Bitcoins: The Future of Money, or a Bubble Ready to Burst?

It’s been called “gold for geeks,” the future of payments or a bubble soon to burst.

But any way you slice it, the gyrations and rapid adoption of the digital currency Bitcoin have grabbed the attention of the financial world of late.

Bitcoins have been around since 2009, but have gained widespread attention only in the past few weeks. Worth only a couple dollars a pop a year ago, the Bitcoin exchange rate has seen some dramatic ups and downs since the end of March.

Here’s how it works: Anybody can get into the game by downloading a program onto their computer and using a number of online exchanges to convert their dollars into bitcoins. After that, the currency can be transferred anonymously and directly between two users anywhere in the world.

Some observers say a payment network like Bitcoin could one day rival a company like PayPal or Western Union. Even the Winklevoss twins, of Facebook fame, have a multimillion-dollar investment in it.

But bitcoins aren’t likely to be a good investment for the average person for the foreseeable future.

“I see this as the first generation of something that may proliferate,” said Judson Gee, managing partner of JHG Financial Advisors in Charlotte, N.C. “Right now, it’s mostly just a speculative investment.”

University of Chicago law professor Eric Posner, writing in Slate this week, was more blunt, calling it a “fantasy” that “resembles a Ponzi scheme.”

The currency traded as high as $266 on Wednesday before crashing. The most popular exchange put a halt on trading for hours, and prices fell below $55. On Friday morning, bitcoins were trading for about $78.

Here are five things you should know about Bitcoin.

WHAT’S SPECIAL ABOUT BITCOIN? Bitcoins are gaining a lot of traction among the technology-savvy because of their privacy, speed and freedom from government regulation.

The only information attached to a Bitcoin account is a long list of letters and numbers. The payments aren’t processed through a bank or clearinghouse; instead, the computational power of its users pushes transactions through a system to make sure they’re not fraudulent.

Payments can cross national borders in minutes as easily as they can cross the street. The system has also proven – so far – to be sophisticated enough to keep people from hacking it.

WHAT CAN YOU DO WITH IT? A small number of merchants are beginning to accept bitcoins as payment, but none of them mainstream.

You’ll now find online stores, hawking everything from gun parts to flowers, that are willing to take them. Physical stores accepting them are few and far between. CNN found a bar in New York City that takes them.

SO WHAT’S BACKING THE CURRENCY? Nothing, really, except the principle of scarcity and the usefulness people find in it.

Only 21 million bitcoins will ever be in circulation, released slowly over time. That creates a market price driven by supply and demand. As news spread about bitcoins, more and more people decided to try them out or to speculate in them – driving up the price.

But an investment could be worth nothing by next month, meaning prices will continue to fluctuate.

WHY SHOULD I CARE? Bitcoins are probably more interesting for the way the system works than for their future as a viable currency.

Some people, like Chris Dixon, a partner in prominent venture capital firm Andreessen Horowitz, have written that Bitcoin could be part of a new era of money, based on math instead of politics and fit for a globalized world.

There’s some evidence that the theme could catch on. Andreessen Horowitz is now a backer of OpenCoin, a San Francisco startup creating a “math-based” currency and payment system similar to Bitcoin. It’s one of a number of new companies starting to enter the space.

“The big money has their eye on it,” Gee said. “This could be very relevant.”

SHOULD I INVEST IN SOME BITCOINS? Not unless you’re ready for a wild ride.

Even before the “crash” this week, bitcoins had been prone to swift movements. That’s going to make it harder for big-time companies to embrace them. And a currency still trying to find its place in the world is going to continue to be volatile.

“It seems like it would be hard for the average individual to go into it and feel comfortable with it,” said Don Olmstead, managing director of Charlotte-based Novare Capital Management.

“If somebody came to us and said, ‘What do you think about it? Should I invest?’, we would dissuade them.”