How can bitcoin be anything but a fad?

It seems you can’t open a newspaper or read a website these days without hearing about the super-yet-mysterious virtual currency known as bitcoin.

Everyone's talking about it. Richard Branson just began accepting bitcoin as a form of payment for flights on Virgin Galactic, which offers commercial spaceflights. The Chinese website Baidu endorsed the currency, and lawmakers in Washington are holding hearings about it.

Even Ben Bernanke, the US Federal Reserve chairman, told senators in a letter that virtual currencies "may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system".

And then, of course, there is the sky-high march of the value of bitcoin. A year ago, bitcoin was worth a couple of bucks. This week bitcoin broke the $1,000 mark.

If it all feels a bit like a 1999-style craze, that's because it is. Peter Leeds of the Penny Stock newsletter put it to me this way: "In a matter of months you won't be hearing about it. It will go the same way of Paris Hilton. People will move on to the next thing."

That's not to say there aren't fervent believers. Bitcoin's early success was a result, in part, of an angry libertarian strain of investor looking for an alternative to the dollar, something akin to a digital version of gold, in the event the world comes to an end – or starts to look like a Keanu Reeves movie.

But there seems to be a disconnect between the idea of what makes a great investment – or a great speculation – and a new currency that will be universally accepted.

Bitcoin, in the short or even long term, may turn out be a good investment in the same way that anything that is rare can be considered valuable. Like baseball cards. Or a Picasso. That’s because there are only so many of them.

But bitcoin aspires to be much more than a collectible, or frankly, even gold. It aspires to be a universal electronic currency. On that score, it is unlikely to succeed.

Why?

Let’s start with bitcoin’s value – or more accurately, the volatility of its value. Which merchants in their right mind are going to accept a currency that seemingly changes its value in wild swings every other day?

Mr Branson’s experience with bitcoin is instructive: while he happily accepted bitcoin as a form of payment, he quickly converted the payment into dollars.

That doesn’t make bitcoin a currency. It makes it a way for merchants, like Shopify – which also accepts bitcoin – to get a little publicity.

Digital money
Then there is the issue of how limited the supply of bitcoin truly is. Bitcoin is digitally "mined" by computers running an algorithm. (If you just rolled your eyes, you're not alone.) The algorithm limits the total number of bitcoin ever mined to 21 million units.

But there is no Bernanke (or Janet Yellen) of bitcoin. Nobody knows who created it and no one controls it. That’s supposed to be a benefit. It’s also why the currency is often associated with illicit sales.

Bitcoin can be transferred anonymously and without banks taking transaction fees. But if, and this is a big if, your peer-to-peer transaction doesn’t work properly, there is no central clearinghouse to complain to.

Whether the US government ultimately seeks to regulate bitcoin is an open question. It seems hard to believe that the government would allow the growth of such an unregulated market in which mothers and fathers , widows and orphans, and other individuals may be subject to all kinds of fraud.

Oddly, the Chinese government has seemingly embraced the early use of bitcoin. Gordon G Chang, writing in Forbes, has a provocative explanation for that stance.

“Digital money can undermine the dollar’s status as the world’s reserve currency. Bitcoin is on track to becoming the world’s first trillion-dollar nonfiat form of money,” he wrote.

Finally, there is the question of what happens if other alternative digital currencies also rise. More than a dozen digital currencies are trying to compete with bitcoin. Can you imagine a world in which we all transact with dozens of different currencies every day with different rules? Neither can I.

"Every big idea starts out sounding crazy. But not every crazy-sounding idea ends up being big," Matthew O'Brien wrote in The Atlantic in a brilliant takedown of bitcoin.

In truth, the best bitcoin can hope for is to be a second-rate version of gold, if that. And Warren Buffett once described gold this way: "Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

That’s pretty much the way a Martian might think about bitcoin. – (New York Times)