Many people believe digital currencies have no real value, including me when I first heard of them back in 2014. I actually thought they don't have any intrinsic value. But I was wrong, because I didn't have a proper understanding of fiat currencies back then (all currencies that are backed by the government are fiat currencies). Before I explain the value of digital currencies, I would like to explain the value of fiat currencies .
Here is the truth about money - It can be anything. Take the US dollar for example, there is nothing backing it up. It went off the gold standard following Bretton Woods conference in 1971, rendering US dollar as a fiat currency. So the dollar really is just a promise, an 'act of faith' whose value is backed by the government. Same is the case with other major currencies including the Indian Rupee, Euro, British Pound, Yen etc.
A digital currency is no different. It is simply internet based money. And like any other medium of exchange, many people around the world have decided it is money. Here is the thing to remember about money, it is whatever people mutually agree it is.
In the past shells, pearls, beads, silver, gold and even paper have all been used as money. You will notice that none of them have any intrinsic value. At the end of the day, a sack of rice has more practical value than a 2000 rupee note or even a bar of gold.
How does a piece of pink paper or a bar of yellow metal hold more value to a human than a sack of rice that can be used to feed a family for weeks?
Because we all agree it does. That is the mutual agreement we have all come to. In my opinion, paper currency may be the most irrational form of money in human history. At least you can decorate yourself with gold, silver, beads, pearls and shells.
Not only that, there is a limit to how much gold, silver and shells that can be found. There is no limit on the amount of paper money that can be created. The closest thing to true money (outside of food) is gold. Gold meets several historical rules that we use to judge value. It is prized for its beauty, difficult to find, expensive to extract and more importantly it is a scarce resource and that is what gives gold its value.
But there are problems with gold too. We have to trust that the refineries that certify the gold's purity are telling the truth. Gold is also difficult to transfer (think of carrying around bags of gold coins or chests of gold bars). And that makes it virtually useless as a practical medium of exchange in daily life.
Now, here is how digital currencies are creating value:
Digital currencies like Bitcoin (Bitcoin is the most popular digital currency) are pre-programmed to create a set amount of coins. Once this limit is reached, no new coins will be created. This creates scarcity. For example the algorithm that governs Bitcoin will create no more than 21 million Bitcoins.
To get a better perspective, there are estimated 35 million millionaires in the world (source: Forbes). That means if every millionaire wanted to own an entire Bitcoin, they wouldn't be able to. There literally is not enough to go around.
To compare that to paper money, there's no limit to how much that can be created. However, gold is finite. That limits how much new gold can be refined each year. You can see that digital currencies actually have more in common with gold than with paper money.
Another important point to note is, digital currencies are virtually impossible to counterfeit. Digital currencies rely on a technology called the 'blockchain.' This blockchain uses cryptography to secure transactions. These complex mathematical algorithms make counterfeiting digital currencies impossible.
Now compare that to cash, we have all heard of reports of fake currencies being printed and circulated. We have also heard instances of discovery of counterfeit gold.
So two important criteria give value to digital currency- scarcity and irreproducibility (hard to counterfeit).
Also the marketplace has already accepted digital currencies. People have bought Tesla cars, rented luxury villas, and bought diamond rings with Bitcoin already. Few European countries started offering citizenship in exchange for Bitcoins. Few security boards in US are exploring options to trade futures using Bitcoin and hedge fund managers are exploring the usage of Bitcoin to hedge risk in their investments.
In conclusion, people have already started to believe they will be able to use digital currencies in the future to buy stuff. That alone makes it have value.