One of the few things I really know about Bitcoin is that I wish I’d moved all my assets into it at the beginning of 2013: $100 invested in Bitcoin at the beginning of the year would have done better than anything else in my portfolio. Bitcoin is a lot of things. It’s a sensation among critics of the Federal Reserve and government control of the money supply more generally. It might provide the effective check on governments’ ability to play fast and loose with their currencies that Peter Theil set out to create when he started PayPal.

Writing for the New York Times, Marc Andreessen explains how Bitcoin works, why it is important, and what it means for cryptography and security. Bitcoin is a technological breakthrough. That much is true. But is it good? Or is it evil?

In a late December post, Paul Krugman laid aside the intriguing positive debate over whether BitCoin will work and argued that Bitcoin is actually evil. As Brad DeLong (via Krugman) points out, fiat currency is at least "stable" in that you can use it to pay your taxes and the Federal Reserve can buy and retire dollars if they think inflation is getting out of hand.

Krugman then quotes Charlie Stross, who argues out that Bitcoin is driven by an explicitly libertarian political agenda that seeks "to damage states (sic) ability to collect tax and monitor their citizens (sic) financial transactions."

In other words, Bitcoin and other cryptocurrencies can limit the ways governments tax their citizens and invade their privacy. In this, there really is nothing new under the sun: people have historically fled oppression and taxation by moving from jurisdiction to jurisdiction or by moving to whatever frontiers were available. The geographic frontier has closed, so to speak: there really aren’t many habitable places to which one can go and be free from government. For people who don’t want to be bothered and monitored, the frontier has moved online.

In 1976, F.A. Hayek wrote a short volume titled Denationalisation of Money, which appeared in revised editions in 1978 and 1990 (with the wonder of the internet being that you can download and read it for a price of zero dollars, or zero euros, or 0 bitcoins). Hayek argued for a competitive market in currencies; cryptocurrencies like BitCoin show how entrepreneurs have decided to stop waiting for governments.

Governments reduce some transaction costs when they impose a single monetary standard, but they create other costs and incentive problems.

Governments reduce some transaction costs when they impose a single monetary standard, but they create other costs and incentive problems. Hayek called for Denationalisation of Money in response to "(p)ersistent abuse of the government prerogative" to coin money. His proposal was simple, and he put it this way (1990: 17): "...I do not want to prohibit the government from doing anything except preventing others from doing things they might do better."

It’s easy to wonder what all the fuss is about given that countries like the United States have well-functioning banking systems and independent central banks run by highly-skilled economists. As Andreessen points out, the real beneficiaries might be people in poor countries with weak or dysfunctional banking systems who "are excluded from products and services that we in the West take for granted." Combined with a rapidly-spreading access to information technology, Bitcoin could be the key to a more integrated global market in which entrepreneurs have better protection from kleptocrats and central bankers with their foot on the monetary accelerator.

Adam Smith identified one of the fundamental problems with trying to centrally plan anything, monetary systems included, in his first book, The Theory of Moral Sentiments (also available for zero dollars, euros, or bitcoins!):

"The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder."

The man of system’s "ideal plan of government" might include specific monetary institutions, and indeed these monetary institutions might be ideal if "he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board." Given, though, that "every single piece has a principle of motion of its own," what look like ideal monetary institutions may find themselves vulnerable to innovations like Bitcoin. Hayek called for governments to denationalize their currencies and to allow monetary standards to be determined by free markets. It may well be that Bitcoin is at the forefront of a market-led denationalization of money.

Patri Friedman, grandson of economist Milton Friedman and son of economist David Friedman, once said that we need "a start-up sector" in governance. Bitcoin and other cryptocurrencies are important players in just such a start-up sector, this one in currency and monetary institutions. Hayek offers the following toward the end of Denationalisation of Money: "A hope one may cherish is that, as competition usually does, it will lead to the discovery of yet unknown possibilities in currency" (p. 126). I don’t know whether Bitcoin will succeed or fail. With the broad sweep of history in mind, though, what really matters is that they be encouraged to try.