The cryptocurrency Bitcoin has seen its value vary between $718.66 and $1242 over the last five days, depending on the digital marketplace one uses. The lowest price I found was on Vicurex, and the highest was on MtGox, with a steady difference of around $200-250 between those sites at any given moment. I find those two sentences bewildering, and although I respect the concept of a decentralized currency, I would not personally invest in such an unstable digital commodity. However, there are other reasons to buy Bitcoins, one of which should be apparent to anyone who sees opportunity in the discrepancies below.
There are many aspects of Bitcoins that make them attractive, but most of these are smoke and mirrors. There is a growing acceptance of Bitcoins amongst companies worldwide, a decision that I believe should be considered by every business owner. With transaction fees that are much smaller than traditional credit cards and the ability to cash out quickly, companies could see notably improved margins with little risk by accepting digital currencies. However, companies would primarily serve as sellers on the open market, and the question at hand is whether one should buy Bitcoins.
The concept of a decentralized digital currency certainly feels appropriate in the technology-obsessed world of today. There is something about Bitcoins that is inherently "cool", though that awe will fade with time, and should not be an investment thesis. Still, the current instability of governments and banks across the globe should give anyone pause, and in comparison Bitcoin's highly controlled dilution appears to be a welcome relief. For those living in highly unstable regions, investing in outside currencies could be a wise hedge, though traditional alternatives still make a lot of sense in this scenario.
However, even with a federal judge ruling it a currency, there is little reason to believe that governments will be accepting of it, since Bitcoin plays the role of direct competitor to a government's most important commodity, their ability to print money with value. The US Government has had no qualms with squashing alternate currencies, and may do so again once they determine the most effective method.
Bitcoins coding is open source, and that instills a large degree of trust and transparency. Their algorithms are encrypted, although law enforcement is still capable of tracking down their illicit use. Using digital currency has quickly become the worst way for drug dealers and gun runners to make sales. The Silk Road and Tor Network have possibly become compromised, while a new alternative Sheep's Marketplace turned out to be a giant scam. And as Nicholas Weaver pointed out on Wired last week, there is no undo button with transactions, even for law enforcement agents, a major flaw in Bitcoins that an ideal digital currency will have fixed. For now, those who have been scammed out of Bitcoins have little recourse.
As drug dealers and sellers become scared to use Bitcoins, its overall utility will be drastically reduced. Although I believe that vendors will rapidly begin to adopt them, that doesn't create incentives for any more customers to begin using them until Bitcoins become far more commonly accepted. With its marketplaces still very illiquid, it appears that this incredible rise in valuation for Bitcoin has been fueled primarily by speculative investors.
Bitcoin 1 Year Chart
Bitcoin 2 Month Chart
The Big Concerns For Investors
First and foremost is the bubble formation of Bitcoins value. Anyone who is considering buying it today as an investment should see this as one of their most serious concerns. Combined with the astonishing illiquidity that was demonstrated by the first graphics in this article, a significant retracement or reversal appears imminent, and could happen with alarming quickness.
The second and less immediate worry is government intervention. While I believe that the US and other world governments would love to see Bitcoin shut down, there is no clear indication that it will happen anytime soon. Still, I believe investments should be in long-term vehicles, and this fear alone is enough to preclude Bitcoins from being investment-worthy for me.
The third and final nail in the coffin for investors can be seen in the Peercoin Wiki: "Bitcoin's security relies on miners. As time goes on, Bitcoin will be forced to move transactions "off block-chain". If Bitcoin moves off block-chain, miners cannot be compensated for these transactions. If miners cannot be compensated, they won't mine. If miners don't mine, network security goes down as time goes on." Simply put, Bitcoin isn't the ideal digital currency, and there are many competitors actively improving upon its relatively static model.
Although fiat currencies have glaring weaknesses, they have also been tested by time and have few liquidity issues. Bitcoins are currently too untested and illiquid to serve as a long-term investment, and its current bubble valuation may pop at any moment. With competition heating up, merely being first in the public mind doesn't guarantee future success.
Still, Bitcoin has its uses, which should keep increasing as legitimate vendors adopt it. It certainly looks like a clever trade could be made between markets, though getting money out of the marketplaces isn't always fast. As Bitcoins become more liquid, their immediate utility will increase, but the path toward mainstream acceptance has critical roadblocks ahead. As things stand, I believe that trading, not investing, is the better reason to put money into Bitcoin today.
Additional disclosure: I have a fraction of a Bitcoin in my digital wallet.