I'm talking about the trillions of derivatives market ..
Retail payments are now a little over 50% electronic: http://www.paymentscouncil.org.uk/media_centre/press_release... , so that's bank money rather than paper/metal currency.
Forex trading is huge: http://finance.yahoo.com/news/forex-market-size-traders-adva... : again, held on account rather than actual notes and coins changing hands. That's not even counting derivatives, but derivatives usually net out (for every put option there is a call option) and don't necessarily require settlement.
However, there's enough of a real market and taxation demand denominated in the US dollar that it's not going anywhere any time soon. The ECD made enough of a commitment to Euro liquidity that it's not going away any time soon.
Bitcoin's market cap is still tiny enough that it could be demolished by a single bored FX trader in an afternoon; but there's no real way to profit from that, as doing so would also demolish the fragile exchanges by which you might cash out.
Many merchants that accept Bitcoin are currently converting as you say via services like BitPay, but I certainly wouldn't go so far as to say that all transactions are being converted.
As for Bitcoin vs Paypal: one basic difference is that money in a Paypal account is denominated in terms of fiat, and as such can be considered fungible with fiat. Bitcoin is not inherently tied to the value of any another currency, so it clearly has a more independent role (not to mention the numerous [1]other advantages).
Seems to me that the deciding factor is: what percentage of Bitcoin's transactions are actual transactions for actual goods and services vs. what percentage are transactions related to speculation on Bitcoin itself. That is very hard to measure, especially since at least a double-digit percentage of transactions belong to the illicit economy.