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I was just about to pay for something with Bitcoins today and I hesitated for an instant thinking that the price might be $10 more next week.

Is it possible that Bitcoin holders will be less likely to spend their Bitcoins on actual goods or services given the wild increase in prices? Or if the prices suddenly start to drop, will people be more likely to spend their Bitcoins?

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Both inflation and deflation are bad for currencies, because they cause people to make decisions that don't really make sense.

Let me give you two examples. I sell toasters for bitcoin; you have bitcoin.

  • Inflation: You know that the price of toasters in bitcoins is going to go up, so you start buying toasters in bulk. You didn't really want all of these toasters, but at least your money isn't going to go down in value.

    Looked at from your perspective, what you did makes complete sense; From a societal perspective though, nothing was gained through this transaction.

  • Deflation: You really want a toaster, but you know the value of bitcoin is going to double next week, so you hang on to your money. This sucks, because microwaving your bread just isn't the same.

    Again, from your perspective, what you did makes complete sense. But from a societal perspective, it doesn't.

And that's how inflation and deflation - or even the threat of it - can damage an economy.

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A rising exchange rate increases the purchasing power of those holding bitcoins. This creates a wealth effect for some of those holding bitcoins. And thus instead of being frugal the increase in perceived wealth may be the catalyst for making purchases that previously might not have occurred.

Additionally, the rising exchange rate may cause some investors to desire to diversify their wealth so they may spend their coins for other investments, such as bullion.

Volatility makes a merchant be less willing to hold the proceeds of a sale as bitcoins since by the time those coins are used to pay for purchases, salaries, etc, then losses could be incurred.

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