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Is Bitcoin plunge a short-term setback, or a long-term confidence-buster? (+video)

The high-flying digital currency has plunged to half its former value. Code glitches that led to the crash can be remedied and the currency strengthened, Bitcoin enthusiasts say. Doubts about its long-term viability persist, however.

By Staff writer / February 12, 2014

People sit inside the Bitcoin Embassy in Tel Aviv, February 2. The sparely furnished property opened a few months ago to support a community of Bitcoin fanatics, perhaps the most active in the world, who are out to build just that - a next-generation trading system based on the digital currency.

Baz Ratner/Reuters

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Advocates of Bitcoin, the crypto-currency that has gained popularity at the fringes of international commerce, say they are unperturbed by setbacks this week that have sent the digital money plunging to half its former value on currency exchanges – and to its actual removal from one exchange. Bitcoin will emerge, they insist, with a stronger underlying digital code that will also strengthen the currency itself.

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Bitcoin Source Code Co-Author Alex Waters and Former Bank of America Global Wealth President Sallie Krawcheck discuss Bitcoin's troubles on Bloomberg Television's "In The Loop."

Many analysts would agree, to a point. Yes, the immediate problem is a technical malfunction in some underlying code, and that is relatively minor compared with previous issues the digital currency has encountered, they say. But if such glitches keep occurring, they will undermine users' confidence that Bitcoin is a stable and reliable currency that can be used without incident, as are government-backed currencies such as the dollar, and will deter Bitcoin's widespread use.  

“This is the equivalent of hackers finding their way into the federal Reserve” and shaking confidence in the underlying monetary system, except at a much smaller scale, says Mark Zupan, an economist and the dean of Simon Business School at the University of Rochester in New York. “How the Bitcoin community responds and provides meaningful assurances will be key to their survival.”

First, the immediate challenge. Here's how the Bitcoin Foundation, a group devoted to promoting the currency, describes what happened. 

“This is a denial-of-service [DoS] attack; whoever is doing this is not stealing coins, but is succeeding in preventing some transactions from confirming," the group said in a release. "It’s important to note that DoS attacks do not affect people’s bitcoin wallets or funds.” 

Analysts who pay close attention to the digital currency elaborate. “It has exposed bugs in the software,” says William Norton, an attorney in Nashville, Tenn., and a digital currency specialist, via e-mail. These bugs, which he calls “transaction malleability,” do not affect the integrity of the Bitcoin protocol itself. “It simply affects the way third-party vendors process transactions,” he says.

Adds Bruce Fenton, president of the Bitcoin Association, “This issue this week did not affect all of Bitcoin, only certain exchanges who had not updated to the most current best practices. The ones affected are working hard to resolve the issue and it does not appear it will be material.”

But there's also a longer-term challenge. Glitches that interrupt smooth transactions hardly inspire consumer confidence – and they will erode the viability of Bitcoin if they keep occurring, some Bitcoin skeptics warn. Money depends upon public acceptance for its usefulness, notes Phil Rooke, chief executive officer of Spreadshirt, a global e-commerce platform.

“Bitcoin has no mass-market appeal. It is of little use to e-commerce retailers and platforms since most consumers are very happy with current payment systems,” he says via e-mail. However, “the hardcore techies that have to try the latest thing are drawn to the novelty of Bitcoin and have fueled the buzz.”

Bitcoin is overrated and will fade, he suggests. “Bitcoin, in essence, is a currency system that is largely designed for the tax-avoiding rich who are anti-establishment and need to send money to really difficult places," he writes.

Businesses that accept Bitcoin will have to revert to their old methods of transactions, adds Mr. Rooke, “as the masses realize that Bitcoin is more smoke than sizzle.”

Not everyone would agree, arguing that virtual payments and virtual currency are here to stay. They are a natural progression for a mobile society, says Greg Gresh, chief executive officer of ZNAP, a mobile payments platform.

It remains to be seen whether Bitcoin is the particular digital currency that will break through to mainstream acceptance, he says. Bitcoin has the advantage of brand recognition at the moment, Mr. Gresh adds, but he wonders whether it will be the catalyst that alters the paradigm. “Will it be the Napster that leads to iTunes? Or the MySpace that results in Facebook?” he asks.

General acceptance of Bitcoin as a currency is undermined by the same consumer resistance that mobile payments are encountering, says Rooke.

“Until it can generate excitement by demonstrating a value-added benefit to both merchants and consumers, then there is no compelling reason to switch from government/fiat currencies,” he says.

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