Fortress Investment Group LLC (NYSE:FIG) director Michael Novogratz thinks that bitcoins will continue to gain value, saying “More and more people are getting involved…there is a fixed supply…prices are going higher…inning 3 of a 9 inning game,” Saumya Vaishampayan of MarketWatch reports. Bitcoins were near $200 when Novogratz announced that he had taken a position in bitcoins, and they are now pushing towards $400.

Bitcoin

Creation of bitcoins

Unlike central bank currencies, bitcoins can’t be created by fiat, and unlike a gold or silver it’s impossible to stumble upon more unexpectedly. Instead, they are created by computers solving an extremely difficult cryptographic problem which becomes more difficult relative to the amount of computing power being thrown at it. For anyone without a technical background, the details can be fairly daunting, but the end result is that bitcoins are created at a remarkably consistent rate.

Bitcoins can be spent completely anonymously, although weak operational security can cause most people to give themselves away, and no government or financial institution can change the value to suit their own needs. It was created by libertarian-leaning security experts and has been proposed as an alternative to fiat currency, but it does face serious challenges.

PayPal considering using bitcoins as payment

The first and most obvious problem is that bitcoins are hard to spend, but that’s changing, and it could also simply mean that bitcoins aren’t an exact analogue of cash. You won’t find any restaurants that accept payment in Treasury bonds, but that doesn’t mean they aren’t useful. Novogratz is almost certainly investing in bitcoins as an asset, not because he wants to make secret purchases on Tor. PayPal has considered integrating bitcoins into their platform, which would open up new opportunities to spend them across the net and could cement bitcoins as the first truly successful electronic currency, but nothing’s official as of yet.

The other potential problem is that bitcoins are inherently deflationary, which gives a huge advantage to people who got in early and also creates an incentive to hoard. Nobel Prize winning economist Paul Krugman has called the entire thing a Ponzi scheme, but even if he’s overstating the case a currency that no one wants to spend isn’t too functional.