It's true that there aren't many ways to exchange Bitcoin for actual goods or services or non-monetary financial instruments right now, but that's not due to any inherent inferiority of Bitcoin: it's due to the fact that governments and central banks have a huge incentive to either outlaw exchanges of Bitcoin for goods, services, or financial instruments like stocks, or at least impose artificial costs on such transactions that are high enough to discourage most people from making them. In other words, Bitcoin is not competing on a level playing field with other forms of money.
Personally I'd see "governments have a huge incentive to outlaw it" as a pretty major inherent inferiority in something purporting to be currency too...
The same applies to any type of money. Google "hyperinflation".
Also, how much of an effect this is depends on how long people expect to hold money in between transactions; see below.
they will require you to pay x% more in Bitcoin (at current exchange rates) where x is a premium to account for the expected loss in value over the period they expect to hold the Bitcoins, plus a margin for risk.
People do the same thing with dollars and other currencies based on the rate of inflation they expect, i.e., the rate at which they expect dollars to lose their value.
Also note that qualifier: "over the period they expect to hold the Bitcoins". In other words, people need enough cash to cover current expenses for some period of time; but that amount can be pretty small compared to their total wealth, and it gets smaller as technology advances and economies evolve. People used to get paid quarterly, so they needed enough cash for a full quarter's expenses. Then the payment cycle became monthly, and now many people get paid biweekly or even weekly, so they need to hold less cash to cover expenses. (More precisely, they need to hold less as a fraction of their total wealth.)
I'd see "governments have a huge incentive to outlaw it" as a pretty major inherent inferiority
It's "inherent" only in the sense that we're not likely to get rid of governments any time soon. Is that a problem with Bitcoin, or a problem with governments?
Individual people, perhaps not. But the US dollar is the most widely-held reserve currency in the world, followed by the Euro. Wikipedia states that approximately 2/3 of reserve currency holdings are dollars.
One can also turn this point around: what requires the store of value to be the same thing as the medium of exchange? The store of value must be convertible into the medium of exchange, but that doesn't mean they have to be the same thing. Yet Krugman blithely assumes that they must be: "To be successful, money must be both a medium of exchange and a reasonably stable store of value." He doesn't even consider the possibility of, for example, an economy based on Bitcoin as a medium of exchange and, say, gold as a store of value. For that matter, he doesn't even bother to mention that very few people actually use dollars as a store of value: people don't keep their retirement funds in cash under the mattress.