Those economic models do not consider the medium of exchange nor the entrepreneurial influence a new currency could pose (as suggested by Hugo). PLUS these economic models do not consider the current state of financial affairs in the world. With the U.S. dollar dropping and OPEC considering to trade oil in Euros and not Dollars, the world’s financial market is very unstable. Such an environment could sway many “iffy” entrepreneurs and consumers to start using Bitcoins because of Bitcoins separation from any world government and the world financial market.

Something this new and innovative should not be pigeonholed into archaic economic models that attempt to explain physical currency. It is time for an economist to step into the realities of the virtual world to acknowledge and identify the correct parameters in which a currency like Bitcoin exists. Gold does not exist in the virtual world for a reason. Bitcoins do exist in the virtual world for a reason. This reason is completely ignored by the majority of economists who are critical of Bitcoins potential.  

“It is possible to use Bitcoin in a way that is almost certainly
anonymous, in the same way it is possible to get almost certain
anonymity on the Internet, by using encryption, onion routing, and never
associating your identity with your actions.

Our point is that
you don’t get this anonymity automatically, and that most casual users
of Bitcoin may not be anonymous, even though many of them may believe
they are.”

I think “the demand for a medium of exchange is the composite of two partial demands” refers to the demand for any particular medium of exchange, not the demand for a facilitator in general.  For a medium of exchange with no commodity value (no use-demand), then the composition of partial demands is 0% for consumption and 100% for use as a medium of exchange.

The question is whether this situation of 0% commodity demand and 100% currency demand can work.  (Whether bitcoin actually has 0% commodity demand is a separate question.)  I do not believe that fiat money actually belongs in this category, because of the distortion of legal tender laws.

I think the problem with 100% currency demand is that there is no rational basis for establishing a price level.  Even if people see the value as a medium of exchange, it does not
address the problem of how to establish a price level.  One bitcoin or
1000 or 0.01 bitcoins serve equally well in facilitating trade.  Which price is to be used?

When a commodity is used as currency, those wishing to use it as currency must outbid the industrial users, and as currency demand rises or falls, a greater or lesser fraction of the commodity will be devoted to currency use, and the price levels will change accordingly.  The currency then inherits its price level from the supply and demand of the commodity.

Now, I would not go so far as to say that there can be no price level for items that have no commodity value.  This is obviously not true.  Price levels are regularly established for things that have no commodity value, whether or not they are used as currency.  What I would argue is that this demand is not rational.  For the sake of argument I will call the non-rational demand numismatic, in contrast with commodity demand.

The same supply and demand rule applies for numismatics that are found to be valuable as a medium of exchange.  Those wishing to use it as a medium of exchange must outbid those wishing to hold it for numismatic reasons, and the market can settle on a price level as a result.  The difference, and the hazard, is that this value is not rational and I believe not stable.

A related question is, if we presume the circular cycle has been broken and price levels have been established, can a currency with 100% demand as a medium of exchange be sustained.  In other words, if the numismatic and commodity demand both fall to zero, can a currency survive only on its medium-of-exchange value?

When there is commodity demand or numismatic demand, those alternative demands provide not only a basis for an initial price level, but also elasticity and price stability over time.  If more or fewer people wish to use it as a medium of exchange, the alternative demands can accept the shortage or surplus without a large change in price.

The elasticity and stability afforded by the non-currency demands does not mean that the currency cannot have stability without them.  But I think it’s important to understand what mechanisms exist, either necessarily or accidentally, that contribute to its stability.

I can think of no mechanisms to sustain the value that exist necessarily, yet I can probably name a few that happen to exist today as a matter of fact.  This means the currency can survive as long as these conditions happen to be true, which is entirely different from being praxeologically necessary.

To summarize, the problem is not that bitcoins cannot or do not have value, but that they need not have value.