What determines the value of a bitcoin? You might as well ask, “What determines the value of a dollar?” (Or a euro or a yen … or even gold.)

The basic economics of supply and demand helps to account for much of the value of anything: if more people want something than the market is currently supplying, demand outstrips supply and the value of that something rises. Gold, for example, has some inherent value as a relatively rare, shiny metal that can be used to make beautiful jewelry and works of art. However, its perception by so-called “goldbugs” as an inflation-proof commodity often helps to propel its traded value far beyond that inherent worth.

Of course, it’s a bit different when you essentially create a something out of a nothing, which one could argue is the case with bitcoins. What are they, after all, but strings of numbers unconnected to anything in the real world except for algorithms and computing power?

But bitcoins clearly have value. Why? This answer from the Bitcoin Forum sums up the reasons well:

“Markets and merchants will in the end keep things flowing. Combined with amount of miners. And a few other million little factors.”

In other words, multiple factors affect the price of the bitcoin virtual currency just as much as they do “real-world” fiat currencies or anything else. We saw that recently, when the value for a bitcoin reached a high of $266 in trading on Mt. Gox in April 2013 before crashing to a low of $50.01 in a matter of days. (Among the reasons: speculators, market-manipulating DDoS attacks on Mt. Gox and other sites, and bitcoin’s sudden “it”-factor appeal.)

According to the historical price data at blockchain.info, bitcoins first showed signs of having a real-life, convertible value in dollars – a whopping 7.4 cents per bitcoin – sometime in the late summer of 2010 … more than a year-and-a-half after the first bitcoins were mined in January 2009.

This doesn’t mean bitcoins weren’t perceived as having any value before that. They were already being exchanged among, spent by and sometimes simply given away by many people in the bitcoin network. (This account in Wired credits Florida programmer Laszlo Hanyecz with the first real-world transaction involving bitcoins, in which Hanyecz sent 10,000 bitcoins to someone in England, who then ordered two pizzas for him using a credit card to pay. At today’s (April 14, 2013) exchange rate of around $140 per bitcoin, that amounts to around $700,000 per pizza! “I don’t feel bad about it,” Hanyecz told Wired in the 2011 article. “The pizza was really good.”)

Which brings us to one more factor that helps, at least in part, to determine the value of a bitcoin: sheer faith.

As another member of the Bitcoin Forum noted in the same thread described above, “Faith in bitcoin determines the price. Whatever increases faith, increases the price, and vice a (sic) versa. This may sound scary, that it is only practically backed by faith and opinion, but the US dollar is based on nothing else as well. It is up to us to supply the faith, and up to the community to support bitcoin to make it succeed.”

Faith, in the case of bitcoins, though, is backed by well-tested cryptographic techniques and a formula ensuring a predictable, limited supply of the currency. Bitcoin fans would say that gives their choice of currency an edge over traditional forms of legal tender.

In fact, the price of (and, by extension, the faith in) bitcoins has tended to increase when confidence in fiat currencies and the traditional economy has fallen. The most recent bitcoin boom in the spring of 2013, for example, came quick on the heels of news that bank-account holders in Cyprus faced a “haircut” on their savings. To obtain a €10 billion bailout from the European Commission, the European Central Bank and the International Monetary Fund, Cyprus’ leaders agreed to a seizure of a portion of savings in large, uninsured bank accounts.

Bitcoins, unlike fiat currencies, are also at little risk of inflation or hyperinflation – something that has plagued numerous economies throughout history. With a built-in hard limit of 21 million bitcoins (not expected to be reached until 2140), the virtual currency is instead naturally deflationary … that is, a bitcoin’s value is projected to increase, rather than decrease, over time as each one becomes progressively harder to mine.

While critics warn that a bitcoin economy is at greater risk of a deflationary spiral, supporters argue that’s not the case.

“Everything is the opposite of the popular fractional reserve banking system (because bitcoin isn’t a debt but an asset),” explains the Bitcoin Wiki. “Bitcoins only deflate in value when the Bitcoin Economy is growing.”

Looking for the definitive bitcoin price? View the Bitcoin Price Index. --