Bitcoin virtual money draws investments, skepticism

Jon Swartz, USA TODAY, @jswartz | USATODAY

SAN FRANCISCO -- Pure gold or Fool's gold?

Bitcoin, "virtual currency" that isn't recognized by any nation or bank in the world, was once dismissed as a goofy idea embraced by nerds and anti-government types. Today, it's considered either an ideal payment system for the Internet or a digital Ponzi scheme.

Yet it has become a scorching-hot commodity among speculators -- including the Winklevoss twins made famous in the Facebook movie, The Social Network -- who are trading the digital currency.

Cameron and Tyler Winklevoss, popularly known as the Winklevii, say they own nearly 1% of the outstanding supply of the $1.3 billion bitcoin market, or about $11 million. (A spokeswoman for the Winklevoss twins declined to comment.)

The Winklevii have plenty of company: Andreessen Horowitz and other venture capitalists on Thursday said they were funding a company, OpenCoin, that is a bitcoin competitor. Tim Draper, founder of Draper Fisher Jurvetson, has invested in CoinLab, which is doing bitcoin-related projects. And Tribeca Venture Partners has put money in Coinsetter, a startup trading platform for the digital currency.

Venture capitalists and entrepreneurs consider bitcoins the ideal currency of the digital age, with decentralized currencies and free movement of money globally.

"Finally, a finance system in the digital era we've been looking for," OpenCoin CEO Chris Larsen says, underscoring what he calls "a lot of excitement in the math-based currency movement."

It is also practical for transactions -- especially those overseas. "On the Internet, which is anonymous, you can pay across borders -- fee free -- without going through the rigmarole and risk of using a credit card," says Chris Dixon, general partner at Andreessen Horowitz.

Those who compare bitcoin to a Ponzi scheme are the same people who called Facebook a failure because its stock price dropped after the IPO, says Jeremy Liew, managing partner at Lightspeed Venture Partners.

"Silicon Valley is more used to the wild swings and pivots of startups, whether companies or currencies, and takes a longer-term view," Liew says. "Facebook built $65 billion of value in nine years, so what happened since the IPO is missing the point. "

The 4-year-old technology, based on mathematical schemes that guard against counterfeiting, is frequently compared to the "gold standard" -- the monetary system before modern central banking took root in the 1930s.

"This is not a fad," says Jon Matonis, a board member of the nonprofit Bitcoin Foundation, created last year to foster and protect the system. "It's based on sound security technology, and it has a lot of the same economic properties as gold.

"It is digital gold," Matonis says.

Too good to be true?

But is it all too good to be true, a latter-day version of fool's gold?

Skeptics blanch at the volatile value of bitcoins, security issues and the the tendency of some transactions to take a long time to confirm.

While bitcoins may be a better investment than gold based on where gold is trading, "the risks of an unregulated security that can also be hacked are too great for any mainstream investor," says Phil Sanderson, managing director of IDG Ventures.

"Any investment made by a non-hedging entity should be based solely on a novelty basis," Sanderson says.

The meteoric rise in bitcoin value is part of its biggest problem, say economists like Nobel Prize-winner Paul Krugman. The supply of bitcoins grows so slowly that any increase in demand leads to higher prices. There are about 8 million bitcoins in circulation now, and the maximum that can be generated is 21 million.

The boom-bust cycle was on full display this week: Bitcoin's quote of $74 on Friday morning was a steep drop from last week's $230.

Security is a nagging concern, with a series of DDOS attacks over the past few days that hampered the service. "All major websites, online banks, retailers are exposed to the same threat and are targeted by hackers all the time, so its nothing unusual," says Andreas Baumhof, chief technology officer at computer-security firm ThreatMetrix. "It just shows that bit coin as an industry is not yet fully matured."

And yet, bitcoin may represent financial stability to some in an uncertain economy.

"If I understand it correctly the USA is still running deficits of $1.2 trillion per year, or $100 billion per month," says Bill Tai, general partner at Charles River Ventures. "What does that say about the sustainability of our currency? Maybe Bitcoin or other real currencies are not a bad idea as an alternative to hold."