I know the US Government is opposed to competing currencies. It seems that it would be a rather simple solution for them to destroy Bitcoin before it grows too much by merely buying all the currency, which would be rather feasible given today's market cap of $80M (as of July 2012), and never selling.
The exchange rate at any one point in time is determined by supply and demand at the markets.
The value of all bitcoins at the current market price is $80 million because the current market price is the point where the demand for bitcoins at a certain price meets the supply. You are describing introducing an artificial demand that would indeed cause incredible rallies in the exchange rate and cause tremendous exchange rate volatility
While some people cash out in a rally, others are buying. This government taking this action would be enriching speculators mostly -- certainly not the best use of the governed's tax dollars.
Even in a hypothetical scenario where this party you describe were somehow able to acquire 9.49 of the 9.5 million coins issued today, there are just about 11 million more that will be issued, so this entity would need to continue buying. But even with just 10,000 coins remember that Bitcoin is divisible down to a Satoshi (0.0000001 BTC). That 10K BTC gives 1,000,000,000,000 Satoshi trading units. That allows plenty enough time to get an update out that provides for even greater divisibility.
Of course, the risk then is that those 9.49 million coins are not destroyed but find their way back onto the market, creating again huge volatility and price inflation. That can technically be done, yes.
I don't think too many speculators are losing even a wink of sleep over it though.
The process of attempting to buy all of the currency would drive the price up arbitrarily high.
For example, I have some bitcoins and plan to sell 10% of what I have left every time the price doubles. I will never run out of bitcoins to sell, no matter how high the price, so it is impossible for anybody to buy them all.
The US government could try to destroy Bitcoin by repeatedly buying and driving up the price, then selling to make the price crash. Eventually they should get tired of paying transaction fees to the exchanges (or run out of money to pay the exchange fees). And, of course, if their buying and selling is at all predictable everybody else will just repeatedly sell high and buy low.
It's impossible to tell the difference between bitcoins that have been lost forever and bitcoins that are being hoarded, so the US government would never be able to tell when they had bought all available bitcoins. And they're going to have to offer a lot more than the current market prices for some people to sell.
It is unrealistic to believe that such a purchase would survive
- Executive scrutiny
- Congressional scrutiny
- Judicial scrutiny
More than likely, a call for Congressional action would come not from the legislative branch, but from the executive or judicial branch. Alternatively, pressure may come from lobbying entities.
Moreover, a Congressperson who authors or support a bill outlawing digital currencies would likely face severe pressure from voters who use them. Remember that laws a written very vaguely, so digital currencies may include in-game currencies like WoW and Diablo gold, Linden dollars, Eve ISK, etc.
Lastly, can you image the headlines?
- Rep. Smith introduces bill to outlaw in-game currencies
- Obama administration authorizes $100M purchase of entire on-line currency system
- Obama spends $300M to disable fledgling Internet currency used by fewer than 5,000 people
As stated before: if the government or who ever tries to buy all existing BTC this would lead to enormous volatility. But what are the consequences(?): Increasing price volatility would harm the possibility of storing value. But as prices for goods and services which are offered in exchange of BTC are flexible, BTC could still be used as a mean of exchange.
There are many exchanges (this reason is good enough by itself) and most exchanges "must" follow some kind of an AML policy so they can get bank accounts opened quickly, safely, ... Just because of that most of exchanges refuse to work with governments, agencies since they know there could problems. Also person with lot of money usually "must" be identified by the exchange.
The powers that be could theoretically accomplish horrendous volatility of the value of Bitcoins by running the price up and then selling. Thus rendering Bitcoin unsuitable as currency.
If speculators think they can game this by market-timing the manipulations better than an insider such as JP Morgan, I suggest they prove in the futures markets for gold or silver to receive their reality-check spanking.
As documented by Catherine Austin Fitts former Managing Director and Member of the Board of Directors of the Wall Street investment bank, Dillon, Read & Co., Inc.; Assistant Secretary of Housing/Federal Housing Commissioner at HUD in the first Bush Administration; and President and Founder of Hamilton Securities Group, Inc. . . .
. . . TPTB have access to at least $4 trillion "black budget" off-balance sheet funds that need no public oversight to be used.
And it probably wouldn't require any where near a majority share of the coins to create debilitating volatility. Remember when it fell from $17 to 1 cent briefly because of one account hacked and sold.