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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. Aside from the fact that the only “Legal tender for all debts public and private” in the US is the US dollar… I researched cryptocurrencies for investments when they first came out and decided against them. Here’s a few of the reason’s why.

    Although the US dollar is not backed by commodities as it was before Nixon removed it from the gold standard, it is backed by tax income, GDP and a country worth trillions of dollars, as is the Euro, Yen, etc. Bitcoin is not a “fiat” currency, it’s only an elaborate Ponzi scheme.

    Bitcoin is backed by absolutely nothing other than the belief it is worth something. It has no income and no assets, so it won’t ever be worth anything. The original purchase price of the coins were not banked or used to buy commodities to back the “currency” with, they were handed over to the founders of the idea. There isn’t even a finite number of coins, new coins are added all the time. The cash generated with each new coin added, takes the same route into pockets of the founders. It has made the founders extremely wealthy and will generate a continued income for as long as they can make people believe it is worth something.

    Cryptocurrencies like Bitcoin that are not backed up with something of value are also illegal constitutionally in the US and similarly illegal in most countries. In the US, only the Federal Government can print or coin currency with the exception that States are allowed to mint Silver or Gold coins with Congressional approval.

    US Supreme Court rulings found that electronic documents are the same as if those documents were printed on paper. The wording in the ruling strongly suggests that any digital currency would be the same as if was printed on paper. Since it is not backed in full by US dollars or anything else of value, it would be digitally “Printing or Minting” money, making Bitcoin unconstitutional and essentially a form of counterfeiting.

    For instance PayPal or a Bank Debit Card are legal, they use the digital representation of actual US dollars that are deposited into an account. Bitcoin is not legal because it does not represent actual US dollars in deposit or anything else of value. It’s legality would not be in question if it had been backed with something of value like a basket of currencies, gold or silver. Since it is used as money, it has nothing of value backing it and since digital copies were ruled the same as printed, it definitely appears to be a counterfeit currency.

    That brings up the question of owning or trading in this currency. Under current law, those who pass counterfeit money are conspirators to counterfeiting. Therefore using Bitcoin would be the same as passing counterfeit money that somebody else gave you. Although you did not actually print the counterfeit money (Bitcoin), you conspired with the counterfeiters (the founders of bitcoin who have profited wildly and continue to profit with each new coin released) when you used it as if it had an actual US dollar value. That makes the holders of the currency both criminally and civilly liable WHEN it is found unconstitutional.

    This is true even if you did not know the money was counterfeit. For instance you accept a counterfeit bill in change from one store, then try to use it at another store where it is discovered to be counterfeit. You could be charged with conspiracy to counterfeiting simply because you tried to pass a counterfeit bill that you got in change someplace else.

    What happens to that counterfeit money that you accepted as change that was discovered to be counterfeit when you tried to spend it? It is seized as evidence, you won’t ever get it back and you are not reimbursed. Same thing could happen to Bitcoin if the law is actually applied to its use. It could become worthless – instantly.

    You could also be liable for damages if someone takes Bitcoin in payment and it later loses any value. After all, it is not “Legal Tender”. Damages have been awarded in the past over barter exchanges that lost value.

    Lawmakers can write laws to allow its use, but without changing the US Constitution to allow anybody to print there own currency without any form of backing, those laws would also be struck down as unconstitutional.

    What is really scary about Bitcoin is eventually Bitcoin could become a threat to the US Government’s (or Euro Zone, Japan, etc.) ability to print their own money, and at that point constitutional law will likely be applied to it. Anybody that is harmed by its use could bring its constitutionality into question too and WHEN it is found unconstitutional, civil liability for its use could become a real problem. Bitcoin is not as anonymous as you might think.

    If you are hedging against a monetary collapse, buy gold or silver. Cryptocurrencies might be good for criminal transactions that you don’t want to be easily tracked (like it or not, then CAN BE TRACKED), but they aren’t a safe haven in a monetary collapse. In a monetary collapse, you’ll could lose more than what you had in them to begin with.

  5. SLCSnowboarder

    “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.”

    This is the key fallacy in the arguments regarding Bitcoin. It is not true that dollars, euros, and pounds are backed by nothing. They are backed by the productivity of their respective nations first, and then by the reputation and stability of the governments. It is true that fiat money does have potential downfalls, but nowhere close to what the “government free” Bitcoin has. It would take little to disrupt consumer confidence in Bitcoin as it is subject to all kinds of technological attacks and pitfalls with nothing to guarantee or protect against its misuse or abuse.

    Some examples of shortcomings and vulnerabilities are explained in the following article:

    1. Hi SLCSnowboarder,

      “Backing” is perhaps not as useful a concept as “limiting.” When money was issued 1:1 with the amount of gold which a bank or government held in its vaults, money could not be inflated (without risking a run).

      With fiat not tied to anything tangible, it becomes unlimited. Productivity, reputation, stability… These abstracts cannot constrain the ability of government to issue currency in unlimited quantity, until the value of the money is debased.

      One only has to look at how fiat money has devalued against hard money (Bitcoin in particular) and how inflation has driven up the cost of goods and services, to see the result of unlimited monetary supply.

      As for destructive technological attacks against Bitcoin, I’ve yet to see one which is practical to implement. Yes, governments could shut down the internet, but not without shutting down a major portion of their economy too. Attempting specific bans against Bitcoin traffic would work for a while, until that traffic was encrypted and disguised.

      The dozen points from the article are insufficient to stop the growth of Bitcoin, in my opinion.

      1. You haven’t seen any successful attacks on Bitcoin? What about Mt Gox?

        Still, I think we are yet to see the biggest technological attacks. The fact about Bitcoin is it relies on miners to authenticate the transactions. And it is no secret that greater computing capacity increases the effectiveness of an individual miner. The question is, who has access to the most high tech, high speed computers?

        Currently, Bitcoin is little more than a novelty investment and has not attracted much attention by large financial institutions or foreign governments. But if they ever wanted to manipulate Bitcoin and wreak havoc in it as a currency, they certainly have the resources to do so. And they could easily use dummy accounts as each node is anonymous.

    2. Bitcoin has a different “mission statement” than a government backed currency. The fundamental distinction is price stability versus system stability. I’m paraphrasing an article I read here but the notion is something like this: Government backed currencies have price stability. That’s the whole point, they can use monetary control to keep prices stable, which can be good in the short term, because stability is certainty, and certainty is generally seen as good for markets and vendors. But it can also be a band aid on a festering wound that periodically leads to major systemic failures like the great depression, the great recession, and our almost certainly upcoming major recession.

      A crypto-currency like bitcoin has much higher systemic stability at the cost of price volatility. The price will ALWAYS fluctuate, and probably wildly at times. But you can be certain of your ownership, and certain that the value of what you own is fluctuating only due to market forces, not government manipulation.

      Is one better than the other? Is a saw better than a hammer? They’re categorically different tools. (also bitcoin isn’t fully mature yet, so perhaps its more like comparing a saw to a blueprint of a hammer.) But many of the vulnerabilities mentioned in the forbes article aren’t really vulnerabilities at all. As we say in the computing world “It’s not a bug, it’s a feature”. Anyone getting involved in cryptocurrencies should absolutely inform themselves and know what they are getting into. If you can’t afford to ride what you own to zero, you probably are holding too much. But once people really understand what blockchain technology is all about, there are a paradigm shifting number of use cases for automated trust, and my personal opinion is that Bitcoin and Ethereum are best poised to capitalize on that, for reasons both technological and sociological.

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