised and realised in trade and exchange. Collateral factories can be sold. That was how money was privately created in those far off days, and how it was directly connected to the real capital wealth from which it derived its fundamental worth.

In just the same way a modern mortgage on a new house creates new money out of a capital asset which has been built, and which has a real value in exchange. A house can be sold to pay down the debit balance on its mortgage account, long after the credit half of the transaction — the money which was created by the mortgage — has been paid to the builder and distributed via the builder's employees and suppliers throughout the economy.

The only difficult bit of managing this connection between money and capital was establishing a meaningful and stable 'unit' of money. That was the government's role. It was not directly involved in the creation of money via ordinary commerce. It's unusual for citizens today to understand how natural and well controlled all this 'free market' private money creation was. Shareholders in banks contributed the original capital buffer, and the bank then created money by collateralising the capital assets belonging to its predominantly local customers.

Private monetary issue could be extended where there was a demand for it, i. If a borrower went bust then the collateral property was sold. If the bank went bust the shareholders and then the creditors lost their money too. This organisation of risks left banks standing on their own two feet; there was no such thing as 'too big to fail'.

Why does Bitcoin have Value?

It also persuaded most banks to act with far more monetary caution than you would find in one of our modern western governments. When depositors transfer some of their current account's credit to pay down the outstanding balance on their mortgage the credit money cancels out some of the debt.

The money disappears. It disappeared in the process of releasing the mortgaged house from its collateral function, and it took the house a few pounds nearer to being the owner's outright property. This again shows how Victorian money was connected to wealth. Money was much more than the dimly understood 'medium of exchange' which people used; it was a call on real property. Bitcoin does not have that link to real property.

Here’s How Bitcoin Gets Its Value

At least, not yet…. So back in Victorian times money was routinely created and destroyed, in the normal course of commerce. This ability to expand when money was short, and to contract when in surplus, created another feature of Victorian money. Because its issued quantity was self-adjusting, a shortage did not drive up its value. Neither did a surplus drive it down. It was the quantity, not the price, which absorbed fluctuations in supply and demand for money.

Bitcoin's limited stock does not have the expansion and contraction mechanism. As a result its price is extremely volatile. Usually a volatile monetary value is not what users of money want. It's exceptionally agreeable while it's going up, but the reverse more than outweighs that advantage.

A money system cannot afford to keep on injuring its users, because they will soon abandon it. When does sound money become fiat money? It's all very well appreciating the elegance of the Victorian's monetary system, but without there ever being a definite boundary, that sound money system has decayed into today's 'fiat' style money. Something went badly wrong. The debit side of fiat money is, in the language of bankers, a "bad debt".

Anyone who gets the power to impose collateral-free-lending on a bank has gained the power to issue fiat currency through it.

Who Sets Bitcoin's Price?

There was little that was fiat about Victorian money. Bank directors didn't wave money into creation in the absence of collateral, or if they did, it was at their own risk and ultimate expense. The stockholders of banks took great pains to employ risk-averse directors, and the directors would usually have had a substantial stake in the bank themselves.

These were powerful motivations to manage collateral prudently, keeping the creation of dangerous fiat money to a minimum. Any fiat currency emerging in the Victorian banking system tended to be expelled naturally. For example where, through the passage of time, falling collateral values challenged the support of a bank's monetary issue, then if the bank failed to re-capitalise, it would itself fail, taking with it all the low-collateral loans and the accidental fiat currency created on its books.

Bank failure actually cleansed the monetary system. Now that is reversed. Banks are considered too big to fail, and a splurge of government issued fiat money resuscitates the corpse of a busted modern bank.

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Our governments have grasped the power to issue fiat currency, which they exercise through their monopoly control of central banks. The "collateral" offered is their sovereign right to tax the people, or — more accurately — the children of the people, as the fiat device is used to defer liabilities for as long as possible, away from the immediate attention of electorates. Governments would probably not have been able to get away with this for so long if the result had been the significant inflation which usually follows uncontrolled fiat issue.

But, at least since the early s and ignoring financial assets retail price inflation has not really been a problem. Increasingly analysts think this disinflationary period will soon peter out, and that the next phase of global economic focus will be 'sustainability', which seeks to replace cheap but harmful economic solutions with more expensive but sustainable alternatives.

This new and naturally inflationary tendency is unlikely to sit easily alongside ongoing fiat money creation. Traditional economists fear the change could trigger very serious inflation indeed. There is a real risk that the result will be the hyperinflationary implosion of our monetary systems, because of their very large fiat element. The ongoing creation of fiat money expresses itself statistically through the growth of the national debt — the uncollateralised debt of government.

It equates to the total of government bonds issued and still outstanding. These — on their own — might have been manageable, but the government's fiat habit has made it extremely difficult, more likely impossible, to bring this back under control. It is not difficult for each of us to estimate how much less we could afford to do in such a scenario, and a reasonable prediction is that if it happened lots of restaurants, holiday companies, fashion retailers, hairdressers, bars, football clubs, leisure parks, and many, many other businesses would cease to exist, and then our economy would generate a lot less tax and we'd be right back where we started.

If it were tried, our economy would turn to mush. Government fiat money creation has generated intractable problems arising from what fiat is all about, which is creating the false money which allows a nation to live beyond its means. When Sterling's long history comes to an end, and it joins the many world currencies already in the graveyard, its death will likely take the form of a sudden hyperinflationary puff. The end game for fiat money. As we have seen, the debits in a money system are what tie it to real property and give the money its fundamental worth.

As the fiat element of a currency begins to dominate numerically it eventually sets off a chain reaction, culminating in very rapid inflation. The aggregate purchasing power of a money system is set at any instant by human emotions, being what they feel about using it in payment. But in the end the value shadows the value of the real collateral wealth supporting it.

Bitcoin Is Known as a Volatile Asset—Here's How It's Priced

As money succumbs to fiat, the people who own that collateral find:. Having to pay rising and increasingly unpredictable interest rates borrowers start to demonetise, paying down their loans with relative ease and reclaiming their collateral as their outright private property.