The idea of a currency with a limited number of units seems to me to be fundamentally different to existing currencies. While other currencies are generally based on permanent inflation - more 'units' coming into the currency pool - which causes each unit to be worth less, Bitcoin is based on a fixed number of 'units', never changing. Does this mean that, as usage increases and time passes, each 'unit' will necessarily be worth more and more and have to be split into smaller and smaller amounts?
In theory yes. If demand grows at a steady rate this will certainly be the case, as less coins will be produced making what is available more desirable.
In reality there are other factors which could affect the value of bitcoins.
- Alternate chain could supersede bitcoins (unlikely at this time)
- Vulnerabilities like what has appeared (with hacking) already in the main markets
- Overspeculation of market trends
Think of it more like gold than a fiat currency in the likelihood of behaviour (nb. my opinion, may not be the case)
If the value does keep increasing it can split into eight decimal places to make a very large number of potential units of currency.
This generally boils down to supply and demand. When the supply is fixed the value would increase with the demand.
If demand continues to increase and supply is constant, then yes. But supply is not going to be constant, that's a wholly unrealistic assumption. Already, alternative currencies and online wallet services are increasing the effective supply of Bitcoins.
If an Altcoin is reasonably predictable valued at .1 Bitcoin, why should I care whether you give me 10 Bitcoins or 1 Altcoin? (The value might go up or it might go down, but so long as they're equally likely, I don't much care.) Thus each Altcoin increases the effective supply of Bitcoins.
Similarly, I don't care if you give me 10 Bitcoins or a Mt. Gox code to claim 10 Bitcoins. Thus Mt. Gox codes act as Bitcoins as well.
Once shorts are available, interest-bearing accounts will be possible. This will allow the two sides of a short to cancel out, require no bitcoins, and the long side will also act as a supply of Bitcoins. I may consider a promise to pay 10.2 Bitcoins next month just as good as 10 Bitcoins today. I may consider a promise to pay the value of 10.2 Bitcoins next month in US dollars just as good as 10 Bitcoins today. (Assuming both promises are backed by an exchange and tracked as exchange assets.)
Although limited total number of bitcoins implies that they will be deflationary in the future. Meaning they will increase in value due to limited supply. They are currently inflationary as about 7200 bitcoins are released into circulation every day. This trend will continue for some time before supply starts to slow down.
This means that there is a great deal of downward pressure on the value of bitcoins (lots of supply). This could lead to the prices going down long before they go up again due to limited supply.
The will go up in value as long as more people continue using them and the demand outpaces the creation of the supply. But once the market is saturated (i.e. the whole world) then the value of bitcoins would become stable, and would only move by market conditions such as a change in the world population, and lost bitcoins which are effectively disappearing from the system will contribute to a continued trickle of deflation.