“I’d feel a little stupid buying these things,” a dear friend of your editor’s recently remarked. “But that’s probably not, in and of itself, a bad thing. After all, I felt pretty stupid buying gold back when it was still $250 per ounce.”

Our friend was referring to a peer-to-peer (P2P) cybercrypto currency called bitcoin. What is bitcoin? How is it used? What are the risks? Let’s begin where all good non-Tarantino stories begin…at the beginning.

The demand for a totally free market currency arose, naturally, out of the dismal state of the current monetary environment, in which governments around the world systematically debase the value of their printed monies in order to pay for the various welfare-warfare states they promised but can’t possibly afford. The resulting inflation is sometimes referred to as a “sneaky tax,” one that silently, insidiously infiltrates the marketplace, with each freshly-inked dollar compromising the value and integrity of each and every currency unit already in circulation.

This is by no means a new phenomenon, as we remarked in this space last Friday:

“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 pengős…Zimbabwean dollars…Greek drachmai…Brazilian cruzeiros…Polish zlotych…Chinese yuan…Nicaraguan córdobas…US continentals…Peruvian soles…Angolan kwanzas…Russian rubles…Argentine pesos…

“…and the list goes on (and on…and on…).”

It is hardly a surprise, therefore, that after having labored under the state’s unquestionable, unchallengeable monopoly on counterfeiting, and enduring the capricious, inflationary whims of the central banker class, the free market would demand – and will eventually provide – a superior alternative.

At various times throughout history, this has meant chaining the Feds to a gold and/or bimetal standard. Alas, as we know too well thanks to the likes of FDR and Nixon, the temptation to inflate is matched only by politicians’ reliable tendency to make promises they can’t keep. And so, gold standards are frequently tossed out the window at moments of manufactured convenience, proving further that entrusting the state to maintain the integrity of its currency is about as effective as locking them in a cell and giving them the key.

The free market requires something better, something beyond the grasp of the state and its many and varied manipulators and do-good meddlers. So, what’s the solution? Again, from this space last week:

“Advocates of a small but fast-growing digital currency network called bitcoin think they’ve found the answer (or, at the very least, an answer). If it is successful, claim its adherents, this totally-decentralized, peer-to-peer (P2P) currency could supplant the world’s central bank-issued money, potentially providing savvy speculators with an opportunity to cash in on the greatest politically motivated market distortion of our time.”

Which brings us back to our original questions. First, what is bitcoin? An article that appeared on Yahoo! News this morning provides as good a definition as any (and a hint that the mainstream is catching on). Bitcoin is “a peer-to-peer system of electronic money that allows payments to be sent directly between two parties without the need for a financial institution.”

The currency also makes redundant the concept of a central bank, Federal Reserve or any other such easily corruptible nonsense institutions. For starters, bitcoins are not generated, but rather awarded to miners – individual computers participating in the network – as a reward for processing transactions and securing the bitcoin currency network, thus providing an entirely decentralized, highly competitive marketplace, much like the Internet itself. What’s more, the amount of bitcoins is strictly (mathematically) limited to 21 million coins. There are currently about 6.5 million coins in circulation and anywhere up to half a million dollars worth (at today’s exchange rate) changes hands daily. As more and more coins are mined, the difficulty (amount of CPU required to mine each coin) increases exponentially, ensuring a steady (though ultimately finite) supply.

As more and more vendors begin accepting bitcoins as form of payment for goods and services, the universe expands against the number of available coins in circulation, thereby driving the value of the currency ever higher. (When we mentioned bitcoin last Friday, it was trading for about B$1 = US$8. Today it hit B$1 = US$14.25.)

As you might expect, bitcoin has its fair share of skeptics; maybe even more than its fair share. Bitcoin has appreciated at an incredible rate since it “took hold” in the online community, especially over the past few months. One of the first ever transactions using bitcoin, according to the forums, involved a consumer who paid B$10,000 for a pizza online one year ago. Those same bitcoins are today worth about US$140,000. Not a bad tip for the delivery guy. Still, such phenomenal currency appreciation has led many to assert that bitcoins are in a “bubble.” And maybe they are…but not for the simple reason that they have appreciated against other currencies.

Value, as Ludwig von Mises described it, is not determined by the nature of objects themselves, but through our interactions with and appreciation for them. “Value is not intrinsic, it is not in things,” he wrote in Human Action. “It is within us; it is the way in which man reacts to the conditions of his environment.”

Is Google Inc., to take a real world example, in a bubble because it has more or less quintupled since IPOing in 2004? Or is it fairly priced at US$525 (or one third an ounce of gold…or B$37.5) because buyers and sellers of the stock agree, in this moment, that’s what it is worth?

Another cause for concern among bitcoin skeptics is that, as the economy of the free market currency expands it will inevitably begin posing a threat to the state’s own money-printing racket. It will, thereby, raise the ire of bankers and politicians who will have every incentive to make the currency illegal in order that they may protect their own monopoly and continue cheating their citizens of the value of their president-stamped notes and coins. Given the state’s nature when it comes to these matters (and here we refer readers to the recent and despicable case against Bernard von NotHaus) there is every reason to expect that it will indeed crack down…and hard.

Here we expect all the usual arguments from all the usual suspects: Bitcoin transactions are anonymous and therefore provide cover for peddlers of child pornography and drug traffickers, they will contend.

But the astute reader knows in his gut there is something very wrong with this line of thinking right from the beginning. Cash is anonymous too. People by things deemed illegal by the state with state-issued currency all the time. So what? Does this mean US dollars should be banned? Some people drive their cars recklessly, with little or no regard for their own safety or for others’. Should we ban cars?

The question, however, is not whether the Feds should do something (moral considerations have rarely, if ever, stopped them before), but whether they could do something, even if they wanted to…

Whether or not you agree with the organization itself, the WikiLeaks scandal did nothing if not expose the limited power of government when it comes to policing the cyber world. Presented with every motivation to “take down” the WikiLeaks site, the Feds went after them in typically cumbersome fashion. Within a few days of the attack on their site, 10,000 WikiLeaks mirror pages had sprung up around the world. Six months after the largest leak of sensitive, highly-classified and obviously embarrassing state documents found its way into the light of virtual day, the organization now has more followers and supporters than ever before. Go figure.

Your editor has no idea whether bitcoin is a great idea or simply a great scam. Maybe it’s both. And maybe it is in a bubble of epic proportions due to implode promptly at high noon tomorrow. And maybe the Feds can and will crush its rapidly expanding base of freely associating participants. Who knows?

In any case, the fact that the market has demonstrated the motivation and, arguably, the means to challenge state-sponsored currency manipulation is good news for freedom lovers everywhere. Bravo!

Joel Bowman

for The Daily Reckoning

An Emerging Free Market Currency originally appeared in the Daily Reckoning. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas.

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