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How Bitcoin Got Its Groove Back … and Then Spectacularly Lost It

By Caroline Bennett - Apr 13, 2013 at 8:45AM

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More money, more problems -- even if it's e-currency.

Bitcoin is not a new idea. But you'd never know that from the overwhelming amount of sudden attention it's been getting lately. The online currency has made headlines because of its meteoric rise in value, but a swift, brutal backlash is already coming. How did this whole thing happen? And as investors, what can we learn from it?

What is it, and why did it get so popular?
Effectively, Bitcoin is a form of digital currency that originated away from a place of authority. The currency was created in 2009 and has been tradeable only since 2010. In short, it's basically an experiment, and its value is extremely difficult to gauge, especially given how recently it's become available.

Some experts believe the e-currency's popularity may have spiked because of the Cyprus economic crisis. When news hit of the government plans to take bailout money from its citizens' bank accounts, a flurry of withdrawals hit the nation. Bitcoins, online currency that had no connection to government payouts, became infinitely more appealing.

But what goes up must come down
This isn't the first time Bitcoin has reached spectacular highs only to bottom out at disastrous lows. In 2011, fellow Fool contributor Mike Pienciak followed the currency as it turned into a 3,000-bagger (no typo) that made the 30% and 100% returns of fellow currencies SPDR Gold Shares (GLD 0.95%) and iShares Silver Trust (SLV 2.63%) look like chump change. Then, two months later, Bitcoin crashed to a mere $2 a share.

This time around, Bitcoin rose to $266, and then it plummeted to $55 within one day. The reason is almost painfully simple. Even though Bitcoin is technically decentralized currency, its most popular exchange, Japan's Mt. Gox, is also the most heavily used. Investors consider Mt. Gox their go-to for any Bitcoin updates, and Mt. Gox simply can't handle that kind of traffic.

The exchange recently shut itself down for 12 hours, to "cool down the market." In the realm of Bitcoin investing, there is no such thing as "cooling down," only freaking out. That's exactly what investors did when they saw their main resource wasn't functioning, and they sold off their stake in droves as a result.

What have we learned from this?
Even after this latest bubble has exploded, Bitcoin is unlikely to disappear anytime soon. The currency will probably have more bubbles, and they be bigger, expand faster, and crash harder than the ones before them. Sure, you could make money off timing the next Bitcoin bubble, but that's not investing; it's trading. For Foolish investing, choose a company you trust and don't mind holding onto for at least five years, not a spastic e-coin that no one's quite figured out yet.

Bubbles seem to expand and deflate faster than ever in this economy. Bitcoin seems tailor-made to be a huge risk for investors.

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