Today, right this minute, we have a massive natural experiment in deflation going on. The demand for Bitcoin (BTC) is far outstripping any increase in supply. If this were a national currency, the central bankers would have been institutionalized for their nervous breakdowns quite some time ago. It would be front page news every day and panic would rule the airwaves.
None of this is happening with Bitcoin. BTC insiders, movers and shakers seem pleased with the increase in value for their currency and the worry is the appreciation of the currency will go away, not that it will continue. Bitcoin pessimists like Paul Krugman, not surprisingly, believe that deflation will lead to transaction collapse and hoarding. Reality, so far, disagrees with them.
I think that the problem is that nobody among the pessimists understands what BTC is for. It's never going to be the legally mandated monopoly currency in any significant economic zone. The ethic of the BTC community works against that. This means that BTC is not competing against the US dollar, the euro, or even the renminbi.
What bitcoin does very well is create a space for moving currency without the ability for it to be stopped. That challenges national currencies in crisis that want to impose currency controls to stop money leaving their borders. You can't stop BTC transactions without draconian controls on communications.
As a practical matter, you can't stop a coin key from crossing borders. It also creates an incredibly small unit of currency. The smallest unit in the BTC world is the satoshi, or 0.00000001BTC. Is there any currency in the world that equals one satoshi? Until bitcoin reaches the point where its smallest transactions (looking at ads and other microtransactions) can no longer be done with single satoshis, BTC will not suffer transaction reduction to to value increase.
Current pricing would seem to imply something of a damper on BTC transaction flow when BTC rises above $100,000 USD per coin. In other words, the cheapest, cheapskate ads are offering a hundred satoshis for a second of your attention in a world where 1BTC is approximately 1,000USD. We have a long way to go before those transactions cease to be denominated in BTC. And even then, there will be prestige associated with working in BTC which will keep interest in the currency relatively high and larger transactions flowing around the $100k level. Any reduction will bring back a number of the bottom feeders from other currencies.
There are several wannabe BTC competitors waiting in the wings for the day that people want to conduct microtransactions smaller than 1 satoshi. They have established exchanges with national currencies and with BTC itself. when BTC grows in value sufficiently to give up the low end of its microtransaction market, the marketers will move on to alternatives until one of them gains enough advantage to be the next BTC.
Ultimately, BTC is about mad money for a lot of people. As an experiment, I've mined BTC overnight and done micro-tasks using the thing in my spare time. Since April of this year, without any impact on my productivity, I've gotten the price of a fairly nice night out with my wife in BTC right now. It's a piece, but only a piece, of an emerging 21st century wallet which diversifies currency use and manages transactions both online and offline. That wallet probably won't fully emerge for a decade at the very least and more likely will take two to really standardize but it will be the death of the ability of national currencies to live on their past reputations. People will gain the ability to react to currency foolishness much more quickly. BTC will be an important part of that technology suite.
crossposted: Chicago Boyz