Why Bitcoin Must Die. Long Live Bitcoin 2.0.

One day, there will be a global digital currency in widespread commercial use whose value will not be controlled by central banks. Governments can forestall this day, as they have for the past 20 years since the first digital currencies were launched, but the market demand for an alternative to inflation-prone fiat money that can be conveniently, securely, and inexpensively exchanged over digital networks will be too strong to resist. Alas, the currency described above will not be Bitcoin, at least not in its current configuration.

Why not today’s Bitcoin? Because the digital currency of the future must choose between two mutually exclusive paths. It can either be anonymous, enabling black market transactions in the shadow economy, or it can be fully compliant with the growing body of know your customer, anti-money laundering laws that constrain global financial markets. A single digital currency cannot do both.

Today’s Bitcoin aficionados appear determined to learn this the hard way. One can only conclude from their rhetoric that they are either ignorant of the history of past digital currencies that have been destroyed by aggressive government enforcement action, naïve about the inherent resiliency of Bitcoin’s distributed architecture, or so enamored with Bitcoin’s growth potential that they are happy to make money while the sun shines and not worry about the future. Even the recent arrest of Charlie Shrem, CEO of the Bitcoin exchange BitInstant, on charges of conspiracy to launder money, operation of an unlicensed money transmitting business, and willful failure to file a suspicious activity report seems to have done little to make the Bitcoin community shake off its complacency. This is not a good sign.

Bitcoin advocates would be well served to study the demise of eGold, a digital currency launched in the late 1990s and regulated out of existence through a Secret Service indictment and plea bargain. eGold was destroyed despite that fact that its provision of anonymity was a false rumor, its executives worked closely with government authorities to investigate monetary crimes, and its founders tried desperately to come into compliance with vaguely worded post 9/11 regulations once they came to believe that these regulations applied to them.

But even if it survives the coming onslaught, Bitcoin faces an even more fundamental problem. Unlike other forms of money, which represent a balance sheet liability to the issuer backed by a portfolio of financial assets that include everything from bonds to bars of gold, Bitcoin’s promise of value rests entirely in the balance between supply and demand in a thinly traded market dominated by speculators. Kudos to Bitcoin for limiting the supply, an excellent feature not found with fiat currencies. But unlike eGold, whose owners were eventually made whole because the physical gold held in a legal trust on their behalf survived efforts by the government to confiscate it, no underlying assets create a floor under the price of Bitcoins. The exchange rate can go to zero just as easily as it shot up to $1,000.

So if you are considering getting into the game, caveat emptor. Money will undoubtedly be made by the sellers of Bitcoin mining equipment, like the pick and shovel vendors who support any gold rush. And overnight millionaires will be created at the expense of the next round of overnight millionaire wannabes. But while Bitcoin has done much to raise the awareness of the potential utility of digital currency, it is certainly not the first effort nor will it be the last.  This game is still in early innings, and the umpire is getting ornery.

Tune in to RealClear Radio Hour to hear an interview with Doug Jackson, eGold founder and former chairman, and Steven Leeds, Director of Corporate Marketing at TigerDirect, which recently started accepting Bitcoins for online transactions.