Bitcoins - a deflationary spiral?

Economics Economics Questions
1

So there are a number of threads arguing back and forth on bitcoin forums about deflationary spirals. To suggest a deflationary spiral (DS) there is to get flamed pretty hard! So I thought I’d as my question here instead.

When Austrians or similar economists talk about there be no DS they are doing so in the context of a broader economy. If I have some goods/services/money that I highly value, and many others are doing the same in the economy, then producers will increase quality or decrease prices so that an economy of transactions can exist and we can all eat. Yay. +1 for the false problem of a DS.

However if we limit our focus to a set of very pretty sea shells I, and my friends, find at the beach (or a newly created digital currency called Bitcoin used amongst a small set of people) - and we think our sea shells are so pretty we would never trade them for less than $1billion, we will go to the grave before those shells ever leave our possession. In this narrow sense trade of this set of seashells would never become liquid and the trade in seashells itself would suffer from the so-called DS, no?

I guess the real question is Bitcoin liquid enough that it represents the broader economy or is it more like the seashell example?

2

A deflationary spiral is nothing but a good old run on the bank or a collapse of a Ponzi scheme. A currency that is not backed by a commodity must be backed by a scheme inherently exposed to the Prisoner’s Dilemma. As I see it, Bitcoin is currently backed (sponsored) by a small group of believers (“prisoners”) motivated to coordinate their actions toward supporting the value of their creation: “Guys, let’s value the bitcoins we own/create so that their value only goes up!”. Bitcoins will collapse when their valuation reaches levels at which the financial profits from dumping them (i.e. exchanging them for a commodity or a currency backed by government fiat) outweigh: (1) the psychic profits from supporting the believer’s cabal and (2) the expectations for their further rise in value.

As in every fractional reserve or Ponzi scheme, all participants (“prisoners”) profit from cooperating (i.e. not blinking, not redeeming, not dumping, not freaking out) until some of them inevitably do blink at which point the optimal strategy violently switches from cooperation to “watch my own a**” mode leading to a collapse of the scheme. Dutch tulips were, at the very least, pretty.

3

I smell a troll party…