And how's the "demand for Bitcoin to the saving side" is going to hurt fiat?
Moreover, the conclusions you arrive at should hold true even without Bitcoin. According to your assumptions and premises, any fiat currency should quickly collapse just because it is inflationary as inflation causes an increase in money velocity, the latter pushes inflation rates even higher, and the hyperinflation death spiral sets in. But it doesn't happen in real life unless the government goes nuts with printing money, and then it is just hyperinflation caused by excessive money printing that has little to do with changes in money velocity
Fiat doesn’t collapse, because there is no asset to compete with. Normal inflation has nothing to do with that.
All right, let’s approach it from another side. A fiat currency is the only perfectly liquid medium of exchange, which is why it stays at equilibrium with better value-storing assets. Normally, the distribution is the following:
1) We use money for transactional purpose, because other assets are not widely accepted, conveniently transferred and because of the legal tender.
2) We use money for short-time savings, because commonly the rate of inflation doesn’t bother us at a short distance.
3) We use money for long-term savings in a less liquid form but with interest (a saving account) in small amounts.
4) We use other specific assets for long-term savings when the value is high.
Money has limited value storage capabilities, but value-storing assets are not as liquid, which is why both are in demand. Everything changes when we add another asset with the following properties:
1) It is equally good as a medium of exchange.
2) It is a good long-term value storage.
In its current state, Bitcoin doesn’t satisfy the first condition, which is why nothing happens. In my thought experiment, I assumed that it actually became a currency, hence was capable of performing the transaction function on par with fiat.
Now imagine that we have an exchange rate of a fiat currency (FT) and Bitcoin (BTC) set to 1:1 initially. You get payed 100 in FT and I get paid 100 in BTC. Say we both spend 80 and save 20. We both can spend our money equally, because they are equally accepted. When it comes to savings though, I can easily keep it in deflating BTC, while you do not wish to keep it in inflating FT and seek to convert it into BTC.
When I’m paid next time, I assume the following: I can spend 80 and keep 20 of my BTC as usual, but I can also spend 60 and sell 20 to you for 22 FT. You will accept an unequal exchange, because otherwise you risk losing more as a result of FT’s devaluation. With the help of speculations, I gain 2 extra FT to spend, which is why it’s a bargain for both of us.
You go to your employer and say that you no longer agree to get only 100 FT and demand to pay you either 100 BTC, or 110 FT, because BTC is appreciated more. Your employer agrees and pays you 110 FT next time. He also raises the price of his goods in FT by 10% to compensate for the growing payroll. Besides, he is aware that the market exchange rate of BTC/FT shifted by 10%.
You get your 110 FT and want to repeat the previous exchange, but I no longer agree to sell 20 BTC for 22 FT. I’m aware of the prices’ correction and such an exchange in no longer profitable, which is why I demand 24 FT for my 20 BTC. You conclude that it’s better to pay 24 now, than to wait until it grows to 26. The next time you get paid, you just go and straight exchange all your FT into BTC, because it can lose value before you will be able to spend it. How are you going to escape the spiral now?
The problem is that it’s a one way train. BTC is always demanded by FT holders, but BTC holders have no interest in FT, because FT can give you nothing that BTC cannot. With an infinite demand for BTC, there is no equilibrium where the exchange rate can stabilize, which leads to the depreciation of FT down to zero.
Why doesn’t it ever happen? Because there is always a two way demand between different assets. First, we buy a value-storing asset for money, but then we have to exchange it back to spend the value. When a demand comes from both sides, the exchange rate balances around an equilibrium.
I hope now it is clear, I won’t be able to find strength to explain it anymore.
Which is otherwise known as Gresham's Law. People will save Bitcoin and spend fiat, with bad money driving good money out of circulation under your hypothetical circumstances
No, for God’s sake, please, leave poor Gresham alone. The process I refer to is only temporary. The Bitcoin’s velocity will drop, while fiat is still capable of satisfying the transactional demand at least to some extent. As the fiat currency inflates and dies, bitcoins will return to the circulation, because there will be no alternative left.