Classical Keynesian economists reject Bitcoin and other deflationary currencies categorically as a suitable global currency, but the other popular argument against Bitcoin — that it cannot continue to grow in worth because one can simply create a new alternative coin — is in fact the solution to the deflationary spiral problem.
The problem with a deflationary currency like Bitcoin is that people are incentivized to save rather than spend now, in anticipation of more purchasing power for one’s savings . Since savers are presumably rational, they would choose to invest in an asset that rises in value (relative to Bitcoins) if such an asset could be found, thus dissolving the deflationary spiral. What asset might increase in value even more-so than the primary currency itself? Another deflationary crypto-currency, of course!
Here I will try to argue that there is selective pressure for a new deflationary crypto-currency during times of a deflationary spiral. For the sake of argument I assume here that Bitcoin is already the sole dominant global currency, to assess what might happen in this “economist’s nightmare” scenario (I am not advocating for a single global currency). I need to show that this new currency (let’s call it BTC2) incentivizes all users to adopt the new currency until it becomes the dominant form of money, eventually superseding Bitcoin, meanwhile spurring new economic activity.
Consider the early adoption phase of BTC2 during a crippling deflationary spiral in Bitcoin-land. A deflationary spiral implies low economic activity, and thus implies less opportunities for investments that yield high reward (greater than simply holding Bitcoins). Speculators will be drawn to a new fixed-issuance deflationary currency like BTC2 for the same reason that speculators were drawn into Bitcoin — the benefit of early adoption. Merchant-speculators will begin to accept BTC2, and as more and more wealth becomes drawn into BTC2, the early adopters will have more and more excess capital to spend on mining equipment (if the BTC2 is also based on proof-of-work), advertising campaigns in favor of BTC2, real estate, startup enterprises, etc. Also, as more savers move their wealth into BTC2, early adopter merchants will begin to offer their merchandise for BTC2 in order to capitalize on the newly created class of consumers.
This seems counter-intuitive, that new economic activity would appear seemingly out of thin air, founded upon what some might consider to be a ponzi/pyramid/bubble scheme. But there are no fundamental physical laws being broken here, merely a redistribution of notional (digital) wealth. One might object that such a wide-scale switchover to a new currency (and consequently a new distribution of wealth) is irrational, but given a situation of a deflationary spiral where commerce grinds to a painful doldrum, I see no reason why the collective wouldn’t jump at the opportunity to switch to a different monetary system given a sufficient catalyst. That catalyst is simply another bubble . As a supernova explosion disrupts the gravitational congealing of matter and blows everything apart creating new activity, so does a new bubble seeded by a new currency like BTC2.
A new promising deflationary currency like BTC2 provides the perfect framework for a catalyst because it promises high yield, but people will only move their wealth into BTC2 if it appears promising. There may be many alternative coins available to choose from, and the one that gains the most adoption and thus wins dominance by virtue of the network effect is the coin that (a) appears to hold the most promise and (b) actually delivers on its promise by not imploding too soon. The most important factor in determining the fitness of a new coin (besides technical robustness) is how well it balances rewarding its early adopters and active participants (e.g. miners) vs long-tail adopters throughout the growth of the coin.
Once BTC2 falls into the deflationary trap, it too will become dominated by a new coin. These coins need not appear one after the other, but will likely appear staggered and originating from different communities around the globe. There may be multiple coins in competition that reach dominance together before they all fall into the deflationary trap one after the other, only to get replaced by yet another coin.
Perhaps there is kernel of truth to both theories held by Hakek and Keynes. All that is needed is free competition of alternative currencies for both theories to co-exist, like two sides of the same spinning metaphorical coin.