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What is Bitcoin Backed By?

Wondering what bitcoin is backed by? The answer is nothing at all, but that’s actually not a bad thing. Like most modern currencies bitcoin is not backed by gold or other precious commodities. In a sense, bitcoin’s value is derived from our common belief that bitcoin has value. The same is true of the American dollar, the British pound, and the European Union’s euro, as well as nearly every other modern currency.

Historically speaking, up until August 15th 1971 most currencies were backed by a commodity, usually gold or silver. In fact, before the invention of paper money, most currencies were coins fashioned from precious metals. Further, following World War II and up until 1971, most of the world’s countries operated under the Bretton Woods agreement, currencies were backed by gold.

The Bretton Woods Agreement and the End of Commodity Backed Currencies

In order to understand the current system, it’s important to understand the old system. Under the Bretton Woods system, central banks would be able to trade gold amongst one another, and currencies would be tied to the value of gold, and pegged against one another. When an exchange rate is pegged, this means its value is set. So if the American dollar buys .75 British pounds, that is the value that it is set at. Most peg rates are actually adjustable peg rates, meaning that policy makers can adjust the value when needed.

The Bretton Woods system was designed to reduce the currency fluctuations seen in the 1920’s and 1930’s. During this period currencies were moving rapidly and uncontrollably, which caused international instability, and helped to worsen the Great Depression, and create the conditions that led to the outbreak of World War II. While the Bretton Woods system worked well for awhile, it eventually caused disruptions of its own.

The End of Bretton Woods and the Rise of Fiat Currencies

The Bretton Woods succeeded in creating stability in the years immediately following the second World War. By the end of the 1960’s, however, serious faults in the system were beginning to emerge. Among the biggest faults was that the U.S. dollar was too strong, which caused disruptions in international trade. For this reason, among others, governments decided to abandon the agreement, and to use “fiat” currencies instead.

Basically, a fiat currency is a free floating currency that is not backed by any sort of commodity. In the past, your dollars or other currencies would have been worth a certain amount of gold or another commodity. In practice, trading in dollars for gold was often highly restricted, still dollars were at least hypothetically worth a certain amount of gold.

Now, the dollar is no longer tied to gold. Of course, you can still buy gold with your dollars, but their values are independent from one another. Most major currencies are also not pegged to one another, but instead are allowed to float. Exchange rates can thus vary between different currencies. A few years ago, a euro could have bought about $1.4 American dollars. Now? A euro will buy only about $1.13 dollars.

Bitcoin is sort of a Fiat Currency, but So What?

Like the dollar and the euro, bitcoin and most other digital currencies are somewhat fiat. They are allowed to float in the market, and their value is determined by the market. In sense, you could even say that digital currencies and their value are determined by consensus.

Unlike traditional fiat currencies, however, there are several key factors that make bitcoin’s value potentially more reliable. First, bitcoins must be mined through computers, which requires an investment of time and money. As it becomes more expensive to mine bitcoins, it is likely that the value of the bitcoins themselves will slowly increase.

Second, while governments can increase their money supply at any given time, thus depreciating the value of individual currency units, bitcoin’s supply is tightly regulated, and the number of new bitcoins entering the market is slowing decreasing. Bitcoin is not subject to the whims of government officials or anyone else for that matter. It is a free and independent currency.

What “Backs” a Currency is Irrelevant, Perception is What Matters

Since the end of the Bretton Woods agreement, the idea that commodities are needed to back currencies has become irrelevant. Instead, public perception and economic policies are what matter. Money has value because we believe it has value. This is true of the dollar, the euro, the pound, and yes even bitcoin.

We can trade our money for goods. Many retailers now accept bitcoin as payment. In fact, when evaluating new “exotic” currencies like bitcoin, adoption rates, the ability to buy goods and services, established history, and community size are arguably the best indicators of a currency’s value. Are people using it to buy goods? Is the community itself large, sustainable, and established? For bitcoin, the answer to these questions is yes.

Many people think of bitcoin as more of an investment asset than a true currency. Part of the reason for is because bitcoin prices tend to swing somewhat dramatically. The value of all fiat currencies can swing also dramatically, however. This is true even for government-backed currencies, which are subject to the whim of government policies. The British pound, for example, has lost much of its value over the past few weeks following the Brexit vote.

In some cases, hyper inflation can even strike with money becoming nearly worthless. Consider Zimbabwe, where inflation got so bad a few years ago that the government started printing up 100 billion dollar bills. When the currency was phased out, 35 trillion Zimbabwean dollars equaled 1 American dollar. More recently, in April the IMF reported that Venezuela would suffer inflation of approximately 500% this year, and 1,800% next year. As this inflation unfolds, Venezuelan money will quickly lose its value.

More often than not, the rapid onset of inflation is caused by government mismanagement and the over-printing of money. This is why bitcoin aims to be government free. People create their own money through mining. Then, bitcoin is allowed to be freely traded in the market. Further, since the money supply itself is limited and already set, policy negotiations are no longer possible. So while it’s true that bitcoin isn’t tied to any commodity, and that it is dependent on our collection perception, like most modern currencies, the P2P currency is arguably a more reliable currency than government-backed fiat currencies.


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43 comments on “What is Bitcoin Backed By?”

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  1. Completely moronic to say the US dollar is not back by anything. It is backed by the full faith and credit of the US. It is worth something because the US is a powerful nation and says it is worth something. If the US ceases to exist then the value of the dollar ceases to exist. So yes, nations’ currencies are back-up. They are back-up by that nation.

  2. The Dumb Warrior.

    I’am not a expert but if you take a look at you see clearly that gold and silver have been hold constipated a incredible LOW price for a longggg time.
    At this day the ratio: dollar/silver is $4,819.00 per ounce and dollars/gold at $34,708 per once. In my humble opinion, people’s like: Gate, Rothschild, Morgan, Westhinghouse, Bezos, Zoukiki… They hold a dammm bunch of cash all together! And don’t expect to see the value of them fortune be shrink at nothing….
    No? 🤔
    So… If one day, somthing have to replace the fiat ( IOU or DEBT ) “paper” or be the backbone of the new WINNER no mather is name, it will have to hold: REAL estate VALUE and UTILITY inside society and must be able to be REAL and hold in hands.
    We call them: PRECIOUS METALS not for nothing.
    Btw: Sorry 4 my bad spelling english is not my first language. 😊

  3. The first rule of economics with respect to “wealth building,” is the conversion of natural resources to tangible assets. You learn this in a first year college economics class. That brings us to the question,…how does cryptocurrency, realistically, contribute to the conversion of natural resources to tangible assets? But, the same can be said of government backed currencies, as they continue to borrow (print) money they don’t have (ie: borrowing against GDP), with GDP being defined as the conversion of natural resources (ie: commodities, tangible assets, products and services, people, etc…). If cryptocurrency removes the volatility introduced by irresponsible governments and self-serving politicians, then perhaps it’s more of a stabilized form of currency than paper money, which these days has no relationship to natural resources that have intrinsic value with respect to wealth building (ie: gold, silver, etc…). In less than 12 months, I’ve gained over 100% profit invested in cryptocurrency. As the pandemic(s) continues, and governments and politicians borrow (print money) to meet the crisis, thereby devaluing their paper money, cryptocurrency has been virtually unaffected. In fact, cryptocurrency has increased in value by over 100% over a year’s time in relation to paper money. I’m not sure how long it will continue, but it seems to me that with policies that can not be whimsically changed by irresponsible governments and politicians, it may prove to be more stable of a currency, with less volatility, compared to government paper currency, at least over the near term.

  4. Computers can only do what they ae programmed to do and the programmers are in control, not the computers! Good greif! what world are uno living to trust in a computer. Today I trust no-one or anything.

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