What is fiat currency ?

Fiat money is government-issued currency that is not backed by a physical commodity, such as gold. The US Dollar effectively became a fiat currency in the 1930s, because Congress showed that it will dilute the gold standard to shorten recessions.

Does fiat currency get its value from the military power of that government ?

Some people believe that the US uses its military force to give the US Dollar value. But the US have never attacked another country for commercial reasons. And there are many examples of countries with high inflation rates at a time when they are scoring military victories. For example Vietnam or South Africa in the 80s.

Where does the value come from then ?

The strongest statistical correlation is to the economic output of the country (GDP). In fact, macro economists often use the equation

GDP = Money Supply x Money velocity

But there is a more fundamental reason why fiat currencies are so valuable. They are brands.

What is a brand ?

A brand is a word or a sign that influence individuals (humans).

Investors know that brands are often valuable intangible assets.

Accountants often struggle to accurately value a brand. Often the historical cost is the only reasonable approximation.

Brands get their value from positive exposure such as advertising or public relations. (The workings of the public relations industry is usually so well hidden from the public, that is has been described as a submarine.)

Sometimes a brand get free, unsolicited media exposure which I will call organic exposure. For example, a journalist may come across a seemingly ordinary man who is a paper millionaire due to his long term Bitcoin investments. The story goes viral through no or minimal effort from the millionaire.

Fiat currencies also get most of their value from organic exposure.

So Bitcoin has the same intangible value as every fiat currency ?

No. This there is a fundamental difference!

This picture is primarily an advertisement to buy burgers. But it also contains another message: Anyone who likes burgers, should also like Pound Sterling.

And there are references to fiat currencies everywhere: On supermarket shelves, restaurant menus, TV shows, news articles. In the US, you even have supermarkets called Dollar General and Family Dollar.

Prices are important to most consumer decisions. So consumers will accept the status quo and be bombarded with these messages. Over the long term it influences their savings and investment decisions.

Is Bitcoin a store of value just like gold ?

Gold has unique chemical and physical properties that gives it many industrial uses. Gold also has ornamental uses and cultural significance.

Bitcoin has no ornamental value. Bitcoin is much less useful. Furthermore, more and more crypto currencies are providing the same useful properties as Bitcoin. So Bitcoin is rapidly using it's uniqueness.

Bitcoin is an original, ground breaking product and is therefore much more like collectors items. So, as it falls in and out of favour with the media, it's value swings widely. The media will soon find a new technology to hype about. That technology may even be a better crypto currency.

But Bitcoin is already very useful for international money transfers!

Yes, Bitcoin exchanges are growing rapidly in many countries. Many of them have low fees, high liquidity and high transparency. So it's cheaper than the antiquated systems used by many banks.

And Bitcoin is also circumventing the capital controls (exchange controls) imposed by some governments.

But neither of these require the Bitcoin price to be has high as it currently is. If Bitcoin drops to $1000, these trends will still continue.

I'm still not convinced!

The volatility of Bitcoin is extremely high. So it's impossible to price anything in Bitcoin. And volatility makes it a poor choice as a long term value store.

Can an economy function with 2 currencies at the same time ?

It's possible for a business to advertise a product in two different currencies at the same time, but it's very, very rare. The only example I know of is entrance to the Rhone Glacier that is priced both in Swiss Francs and Euros. The reason it's so rare is that consumers will often exploit the arbitrage.

It's much more common for a business to advertise a product in one currency, while settlement is in another. For example, Booking.com may list hotels in Vietnam with dollar prices. The hotel accepts cash, but only Vietnamese Dong. This transaction hardly changes the perception of the tourist. He will still use the dollar for his long term savings.

But you've been wrong about Bitcoin for a long time!

For many years the public believed that the sun rotates around the earth. Eventually science triumphed. I am sure we'll see the same thing with Bitcoin.