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The Bitcoin Phenomenon: How Cryptocurrencies Gain Value

A Google search for “Bitcoin” returns $738.99 USD as the current value of 1 BTC.

In 2010, one Bitcoin was worth $0.008.

So how did Bitcoin become the biggest cryptocurrency in the world within 6 years?

Initially conceived in Japan by Satoshi Nakamoto, Bitcoin was designed as an open source peer-to-peer cryptocurrency. Nakamoto designed the Bitcoin system to generate its own digital currency. Through a process called “mining,” users could obtain new Bitcoins in exchange for computational power. But no currency can be unlimited. As more Bitcoins were procured, the mining process became exponentially harder. However, this did not deterred users: miners have invested millions of dollars into mining farms, facilities housing thousands of computers dedicated to harvesting Bitcoins.

In order to explain the growth of Bitcoin, we must first establish the value of currency. By itself, cash has no intrinsic value. It is only because society as a whole accepts cash as a medium of exchange for actual goods that we place any faith into the green papers in our wallet. Some currencies are more stable in value than others, such as the American dollar, which is constantly regulated by system such as the Federal Reserve, over nations whose currencies fluctuate in value due to unstable economies. Here we see the obvious presence of direct-benefit effects: the American dollar sustains its value because the American people trust in its stability.

Not surprisingly, Bitcoin’s rise in value was also driven by network effects. At its inception, Bitcoins were practically worthless due to the small community of people who used them. However, as soon as the first “legitimate” organization (Wikileaks) began accepting the cryptocurrency, Bitcoin experienced a surge in popularity. In the eyes of the people, these “endorsements” for Bitcoin indicated potential positive payoffs. A cascade began: as more merchants accepted Bitcoin as a form of payment, more users flocked to the virtual currency. Similar to the fax machine example, what began with little intrinsic worth accumulated more value as more people used it. And Bitcoin continued to grow as the biggest cryptocurrency to date. Economists have predicted that “bitcoins will attain their true value of zero sooner or later, but it’s impossible to say when.” Looking at Bitcoin’s current rate of growth? Not anytime soon.

Sources:

http://www.investopedia.com/ask/answers/100314/why-do-bitcoins-have-value.asp

http://money.usnews.com/money/personal-finance/articles/2013/05/15/how-did-bitcoin-become-a-real-currency

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