Bitcoins Reuters

The price of bitcoin fell around the world on Dec. 5, just after the People’s Bank of China announced that domestic commercial banks in the country could no longer deal in the digital currency bitcoin (BTC).

For a day and a half, trading prices plummeted, dropping 50 percent from record-setting highs to just under $600 on Mt.Gox, “the world’s largest Bitcoin exchange.” The price of bitcoin has risen again, further illustrating how volatile the cryptocurrency is.

The decision to halt financial institutions from deals involving bitcoins came after a period of high arbitrage with the Chinese Yuan (CNY), where opportunistic investors capitalized on the value differences between BTC, USD and Yuan. As more regulation from national banks is potentially on the horizon, some investors are questioning the future of the currency and its money-making potential.

Just like other currencies, there are two major ways to make money from the digital currency: trading and saving. Bitcoins can be traded on open markets, taking advantage of the differences between values of currency in different nations, otherwise known as an "arbitrage play." Most arbitrageurs are financial institutions like banks or brokerage firms, which have high amounts of liquid funds available to move through the market in the time to make risk-free profits.

What makes the bitcoins different is the high volatility that other stable currencies don’t have. This is what led to the People’s Bank of China ceasing bitcoin transactions at the commercial level; individuals are still allowed to buy and sell BTCs in China as long as they take responsibility for the risks.

A stable currency’s value rises and falls on a daily basis, but on a much smaller scale then what can be seen with bitcoins. Where normal arbitrageurs are dealing with minute changes in value (less than a penny’s difference can still mean thousands of dollars profit risk-free), bitcoin arbitrageurs deal in the difference of full dollar amounts. As of this writing, current closing prices on Mt.GoxUSD are $875; Mt.GoxCNY closing prices are 5415CNY, or just shy of $892.

For example, say Joe was an early investor, and he has 5000 BTCs sitting in a digital wallet (much like Kristoffer Koch found he had late this October). If he were to sell those on Mt.Gox today, he would be $4.375 million richer. However, if he were to take advantage of the arbitrage between CNY and USD values of BTCs he could create $80,000 more for himself, grossing over $4.45 million. Of course, this is a simplistic exercise; there are fees associated with foreign transactions and currency exchange, but the point is the same. Just before the Dec. 5 crash, USD values were around $1,200, and depending on the bitcoin exchange, foreign prices were even higher.

The second way of making money with bitcoin is a higher-risk, higher reward situation. Bitcoins can be treated like a commodity and can be invested in; you can buy a set amount, wait for the value to rise and sell the same amount for profit. A simple buy-low, sell-high scheme. However, due to the nature of the market and the inherent volatility of the currency, this isn’t a long-term solution. As demonstrated by the market crash last week, if an investor holds on too long, the person can lose a lot of money. But holding out longer seems to allow the market to stabilize. While prices have yet to return to the highs of $1,200, in a week’s time prices fell to $600 and then climbed back to where they are now. Arguments can also be made that early investors, and even investors as recent as early 2013, stand to make money as prices may never see the sub-$100 range.

There is, also, a third way, one much less discussed: trading within cryptocurrencies. Right now there are 45 digital currency values listed on the site, some major and some minor. With values ranging from less than a cent to $31, these “coins” are bought and sold very quickly as the markets change, just like the stock market.

“I think the stock market is totally dated, unless you are moving tons of cash,” said John Hammond, a day trader who is seeing some great movement in the Bitcoin trading market.

Hammond wouldn’t be the first person anyone would peg as a day trader. Part businessman, part artist, Hammond is a DJ in the psychedelic trance genre of electronica, performing under the name Konvndrvm. He bought his first Bitcoin for a large sum to him at the time, $90. That was in July this year. Now he trades in the smaller currencies, with successes and losses as he has learned the ropes of this new frontier.

“This is the wild-west,” Hammond said, referring to the volatility of the market. “Even I was skeptical -- I got in after the first big crash, but I didn’t buy enough.”

Six months later, Hammond spends most of his free time focusing on day trading, 12- to 14-hour days buying and selling smaller digital currencies.

“I got really lucky with sexcoin,” Hammond said. “It’s an alternative currency to be used in the adult entertainment industry.” Sexcoin is a Bitcoin version of a penny stock currently valued at $0.088 per coin.

The up-and-coming digital currency is called Litecoin; some call it the silver standard to Bitcoin’s gold.

“If I had bought litecoin [in July],” Hammond reminisced, “then I could have made a lot of money. At that time it was only $2 to $4.”

LTCs are currently trading at $31. While alternative currencies are attractive for the potentially big gains, just as penny stocks are, they also stand to lose a fair amount of money as well.

“You can make a lot of money if you get out in time," Hammond said. "That’s the boom and the bane of alternative currencies. It’s easy to buy in and triple your investment, but it kind of cripples that currency."

Crippling a currency means some people gain a lot, while others lose their investments. Hammond trades for fun and as a way to support his business as an artist and his recording label, Jellyfish Frequency, a not-for-profit label that donates money raised by release events to charities like the World Food Programme, the food assistance branch of the UN, and Free Tibet, among others.

With all of the discussion being focused on how to make money with the cryptocurrencies, it is easy to forget that Bitcoins are meant to be spent. BTCs can be used to buy things great and small, from martinis to cars to trips to space. With more retailers accepting BTCs, the currency gains validity grounds for lasting power.

However, there are still problems with the bitcoin that need to be overcome. Just a day before the crash last week, Lamborghini Newport Beach, a dealership in Southern California, sold a Tesla Model S to a buyer using Bitcoins. He paid 91.4BTC for the high-end all-electric car, which at the time was valued at $103,000. But at this particular moment, the same amount of BTC is only valued at $77,690, or a net loss of over $25,000 because of the crash.

Lamborghini Newport Beach used BitPay, a payment processor, to transfer funds immediately back to USD, thus reducing the risk of loss. However, not all retailers are using the service; some accept the currency directly, thus avoiding fees and potentially increasing the value of their goods as the market rises. BitPay advertises “over 12,000 businesses and charities accept bitcoin” through their services.

Whether it is for personal or professional gain, there is a lot of money to be made through bitcoins and alternative cryptocurrencies. How stable or great those gains will be, or if losses will be all one sees, will play out in time.