It was the darling of "Web 2.0", a social media site worth $200m (£130m) which had the potential to outshine Facebook.

But the Digg website has been sold for just $500,000 after its founders became the latest internet shooting stars to crash back to Earth.

Founded by Kevin Rose, then 27, in 2004, Digg allowed users to share and rank their favourite web links. The model, in which news stories with the most votes rose to the top of the service, helped to kickstart the social media boom.

Mr Rose became an internet “rock star” as the site became one of the web’s most viewed. He featured on the front of Business Week, with the headline: “How this kid made $60m in 18 months”.

Digg was valued at $175m and in 2008, Google reportedly offered to buy it for $200m. But today Mr Rose and his co-founders sold the site to a New York company, Betaworks, for a hugely discounted $500,000 plus equity. The service was “going back to its start-up roots”, its managers said.

Digg started to falter after Facebook and Twitter allowed people to share recommendations directly with their friends and followers. Staff became disillusioned after the Google approach was rebuffed and the majority of the company’s software engineers, vital for maintaining the service’s innovative appeal, left in May for a rival. Mr Rose himself quit last year to work as a venture capitalist for Google Ventures.

Users disliked a series of redesigns and web traffic migrated to competitors such as Reddit and StumbleUpon. By the end of 2010 Digg’s audience had fallen by more than half, although it still gets more than 16 million unique visitors a month.

The sale price represents a big loss to the investors who put up £45m in private equity at its peak.

Matt Williams, Digg’s chief executive, wrote in a blog post: “Over the last few months, we’ve considered many options of where Digg could go, and frankly many of them could not live up to the reason Digg was invented in the first place – to discover the best stuff on the web. We wanted to find a way to take Digg back to its start-up roots.”

Digg: What is it?

The Digg website is entirely created by users selecting and sharing news. When other users like a story or video link placed on the site, they click the Digg button. Links with the most Diggs rise into the top 10.