Bitcoin is not a stock. It does not have a CEO, a board of directors, Articles of Organization, dividends, or most of the other trappings you would expect to find with a corporation. It is an asset unlike any that has ever existed prior to its invention, and for this reason, many struggle and fail to understand it. Bitcoin is both an open-source software project and a distributed network of computers and hardware devices. Just as no one company owns or operates the internet, Bitcoin lives outside of 20th century notions of business and organization. It is a creature of the internet and is the emergent money protocol of the same. So why does Bitcoin have value?

Meet Carl Menger

Carl Menger, the father of the Austrian School

To understand why Bitcoin has value, let's take a little trip back in time to Austria circa 1867. Carl Menger, then working as a journalist, noticed discrepancies between what he had been taught in university, where "classical economics" was orthodox, and what he observed in real-world markets. Classical economists such as Adam Smith, Thomas Robert Malthus, John Stuart Mill, and David Ricardo generally believed in variants of the "cost-of-production theory of value" or the "labor theory of value." Labor theory says that the value of a good or service is equal to the amount of labor required to produce it. Similarly, cost-of-production theory states that the price or value of a good or service is determined by the tax rate and the factors of production (including labor, capital, and land). While these theories may seem plausible at first glance, a simple example will show why they must be flawed.

A Giant Hole

Imagine a man who loves to dig holes. Perhaps this man inherited a small fortune and he decided one day that the key to increasing his property value was to dig a massive hole in his backyard. His obsession led him to spend $500k for an excavation company to dig a giant pit. He then listed his home for sale and tacked $500k on his asking price. This seemed fair since he had "invested" as much in digging the hole. He was a big believer in the cost-of-production theory of value. The problem was that no one else on earth had a similar strange obsession with useless holes. No one was willing to pay the price he was asking. Sadly, he didn't understand that all value is subjective, in that it is dependent on the one doing the valuing: the buyer.

All Value is Subjective

Carl Menger understood this phenomenon and called it the "subjective theory of value". The value of a good is not determined by some "intrinsic" property nor by the labor or amount of input cost associated with its production. Value is determined by an individual acting in rational self-interest to achieve a desired end. If a good offers utility beyond any other comparable tool in the achievement of an end, and the cost to utilize this tool is not significantly higher than the alternatives, then this tool will be favored.

A Carpenter and a Blacksmith walk into a bar...

For example, imagine a carpenter with a wooden mallet who learns of a new mallet for sale by the blacksmith. This new mallet is called a hammer and the head is made of iron. The blacksmith demonstrates the superior power and durability of his invention and, even though the price is 20% more than a traditional wooden mallet, the carpenter sees that it will last far longer and improve his productivity. He buys the hammer and benefits in the short-term by completing his work 10% faster and in the long-term because the iron hammer head does not wear out like the mallet head. He is so happy, he buys a second hammer as a back-up. Happy with the obvious success of his invention, the blacksmith tries to sell the carpenter a third hammer, but to his disappointment, the carpenter declines. Here we see another principal of economics (which Menger discovered) called "marginal utility".  While the carpenter finds that his new hammer is very useful, and even buys a second to be sure that he is never without one close-at-hand, he only has the ability to use one hammer at a time. He doesn't have four arms. The benefit he would receive from buying a third or forth or fifth hammer is close to nothing. If the additional (marginal) utility of acquiring additional hammers is very low, then the carpenters willingness to pay for another hammer is also low and thus he will not buy another. Marginal utility further illustrates that value is subjective.

Bitcoin is Money

Bitcoin has value because millions of market participants have found that it is the best tool for the job. They have all found, usually through a painful process of trial-and-error, that Bitcoin is the best money that has ever existed. Unlike other goods, money is unique in that it is not acquired to be consumed but rather to be traded in the future for a good or service. Money emerges organically in the marketplace as the most salable good across scale, space, and time.

Money at Scale

"Scale" (often called divisibility) means that you can use the same sort of money to buy an apple or a house. In other words, each unit of money can be combined or divided to purchase any good or service and comes in standard units (dollars, cents, kilos, ounces, etc.) which can scale up or down for large or small purchases. In the future, only very wealthy people will own a whole bitcoin. Thankfully, each bitcoin can be subdivided to 100,000,000 units, called "satoshis" or "sats". Sats can also be further divided to "millisats" for very small transactions. This property makes Bitcoin far superior to precious metals. Because of a relatively high value per ounce, it is impractical to use gold for small purchases. Conversely, fiat dollars do not come in very large denominations, and moving millions of dollars of notes is cumbersome; so checks, bank wires and other methods are used for large transactions. Bitcoin suffers from neither of these constraints and benefits from absolute mathematical precision at any scale, micro or macro.

Money Across Space

Money needs to be portable across distance to be useful. Bitcoin is a purely digital money meaning that, at the foundation, it is information. Any medium of human communication could be used to send a Bitcoin transaction. Today, this is typically accomplished over the internet. However, Bitcoin transactions can also be received by satellite and some have started experimenting with ham radio and mesh networks. Bitcoin can be sent to anyone, almost anywhere on earth, 24/7/365 in seconds. You could send $1 million in Bitcoin with a few keystrokes to anyone you wish in the time it took you to read this paragraph. In contrast, sending $1 million worth of gold to someone in another country would be somewhere between very expensive and impossible depending on the country and would take a week or so to arrive. A bank wire might only take a few days to arrive but it will cost you and, depending on the country, you might not even be allowed to send it. Compared to the cost of shipping and insuring gold or navigating the hassle and cost of wiring money, Bitcoin is the clear winner for money utility across physical space.

Money Through Time

Most important of all, good money must be scarce for it to maintain value across time. A scarce money is one where the supply cannot be easily inflated. Historically, gold has tended to be used as money because, prior to Bitcoin, it was the most scarce or "hardest" money on earth. Gold supply increases from gold mining by about 1.5% per year. Put another way, the annual stock (above ground gold) to flow (new supply) ratio of gold is about 64:1. The higher the stock, the harder it is to inflate the supply quickly. Another precious metal, silver, has a stock-to-flow ratio of 22:1 which puts annual inflation of silver at about 4.5%, significantly higher than gold. Both of these assets look close to pristine when compared to the US Dollar which was subjected to a jaw dropping 62.5% inflation of M1 in 2020 from just under $4 trillion in January, to over 6.5$ trillion by the end of the year. So how does Bitcoin stack up to the competition? Currently, Bitcoin has a stock-to-flow ratio of 40:1 which is an annual inflation rate of 2.5%. However, every four years Bitcoin's inflation rate is cut in half. This is hard-coded into the protocol and happens automatically. The next "halving" as it is called will occur the first quarter of 2024 (somewhat like a pregnancy, we can't know with certainty the exact date because it is contingent on block time, which is a function of the "mining" hash rate). When this halving occurs, the inflation rate of bitcoin will be cut to less than 1.25% and will continue to fall until the final supply cap is reached in the year 2140, at just shy of 21 million bitcoins. Bitcoin is the "hardest" money known to man, being the first asset in human history with absolute scarcity as a defining property.

10x Better Money

For a new technology to beat out an incumbent, Peter Thiel is famous for saying "you have to be 10 times better than the second-best." Money is a technology for moving value across space, time, and scale. Bitcoin is the newest contender in a domain where governments have managed to hold monopoly power for many decades. We didn't grow up in a world with currency competition, so it is understandable why so many have struggled to understand what is happening with this new "magic internet money." It helps to take a step back to look at money as Karl Menger did. When we do, we see that Bitcoin has value because the market of millions of individual rational actors have decided that it is the best tool for the job of preserving and transporting their hard work and savings into the future. Even if you find reason for skepticism, you'll likely do well to listen to Satoshi Nakamoto (the pseudonymous inventor of Bitcoin): "it might make sense just to get some in case it catches on."