Quote from: thefiniteidea on February 02, 2013, 10:57:48 PM

An area dedicated to discussing the differences of these two terms and the theories supporting them.

I'm looking forward to an in-depth discussion on the subject! I've noticed that confusion between the two seems to come up quite a bit on the forum, and thought it may be reasonable to dedicate a thread on the matter.

Pulled from a discussion in Wall Observer

Price-Deflation is what you are used to hearing about in Bitcoin. That term is used to describe the prices of goods/services as they decrease, because the value of Bitcoin goes up.

Price-Inflation is the opposite. When prices of goods/services increase because the value of Bitcoin goes down.

So, when dealing with Price-Inflation or Deflation, there is an inverse relationship of price and value, in regard to goods/services and Bitcoin.

Example: As the Bitcoin price goes from $10 to $20, the prices of goods/services goes down from 20BTC to 10BTC. As the Bitcoin price goes from $20 to $10, the prices of goods/services goes from 10BTC to 20BTC!

Why does the price of Bitcoin go up and down? The price of BTC goes up and down based on the exchange rate, or market price, which is set by buyers and sellers, or traders. They directly trade the Bitcoin currency with all sorts of other currency, and even some with gold; the most popular being the USD (US dollar). They set the price when executing orders to buy or sell. I will get into the actual reason of why the price fluctuates in the last section.

Now that we've gone over PRICE Inflation and Deflation (which honestly, to me, is a term made popular by Keynesian's to hide the real facts, as price inflation/deflation is simply the market exchange rate, reflective of the money supply into a currency from itself and other currencies), let's go over the REAL inflation/deflation of a currency (otherwise known by many as Monetary Inflation).

MoneySupply-Inflation is when the value of Bitcoin decreases when the total supply of Bitcoin increases. In our current state, this is at a generation rate of 25 BTC every 10 minutes.

MoneySupply-Deflation will essentially never occur. It is when the value of Bitcoin increases when the total supply of Bitcoin decreases. This may happen, say, when someone loses their private key and all the BTC associated with it are lost. This effectively "makes the rest of us richer". That being said, there is a SET DECREASE in the generation rate of BTC, so you have sort of a "deflationary effect" in the value, as long as more exchange occurs for BTC at a rate which is faster than that set generation rate.

When all 21 million coins are produced, the MoneySupply will be neutral, and the value will continue to increase (prices will decrease, consequently), as long as people continue to exchange in BTC.

This leads me to the last section.

What determines the PRICE of Bitcoin? The VALUE of Bitcoin at a particular moment.

What determines the VALUE of Bitcoin? The SUPPLY and DEMAND of Bitcoin in the economy.

What determines the SUPPLY of Bitcoin? Currently, the MoneySupply-Inflation rate of 25 BTC every 10 minutes, and traders willing to SELL Bitcoin to BUYERS in exchange for other supplies of money (currencies).

What determines the DEMAND of Bitcoin? Traders willing to BUY Bitcoin from SELLERS in exchange for other currencies.

Therefore: BUYERS, SELLERS, and MONEYSUPPLY-INFLATION (miners) determine the VALUE of Bitcoin, which determines the PRICE of BTC as BUYERS and SELLERS trade based on that VALUE (or supply and demand) of Bitcoin.

We don't exactly know the totality of the supply and demand. Sure, we could try and aggregate data from all the exchanges, but we will never be accurate as there are exchanges which can not be accounted for (OTC). The cool thing is that we DO know the MoneySupply rate, and we DO know the exchange rate. From this, we can determine a real value of Bitcoin when simply multiplying the two factors; a sort of inflation-adjusted view of the currency.

Effectively, the quantitative analysis of supply and demand is really what the currency exchange traders attempt to accurately determine which is conveyed through buying and selling of Bitcoin, setting a VALUE via the PRICED exchange rate of the currency. On a side note, most of the big Market Makers (FX Traders) use this price movement as a way to make a profitable living, as well. Especially when price fluctuations are a consequence of hype or fear (bubbles, cliffs), not factual supply/demand data, and are wildly out of the real price range.

Thus, if you analyze the proper macroeconomic data in an attempt to forecast future DEMAND for more Bitcoin (price increase), you will realize some very interesting things, and have a more accurate picture of where the price is going...

Happy trading! Wink

Ek334433

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