Following a 1,000,000% Gain, a Slow-Motion Crash

No, there's not the slightest touch of hyperbole to that headline. Rather, it's the completely accurate, if exceedingly brief, tale of Bitcoin's short life. Far from dead, however, the digital currency continues to hold promise, and its trajectory bears more than a passing glance.

When I first wrote about Bitcoin in June, it had recently gone parabolic, first crossing the $1 mark, and then rapidly shooting up to the $9 range (if you don't know a Bitcoin from a Malaysian ringgit, see my previous article). The ascent, however, was still in the middle innings. Not two weeks later, the Bitcoin was trading at more than $30, having appreciated 10,000-fold since dollar-denominated trading began in 2010.

Then, of course, the inevitable occurred. Exuberance gave way to sanity and profit taking, and the Bitcoin first plummeted, then more gradually but steadily slid, eventually finding its way back down to the current trading range of $2-$3.

Was a bubble phenomenon in the cards for Bitcoin from the get-go? In mid-2010, lead core Bitcoin developer Gavin Andresen cautioned:

Bitcoin will get mentioned someplace with lots of readers, a bunch of those readers will like the idea and try to buy Bitcoins, their price will rise which will draw even more people to "invest," which will drive the price up even more ... until people decide that the price isn't going to rise any more and everybody rushes to sell before the price drops. I predict there will be between one and five Bitcoin bubbles (price will double or more and then crash back down below the starting price) in the next four years.

Rendering Bitcoin susceptible to bubble dynamics is its immediate appeal as a genuine, if fledgling, fiat money alternative; its relatively illiquid trading market acts as a double whammy. Consider that daily volume above $1 million represents a heavy day, and that total volume in the past year amounts to roughly $75 million. Compare that to SPDR Gold Shares (NYS: GLD) and iShares Silver Trust (NYS: SLV) , where average daily dollar volume is in the billions. As an alternative to holding one's wealth in greenbacks, Bitcoin is on the map, but just barely. As such, it's a speculator's dream.

But what about the long-term prospects? In an email, Andresen relayed that he remains upbeat on Bitcoin's future. Furthermore, he mentioned "dozens" of development-stage projects, including secure "Bitcoin wallets" for cellphones. Although he doesn't see such ventures as critical to Bitcoin's success, they could, in my view, provide a notable boost. As for potential legal issues, which have been cited elsewhere in the media as Bitcoin's eventual death knell, Andresen is likewise optimistic. "New technologies are always ahead of the law," he quips, adding, "Bitcoin doesn't fit neatly into any of the categories our legal system has created for 'things that act as money,'...I wouldn't be at all surprised to see Bitcoin first really take off somewhere else in the world, where the financial system is more open to innovation."

Of course, price stability is the real key to Bitcoin's future, and here, even Andresen was surprised by the magnitude of the recent run-up. Moreover, he sees continued volatility across the next few years. For now, many may be put off by Bitcoin. And for good reason. Even though the Dow Jones Industrial Average (INDEX: ^DJI) now routinely swings hundreds of points in either direction on a day-to-day basis, it's up 2.3% since Bitcoin's June peak. That beats a roughly 90% loss. Meanwhile, in the gold world, "boring" old industry behemoths NewmontMining (NYS: NEM) and Barrick Gold (NYS: ABX) are up 32.5% and 18%, respectively, in the same time frame.

Going forward, Bitcoin projects such as those cited above, which aim to expand the marketplace, should help smooth the price volatility. Ultimately, however, Bitcoin cannot succeed until the market begins to view it according to its design -- as a legitimate currency with predictable supply growth -- and not a get-rich-quick investment. If you want to bet on when that will happen, there's likely someone out there who's eager to accept your wager -- in Bitcoins.

Want to diversify out of fiat currencies? If you're currently taking more of a shine to gold than Bitcoins, clickhereto download The Motley Fool's free report on an under-the-radar gold miner poised to unearth hefty profits.

At the time thisarticle was published Fool contributor Mike Pienciak holds no financial interest in any company mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.