Could this virtual currency become the new gold standard?

I wrote here a few weeks ago about free banking the idea that anyone should be able to set up their own bank and issue their own currency. But it turns out that I was being very old fashioned about the concept: these days you don't need to set up a bank to have your own currency. Instead you just go ahead and create it.

That's what Satoshi Nakamoto did with his peer to peer (P2P) virtual currency, the bitcoin, in 2009. You can find out how bitcoins are created (they are effectively mined much like gold) and check out the technical details.

But the key point is that there are now around 6.5 million of them in circulation, kept on users' desktops in 'wallets' and accepted as a valid form of monetary exchange by a large and growing number of websites. It is also exceptionally secure (no third parties such as Paypal are involved in transactions). According to the Technology Review,the nature of the mathematics used to create the currency "ensures that it is computationally easy to verify a transaction but practically impossible to generate fake transactions and spend bitcoins you don't own". So even if you don't trust the person sending you bitcoins, you can be sure that the money itself is genuine.

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Better still, the bitcoin involves no central authority and no central bank of any kind. That makes it free from government interference and from the irresistible temptation to make promises and print money to keep them. Finally the number of bitcoins is limited and known to be limited: Nakamoto has programmed a ceiling of 21 million of them over time, so there can be no long-term inflation for those who use them. Instead, the monetary base will expand in a slow and controlled manner until it stops expanding and ends up with a fixed monetary base.

None of this means that bitcoin doesn't have its detractors thanks to a bit of publicity and the fact that more sites are accepting them, the US dollar price of a bitcoin has gone from around zero to $18 in the last year and is still rising (you can see the exchange rates). You might think this tells us more about the long-term direction of the dollar than the bitcoin, but it has led lots of bloggers to suggest that there is already a bitcoin bubble on the go.

Maybe there is. And if bitcoin isn't a bubble, it might be just a fad one that will collapse in value once it isn't novel any more. But given the fact that post-financial crisis and QE, we now know for sure that our central banks are not competent enough to properly protect our national currencies, it is pretty tempting to think that there is room for a new anonymous, international, flexible, decentralised and completely secure currency of some kind, be it bitcoin or a later similar effort.

As our own Bill Bonner puts it: "The history of centrally controlled monies is a history of theft, inflation and, eventually and invariably, defaults. From coin clippings during the Roman Empire through to debasement of German marks under the Weimar Republic... to hyperinflationary corruption of, in no particular order, Hungarian pengos, Zimbabwean dollars, Greek drachmai, Brazilian cruzeiros, Polish zlotych, Chinese yuan, Nicaraguan crdobas, US continentals, Peruvian soles, Angolan kwanzas, Russian rubles, Argentine pesos, the list goes on (and on, and on...)."

So it makes sense that the market should demand and then have a go at creating a superior alternative. If I could figure out how to do it (which so far I haven't, something that might turn out to be part of bitcoin's problem) I might have a go at mining a few virtual coins myself.