"The word hobbit has an unknown origin. However, as designating a diminutive legendary creature"
How does that square with
By Tolkien's own account, the coining of the name hobbit was a spontaneous flash of intuition. When he was busy grading examination papers, the word popped into his mind,
Geofferybard 02:13, 14 February 2011 (UTC)
It should be noted that in Tolkien's works, Hobbit is a proper noun and thus is always capitalized just like he capitalizes all the other races.