Why the value of bitcoins will stabilize

[bitcoinbear]

I have been thinking about inflation and deflation. There are a few threads around about how deflation is bad for investing, and why would anybody make loans in a deflating economy. These concerns are only an issue in a massively deflating currency, a slowly deflating currency will not be horribly different that a slowly inflating currency.

The big difference between inflation and deflation, and why the value of bitcoins will stabilize, is that inflation can continue at an arbitrary rate forever, but deflation must slow dow. And when I say the value of bitcoins, I do not mean the USD/BTC exchange rate, I mean the purchasing power of bitcoins for real goods.

Inflation can continue at a steady rate forever because the value of each unit is getting smaller. So even though the percentage stays the same, the difference in value is decreasing over time.

Deflation cannot continue at a high rate because of the exponential nature of the increase. The bitcoin market cap is small right now, but if the value increases exponentially there will soon not be enough to spend the bitcoins on. As the value rises, people saving will be more and more tempted to spend their currency for goods or services. Any time money is taken out of savings and spent it will counteract deflation. Eventually an equilibrium will be reached. So even though bitcoins can continue deflating forever, the percentage of deflation will steadily decrease, and the value of the bitcoins will asymptotically approach some true value.

That is not to stay that the price of bitcoins will be unchanging, since the underlying fundementals (amount of users, proportion of saving and investing) will change and change the underlying value, and since USD is inflating the USD/BTC will generally rise over time. But the point is that as bitcoins mature the value will stabilize, and then investments made using bitcoin will make much more sense than in today's climate.

[justusranvier]

It's also important to nail down what people mean by "investment".

Are they talking about speculation or are they talking about individuals using their savings to start their own businesses, companies retaining profits to buy capital equipment, open new production lines, etc?

[Stephen Gornick]

if the value increases exponentially there will soon not be enough to spend the bitcoins on. As the value rises, people saving will be more and more tempted to spend their currency for goods or services.

The Ben Bernank says exactly that:

but also the prices of various assets, like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they'll feel more -- more disposed to spend.

 - http://www.zerohedge.com/news/punchline-his-own-words-bernanke-advocates-blowing-asset-bubbles-antidote-depression

But consumers actually have to believe they are more wealthy.  Here's another recent article on that very topic:

 - http://www.zerohedge.com/news/retail-investors-just-say-no-bernankes-artificial-wealth-effect

[Adrian-x]

It's also important to nail down what people mean by "investment".

Are they talking about speculation or are they talking about individuals using their savings to start their own businesses, companies retaining profits to buy capital equipment, open new production lines, etc?

This is a hugely important distinction and I think causing confusion.

1) I have invested in Bitcoin (I bought some Bitcoin and it is appreciating in value) it is a good investment  speculative
2) I have invested in capital equipment, ( I used my savings to start a business providing some benefit, the cost of setting up my biasness is an investment.)  

For arguments sake the type of investments that is necessary for building an economy based on triad of goods and services should be the default understanding. Other investment types should be prefaced by a descriptor eg. "speculative"

[Adrian-x]

Deflation cannot continue at a high rate because of the exponential nature of the increase.

This is why some Keynesians think there is risk of a deflationary spiral, I don't hold that view. But it is controversial none the less.

The bitcoin market cap is small right now, but if the value increases exponentially there will soon not be enough to spend the bitcoins on. As the value rises, people saving will be more and more tempted to spend their currency for goods or services. Any time money is taken out of savings and spent it will counteract deflation.

"The bitcoin market cap is small right now" the size is only potentially huge, it is neater small nor big the size is a factor of subjective evaluation, measured as the exchange rate with fiat .
Think of it like the Balance of trade, the speculative investing in Bitcoin is equivalent to a trade surplus. While there is a demand for Bitcoin we have a trade surplus.

In order to maintain a triad surplus of a fixed commodity you have to adjust the price. (so I can agree the market cap is small if the demand continues to increase)  
"there will soon not be enough to spend the bitcoins on" Who is going to provide theses goods and services? (Mr.99%)
Consider you can already buy anything you can afford by exchanging your Bitcoin's for fiat today.

Any time money is taken out of savings and spent it will counteract deflation
I agree with you here again. But consider if the goods and services are provided by (Mr.99%) are paid for in fiat - the Bitcoin community will be running a trade deficit, this will cause the market cap to shrink.  
But if (Mr.99%) accepts payment in Bitcoin and does not convert them to fiat,  but then uses them to buy goods and services inside the Bitcoin economy then Bitcoin's' balance of payments is not affected.

Other debates I have been interested in reading relate to how savings and investing drive economic growth and are a function of inflation or deflation.  

The general consensus among the people who like Bitcoin Austrians is deflation discourages investment and inflation encourages the investment of capital.

Bitcoin is suffering for the paradox of thrift. it seems deflation is encouraging savings and not investment within the Bitcoin economy.
In a free market the value of Bitcoin should be stable if there is a balanced trade deficit between Bitcoin and fiat. If the desired goods and services are not generated within the Bitcoin economy spending the Bitcoin's will create a trade deficit and value of Bitcoin's shouldn't be stable.  
 

[lebing]

Yes, I think we can all agree that it will stabilize eventually... but achieving the market cap necessary in order for this to take effect? This could be 15-20 years from now.

[allthingsluxury]

I have great faith in the bitcoin economy. I strongly believe we will get there over the course of the coming years. It will take time of course. Hopefully it stabilizes and slowly climbs higher, as we know parabolic rises are only good for those trying to make a quick messy buck.

[bitcoinbear]

I have great faith in the bitcoin economy. I strongly believe we will get there over the course of the coming years. It will take time of course. Hopefully it stabilizes and slowly climbs higher, as we know parabolic rises are only good for those trying to make a quick messy buck.

There was a thread around here somewhere with a graph showing the price over time is following y=x^(1/2), which is a parabola with the open end to the right.

[Enky1974]

I have great faith in the bitcoin economy. I strongly believe we will get there over the course of the coming years. It will take time of course. Hopefully it stabilizes and slowly climbs higher, as we know parabolic rises are only good for those trying to make a quick messy buck.

There was a thread around here somewhere with a graph showing the price over time is following y=x^(1/2), which is a parabola with the open end to the right.

I've found something slightly different using non linear estimation of statistica 7 by statsoft:

using daily data
average
y=-5.1033+x^(.31)

low confidence limit 95%
y=-5.26689+x^(.30358)
up.confidence limit 95%
y=-4.93971+x^(0.31243)

it seems to expand at a slower pace , using the upper confidence limit and 10 years you have 3085$ , using the other formula for low conf limit you have instead 894$
so in 10 years btc should be between 900 and 3000 usd with 95% confidence

[bitcoinbear]

I have great faith in the bitcoin economy. I strongly believe we will get there over the course of the coming years. It will take time of course. Hopefully it stabilizes and slowly climbs higher, as we know parabolic rises are only good for those trying to make a quick messy buck.

There was a thread around here somewhere with a graph showing the price over time is following y=x^(1/2), which is a parabola with the open end to the right.

I've found something slightly different using non linear estimation of statistica 7 by statsoft:

using daily data
average
y=-5.1033+x^(.31)

low confidence limit 95%
y=-5.26689+x^(.30358)
up.confidence limit 95%
y=-4.93971+x^(0.31243)

it seems to expand at a slower pace , using the upper confidence limit and 10 years you have 3085$ , using the other formula for low conf limit you have instead 894$
so in 10 years btc should be between 900 and 3000 usd with 95% confidence

The general shape of the curve is the same, a larger rise now with a gradually lowering slope, leveling off as you move into the future.

Since the USD is continually inflating, the value of a bitcoin may remain constant but still have an increasing price against USD.