Bitcoin - Wealth Effects; Affects

Market demand and supply of liquidity is a potent equilibrium which impacts the economy directly. Respecting it's virtuoso in calibrating the consumption and production pattern, a major part of institutional resources is diverted to command the settlement process. The modern monetary instruments which are at the behemoth of innovation has brought a novel exchange mechanism - efficient and easy, and the "Caesar" among the currencies whose dawn and dusk would thrive in international exchange rates. The initial insights falls down to it's impact on inflationary pressure through a wealth effect considering the magnanimous capital gains brought in recent years.

 Looking at qualitative aspects two situations are there -

1) Subsequently, if Bitcoins gain consumer confidence, their velocity of transactions will increase rapidly, indeed then consumer demand of aggregate goods would increase.

In crude form,

Money Supply Of Bitcoins (MS) =

No. Of Bitcoins (M) × Velocity of Bitcoin transaction (V)

Where velocity of Bitcoins means how much a single bitcoin is transacted in a period cycle.

Thus money supply would increase owing to increase in velocity owing to high consumer confidence thus leading to higher consumer demand and subsequently inflation.

But people would be switching from domestic currency to Bitcoins, thus similar analysis shall apply for domestic currencies, thus it would result in lower velocity of transaction for a single dollar bill. This would Reduce money supply of domestic currency and therefore would lead to fall in consumer demand made in domestic currency.

Till now looking at Consumer demand overall, it would not result in higher inflation as money supply measured in terms of domestic currency and Bitcoins would remain same. Thus consumer spending should not increase.

Now if huge capital gain is made in Bitcoins resulting in increase in wealth for sustained periods then it would lead to two affects-

Increase in Bitcoin money supply measured in nominal terms measured in dollars.

As mentioned above

MS of Bitcoins = M × V, 

but if we measure it in terms of dollars, then

Nominal MS of Bitcoins  = M × V × Current Price of a Bitcoin

                                       = M × V × 10,500 $/Ƀ (Current Price)

Now it's important to look at the effect on the Price index of goods. Bitcoins as a medium of exchange caters to a specific section for payment of online services. If we have price index for such section of commodities (which I am unaware right now) then divide the above equation with the new price level of index , for getting real money supply of Bitcoins.

I intuitively believe that such capital gain in Bitcoin would increase it's real value of money supply of Bitcoins but for a short to even medium term. Pricing of online services is actually done in dollar value, thus if Bitcoin becomes valuable then actually price Stated in Bitcoin may fall while same price stated in dollars would rise. Thus I am assuming here that pricing of online services is done based on dollar money supply.

2) Wealth effect would apply if Bitcoin value rises and also stabilizes. The volatility in Bitcoin right now may actually make consumer cautious, but if it stabilize more then any value addition in Bitcoin value like done by any other investment in wealth would actually increase consumer spending leading to inflation.

I have made a lot of assumptions, any comment regarding them or to improve upon would be welcomed.