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Bitcoin mania is back! But is it a bubble?

October 24, 2013: 1:48 PM ET
The price of Bitcoins are on the rise again. But are they destined to plunge? Maybe not.

The price of Bitcoins are on the rise again. But are they destined to plunge? Maybe not.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

Remember that Bitcoin bubble? The price of the virtual currency rose as high as $266 in early April when everyone was worried that problems with banks in Cyprus could lead to a huge euro disaster.

The mainstream media (CNNMoney included) started doing stories about investors snapping up bitcoins, and bars and doctors accepting payment via the digital currency. It became clear that Bitcoin was starting to look a bit like the 21st century version of tulip mania.

The Cyprus crisis ultimately ebbed and the value of bitcoin promptly plunged to $54 from $266 in a matter of days. The price roared back to about $150 later in April but quickly retreated to around $70 by early summer.

Related: How porn links and Ben Bernanke slipped into Bitcoin's code

Many people then quickly forgot about Bitcoin. It seemed destined to become 2013's financial equivalent of the pet rock. Or #Linsanity. Remember him, Knicks fans?

But a funny thing has happened in the past few months that hasn't gotten a lot of attention. Bitcoin has bounced back sharply from its lows. The price is now around $212. And some investors think it could soon hit new highs.

At first blush, the rally doesn't appear to make sense.

If the United States had actually defaulted on its debt, that might have been a good reason for Bitcoin, as well as gold, to surge. The dollar would have looked a lot weaker in a post-default environment and investors could have been more willing to flock to currencies that aren't subject to the whims of dumb politicians.

But the default didn't happen.

There's also the issue of online black market Silk Road, which was shut down by the FBI earlier this month. That site, which only accepted bitcoins as payment, was infamous for allowing users to surreptitiously buy illegal drugs and hardcore weapons.

The value of bitcoins did dip the day that Silk Road was shut down. But prices have since resumed their rally.

Related: Why the Silk Road bust could help Bitcoin

So why is Bitcoin still popular among investors? One bitcoin owner (and he literally owns just one bitcoin) says it's simply a case of supply and demand.

"It's not about the news and headlines. There is a finite supply of bitcoins being released," said Leigh Drogen, CEO of Estimize, a site that crowdsources earnings and sales forecasts from a wide group of investors.

Bitcoins are "mined" by a complicated computer algorithm that's designed to ensure that there are never more than 21 million bitcoins in circulation.

According to Bitcoin website Blockchain, there are currently about 11.9 million bitcoins in circulation.

"The more people that want to own bitcoins, the more the price will grow. The gradual adoption of the platform is driving the price higher," Drogen adds.

One of the main allures of Bitcoin is that the supply will never get too high. Critics of good old-fashioned paper currencies like the dollar, euro and yen complain that their value can be manipulated (usually not for the better) by central banks that turn on the printing presses when they see fit. Sound familiar?

Still, Drogen admitted that investing in Bitcoins is very speculative. So don't sell all your stocks and bonds and put the money into that proposed new Bitcoin ETF that the WInklevoss twins of Facebook (FB) fame are launching.

Related: SecondMarket beats Winklevii to the punch with Bitcoin fund

"I own one bitcoin just for the hell of owning a bitcoin because I want to understand it," he said, adding that he bought it several months ago. He didn't disclose the price he paid. But thanks to the recent rally, that investment is in the black. And he's not planning to sell it anytime soon.

"People are afraid of what they don't understand. But that's often when you can make the most money," he said.

However, investing in Bitcoins is not for the faint of heart. Drogen is advocating a buy-and-hold strategy. Many traders are trying to quickly move in and out of the cryptocurrency. And that's dangerous.

The relative scarcity of bitcoins has led to extreme price volatility on a daily basis. There is no central exchange to buy and sell bitcoins either.

Drogen even joked about how many Bitcoin investors get together in the real analog world to trade them. There's a monthly gathering in New York's Union Square Park that he went to once. He said it was like what the stock exchanges used to be when people and sheets of paper outnumbered machines.

"It's strange. Bitcoins are such a new technology but people meet and trade them in an old school way," he said.

Related: Bitcoin is more powerful than world's fastest supercomputers

Of course,  people still trade them online as well. And if you look at Mt. Gox, one of the more popular sites for trading bitcoins, prepare to be nauseous. Bitcoins traded as high as $233.40 today and as low as $175.30. You could sail an aircraft carrier through that price gap.

Drogen thinks the idea of a digital currency will be around for a long time, though he conceded that Bitcoin may not be the ultimate winner.

"The idea of a cyrptocurrency is not going do die. Even if Bitcoin doesn't survive, something else will emerge," he said.

But that's all the more reason to play it safe with Bitcoins. If you want to plop $200 and change on one bitcoin, there are worse things you could spend your money on. Just don't make bitcoins a major part of your portfolio.

Reader comment of the week! These are dark days for two iconic retail chains: J.C. Penney (JCP) and RadioShack (RSH). A tweet by stock market analyst Brian Sozzi prompted me to joke that the two should join forces. But one reader had a brilliantly sarcastic retort

Ouch! Well-played. Although it would still be nice to get a free haircut for my kids at the Shack next time I need a pack of D batteries.

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