A recurring criticism of bitcoin is that it has no backing from a government or reserve of assets. Because of this, critics say it has no intrinsic value.

To some extent, these comments have merit. Bitcoin does not share the same underpinnings as traditional currencies, nor is it backed by reserves of real-world assets, cash, or cash equivalents like stablecoin cryptocurrencies. But many see bitcoin’s lack of government backing or involvement as a feature rather than a shortcoming.

Bitcoin is backed by a combination of complex mathematics and cryptography techniques that allow the protocol to operate. More specifically, Bitcoin uses a series of cryptographic algorithms to secure its network and issue the currency.

Together, these algorithms lay the foundation for a robust electronic payment system that is permissionless, borderless and censorship-resistant.

The Bitcoin protocol, as it is known, operates based on a set of computer-coded rules that dictate important parameters for its native cryptocurrency. A distributed network of volunteers follow these rules and perform key roles, like mining, to help maintain and secure the network using their computers. The volunteers are often rewarded for their work on the network via mining rewards.

In this way, Bitcoin is able to replace a great deal of human-involvement with software. You can think of it like a vending machine. The protocol largely works automatically but still requires humans to help maintain it.

Traditionally, national currencies such as the U.S Dollar or Great British Pound were backed by equivalent reserves of gold. This meant every unit of physical currency could be redeemed at any time for its worth in gold.

By pegging paper notes to a precious, finite commodity, it helped assure the value of the underlying currency and limited the amount of new units that could be issued. 

Eventually, the scarcity of gold stifled economic growth and countries were keen to expand faster than the availability of gold would allow. This led to them abandoning the gold standard and delinking their currencies from any physical backing.

To date, all national currencies have transitioned to “fiat” currencies. These have zero backing from real-world assets. Instead, the value of the underlying currency relies on the ability of each country’s respective government to pay off its debt.

The prices of fiat currencies are no longer fixed to the value of a commodity, but based on the stability of the government issuing it as well as the general principles of supply and demand. Generally speaking, the stronger a country’s economy, the higher the demand and value of its fiat currency.

Without the backing of gold, fiat currencies have no intrinsic value. Their only monetary value is set by the faith its users have in their respective governments to maintain economic stability.

Through excessive printing of new currency and its knock-on effect of causing inflation, the purchasing power of these fiat currencies typically falls significantly over time. Between 1900 and 2010, the purchasing power of the U.S dollar fell by 98%.

In some cases, surging prices can lead to hyperinflation which often spells doom for the underlying fiat currency. It’s generally accepted that hyperinflation occurs when the rate of monthly inflation exceeds 50% (when the prices of general goods and services become 50% more expensive within a one-month period).

Over 35 fiat currencies have collapsed from hyperinflation in the twentieth century alone. When citizens recognize their money is depreciating rapidly they may decide to exchange it for other foreign currencies or commodities to hedge against rampant inflation. Hyperinflated currencies also lose their international appeal, causing countries to cash out and hold more stable assets.

Fiat currencies, therefore, only have value and function when governments properly maintain them as a trusted medium of exchange.

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