This post is taken from Quora, where I participate regularly in Bitcoin related discussion.
TL;DR The “value backing” of any means of exchange is essentially tied to the confidence with which you can assume that someone else will value it.
Read on to discover the similarity between Brad Pitt and Bitcoin.
But first, let’s look at some of the other forms of currency that people no longer feel compelled to question.
So what is the value backing of Gold?
Well, it’s been around a long time, so there are some historical signals about the likelihood that it will continue to be valued. But it’s price is certainly not based on it’s utility.
The original basis for it’s value as an exchange are these properties:
1) It doesn’t degrade. This is actually a very rare property of material. So you know it will be around.
2) The supply is fairly well known. Yes more gold is produced every year, but it’s very rare that a massive increase of supply comes as a surprise.
3) Though somewhat rare, it’s ubiquitous enough to actually be used as a means of exchange.
At it’s essence, it’s valuable because you can reasonably expect that other people believe in it.
In fact, I would argue that gold paves the way for bitcoin very effectively.
So what is the value backing of the US Dollar?
Hang out in some of the bitcoin forums around the web, and you’ll soon realize that the words “fiat currency” are written with a snarl, dripping with disdain.
Since Richard Nixon ended the removed the convertibility of gold the US dollar to gold (the gold standard), the US Dollar has essentially been backed by the “full faith and credit” of the US Government… wait what?
The government is just a bunch of people… I guess they have some land and some building too… so if the dollar falls apart, will China be made whole with the title to Yosemite Park?
Will you be able to exchange the dollars you hold to pay the government workers to work for you?
That’s not to say that the dollar has no intrinsic value. Since much of the world has agreed to use it, it is valuable simply because of it’s utility as a means of exchange!
I can have 100 dollars, and some of that and sell it in exchange for a pizza.
If I have 100 acres, I could probably sell some of it for some pizza, but the pizza guy would probably tire of owning postage stamp sizes of land all over the county. A gold bar is similarly difficult to subdivide.
So the dollar is valuable because of the significant infrastructure that makes it trustworthy, including anti-counterfeit measure of physical cash, and the checks and balance that prevent it from being created out of thin air.
Again, it boils down to the dollar being backed by the belief that others will value it, and, to a great extent than gold, it’s highly portable.
In fact, I would argue that fiat currencies like the dollar pave the way for bitcoin very effectively. (more on that later)
Let’s take this to it’s most absurd extension then, shall we?
What’s the value backing of Brad Pitt?
Without the assistance of Wikipedia, I can tell you that this man can easily earn $20 million dollars for a few months work.
So what backs his value? Nothing tangible. There are equally good looking people out there. But none of them have his name, persona, reputation and acting career.
He also has the following properties:
1) Like gold, his supply is predictably constrained
2) Like dollars, he is very portable. In fact, Brad does one better than dollars, because you can film him, put him on a screen of any size, and sell him.
3) Like most means of exchange, his value is still ultimately based on the fact that we can reliably predict that other people will value him.
What’s the value backing of Bitcoin?
Do you see the pattern here? The value is based on faith in the continued worth of something.
The difference however, is that we’re moving up the chain of abstraction, trading the benefits of tangibility for the benefits of portability.
Bitcoin is like gold, because it’s supply is constrained and knowable and they last forever. Sure, you can lose bitcoin by losing access to your wallet, but you can lose gold too. In fact, the bitcoin algorithm was designed to mimic some properties of gold.
Bitcoin is like dollars, because it can be moved around, and it can be easily subdivided and aggregated.
Bitcoin is like Brad Pitt, because it’s value is based on the expectation of how others will value it. It also allows for money to be transferred as easily as you can download Fight Club.
But bitcoin is unlike any other previous currency, in that no central authority has power over it.
The strongest thread between all the cases we looked at was that value is always going to be faith based.
When a means of exchange is abused by those who control it; making more of it when it’s convenient, handing it out to their friend, creating debt which will be nearly impossible to pay down, the value of that currency is eroded.