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Digital Theft of Virtual $500,000 May Spell the End of Bitcoin Dream

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The dream of a decentralized, anonymous virtual currency -- Bitcoin -- may be about to crumble to pieces.

Bitcoin, a two-year-old peer-to-peer network that issues a digital currency and ensures it can't be duplicated or spent twice, was an obscure phenomenon a month ago, traded for other currencies on a few online exchanges and used to pay for goods and services on a couple Craigslist-like websites. It has captured the imaginations of a fringe element of hardcore geeks, who admire it for its elegance as a technical solution, and some anarcho-libertarian dreamers who cherish the idea of a money outside the state's influence. The exuberance of early investors has led to some breathless speculation about Bitcoin's future. You can pay with Bitcoins at a Mediterranean fusion eatery and a fetish dungeon in Manhattan,

It's even inspired a cottage industry of slackers with overly powerful computers whose sole work-like activity is tweaking their rigs to "mine" for Bitcoins; here is a blog, which we hope is tongue-in-cheek, documenting Bitcoin-mining accidents.

Of course, its supposed anonymity also has attracted sellers and buyers of illegal goods, and the resulting attention has induced chaos in Bitcoin exchanges.

The market exploded then quickly deflated earlier this month, when Gawker's Adrian Chen posted an exposé on Silk Road, the underground online narcotics market that trades in Bitcoins. Within days, the Gawker-driven attention fueled a huge spike in Bitcoin prices.

Then, predictably, publicity-hungry legislators in Washington jumped on the story, calling Bitcoin a money-laundering operation and demanding a crackdown. Bitcoin prices tumbled as investors jumped out.

In another, possibly related, development sure to frustrate the anarchist and black-marketeer elements of Bitcoin's user base, one of the main exchanges for Bitcoins announced it would cooperate with authorities on tracking illegal transactions, while acknowledging that Bitcoins are far more traceable than many of their proponents believe. While this should reassure governments, it could also reduce demand by driving a certain class of user out of the market in favor of the more traditional briefcases stuffed with non-consecutive bills.

But Bitcoin might have more serious problems than disappointing money launderers and anarcho-utopian idealists. Check out this takedown on by Adam Cohen, an "internet economist," who argues compellingly that built-in deflation and incentives for hoarding, especially for early adopters, make Bitcoin a stupid idea at its core.

Cohen goes so far as to call Bitcoin a scam, designed to enrich the few who bought the currency in huge quantities when it each one traded for a dollar or less. Indeed, most of the eloquent defenses of Bitcoin found in blog comments seem to mention that the author bought into the currency early and has made -- or stands to make -- handsome sums exchanging the virtual currency for a real one.

Meanwhile, Bitcoins are as vulnerable to theft as paper money, as the world just learned when a hacker pulled off the first major Bitcoin heist, swiping digital currency theoretically worth half a million dollars from an investor's hard drive. And chatter is arising on tech blogs about how a competitor to Bitcoin might improve on the original model. One might assume some of the biggest enthusiasts for a new Bitcoin would be potential investors who missed out on the Bitcoin ground floor.

The market seems to have been holding steady for at least the past few days, at about $19 per Bitcoin. But if you buy in now, not only are you risking exposure to a catastrophic crash, you're only enriching the early adopters who paid pennies for their Bitcoins and need suckers like you to cash out.

So, if you have to ask, we would say no, this is not the best place to put your money right now.
POSITION:  No positions in stocks mentioned.