Bitcoin: The Ultimate Free Market Currency

Senators Charles Schumer of New York and Joe Manchin of West Virginia have requested that the Drug Enforcement Agency investigates the website Silk Road, according to

. Silk Road is a website designed to be accessed anonymously and to facilitate the transaction of illegal drugs. To ensure additional security, all economic transactions on Silk Road are conducted using bitcoins.

is a peer-to-peer currency technology. Essentially, it allows users to trade Bitcoin files. Bitcoin currencies work just like any other fiat currency, except in a digital format. As long as other users are willing to accept bitcoins, they maintain a value. In fact, that value has skyrocketed recently--the Bitcoin has appreciated against the U.S. dollar over 200,000% in the last year. Perhaps most interesting is that the rate of inflation in the Bitcoin currency is mathematically fixed and should never exceed 21 million bitcoins. Thus, if nothing else, the Bitcoin should provide some interesting natural experiments for monetary economists. The bitcoin was invented with the goal of anonymity. The creators anticipated a crackdown in advance, and designed their technology to be inherently unregulatable. With the Feds bringing the heat, will the Bitcoin live up to its purpose? Will agencies like the DEA be forced to go after the marketplaces themselves, rather than the currency? With many of these marketplaces located offshore, will the U.S. government actually be able to do anything about it? Of course, the government could find its own uses for Bitcoin. The CIA recently asked a

to give a presentation on the technology this month. Might the CIA use the Bitcoin as a way to pay informants in totalitarian regimes like North Korea? Speculation has been rising for years that the U.S. dollar is going to lose its reserve status. Dollar-bears point to bloated budget deficits and anemic economic growth and argue that the dollar's time is quickly coming to an end. That may be true, but what will replace it? Some have argued for gold. Others, the Chinese yuan. Perhaps a basket of global currencies, or the International Monetary Fund's Special Drawing Rights (SDRs). Maybe that thinking is flawed: a relic of the past. Could it be that the future of monetary finance lies not in precious metals or in government paper, but digital files like the Bitcoin? Will the Bitcoin be the world's next reserve currency?