Michigan State University

Crypto Data Digest 05

Benjamin Hall

Price is what you pay, Value is what you get

Proof-Of-Work

For something to be an effective currency, it must have value. Until 1971, the US dollar (USD) represented actual gold. The gold was scarce and required work to mine and refine, so the scarcity gave the gold value. Cryptocurrencies are similar. “Coins” (which are nothing more than publicly agreed on records of ownership) are generated or produced by “miners.” These miners are people who run programs on specialized hardware made specifically to solve proof-of-work puzzles. The work behind mining coins gives them value, while the scarcity of the coins and demand for them causes their value to fluctuate.

The idea of work giving value to currency is called a “proof-of-work” system. The other method for validating coins is called proof-of-stake. Value is created when transactions are added to public ledgers, since creating a verified “transaction block” takes work. This is what makes the blockchain decentralized; the million or more miners all over the world validating transactions.

Store of Value

Cryptocurrencies will only be worth more money in the future if they take off as a method of spending or as a store of value. Bitcoin’s usage has shifted more towards being a store of value and a network that allows users to transmit value, rather than as a day-to-day medium of exchange. For example, people don’t really use Bitcoin to buy burritos and most people don’t send money to friends or family (think Venmo, PayPal) via Bitcoin. Similarly, people buy gold or silver not because they want to spend with it, but because they know it has permanent storage value for its utility.

Not surprisingly, if cryptocurrencies become popular in usage, they could become so heavily diluted by the sheer number of cryptocurrencies (currently more than 5,000) that any given cryptocurrency only has a tiny market share, and thus not much value per coin. This makes it very challenging to determine a realistic cryptocurrency valuation.

Network Effect

The value of Bitcoin or any other cryptocurrency is based largely on its network effect. Although it could one day go to zero, if enough people consider it a store of value, it could continue to maintain or grow its worth. As bitcoins become harder to mine, their individual value will increase if enough investors remain interested in storing value in the network.

Utility

A coin’s utility is also strongly correlated with its value. Ethereum is a good example. For a person to execute commands and develop applications in the Ethereum Blockchain, one needs to hold ETH. To transact on the blockchain, ETH is converted into gas which represents the ‘fuel' for the Ethereum ecosystem.

ETH is utilized as a currency within its system to fuel transactions and development. The more people that execute transactions and develop apps, the greater the demand for ETH. In other words, Ethereum was developed to be broader than Bitcoin in terms of using blockchain technology to transfer various types of value. Ethereum is like a decentralized app platform with a built in currency (ETH). Typical app platforms have a central authority like Google or Apple, and developers can request to put apps on those networks to sell to consumers. Ethereum can do that without a centralized source or server. As a result, decentralized applications (Dapps) created on the Ethereum network enable users to transact without third party interference.

 

 

Sources

https://cryptocurrencyfacts.com/how-does-cryptocurrency-work-2/

https://www.lynalden.com/cryptocurrencies/

https://www.coindesk.com/framework-valuing-crypto-tokens

https://www.finance-monthly.com/2021/04/understanding-the-ethereum-block...

https://ycharts.com/indicators/ethereum_transactions_per_day

https://www.leewayhertz.com/proof-of-work-vs-proof-of-stake/

https://www.longtermtrends.net/bitcoin-vs-gold/

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