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Bitcoin is a digital currency, which has monetary value and can be exchanged for fiat money. Most people are interested in knowing if it is backed by any commodity or currency of value and this is because this was how the financial system worked before now. Some time ago, nations used currencies backed by a valuable commodity such as gold or silver, but mostly gold, however, at some point in the 20th Century, most nations abandoned this standard for their monetary system.
How did the gold standard work?
In the gold standard, money was backed by gold. Here, a unit of money was associated with the value of certain gold coins in circulation. This system was established in 1821 and more common where a unit of money had the same value as a certain amount of gold coins and is known as the gold specie standard. This monetary standard ended in World War I.
Following the end of the gold specie standard in 1925, another system was adopted (first by Britain) where the gold coins were not in circulation, but the government issued what was known as gold bullion, in exchange for the currency in circulation. This gold bullion carried the value of a certain number of gold coins; therefore, buying this gold bullion was equivalent to buying gold. This system was known as the gold bullion standard.
The third system was like a de facto gold system, was after the World War II, where a fixed exchange rate was given to the currency of a country operating in a gold system (any of the first two above). Here, all other currencies were tied to the U.S. dollar.
Ups and downs of the gold and Currency system
When the gold system was being used, the major advantage was that there was long-term stability in price, inflation was rare (during wars), and exchange rates were fixed.
The disadvantages of this system were plenty. The countries with larger deposits of gold were richer. Also, to correct economic downturns, money supply is increased, but since money is backed by gold, no increase in gold supply means no increase in money supply, which in turn limits economic growth.
Generally, this system hardly allowed even spread of wealth in a nation.
With all these considered, most nations of the world prefer to operate in economic freedom, with fiat currency (currency not backed by gold) where policies can be made without the setback of lack of gold production. This system means that no matter how educated, industrious, beautiful or privileged a nation is, if it does not have large gold deposits, it could not really be rich.
Bitcoin is compared to the gold system money
After knowing the impact of operating the gold system, it is easy to know that Bitcoin is not backed by gold, as this is the era of economic liberty. Bitcoin has some really serious similarities with gold-backed money, for which reason the very question arose.
Here are some similarities:
- Both have limited and predictable supply of its units
- None are controlled by a central bank or authority
- Inflation is low or non-existent when both are involved
- You have to mine gold, in order to create more gold-backed money and you have to spend resources in order to mine Bitcoin.
Nonetheless, Bitcoin is not backed by gold, and if at all it should be likened to any kind of money, it is most similar to fiat money. Which has no intrinsic value as such but is generally agreed on as being valuable.
Why Bitcoin does not need to be backed by commodity
In the 21st Century, money is circulated having no intrinsic value as such but is generally agreed on as being valuable. Therefore the markets and consensus determine the value of fiat money. Bitcoin operates in this manner and thrives. However, Bitcoin is regarded more as a stock which is usually exchanged for fiat currency such as U.S. Dollars, Euros and so on, maybe because of its quickly soaring value. It doesn’t take a genius to see that Bitcoin has combined the advantages of both fiat money and money backed by gold, hence becoming the new age currency.