While there have been a number of well-known private currencies during the last few centuries, the ones that could have challenged government currencies were usually taken down in one way or the other by the state. A recent report titled “New Private Monies, A Bit-Part Player?” issued by the Institute of Economic Affairs think-tank however speculated that because of the success of Bitcoin there might be a flood of private currencies in the near future.

The report reads:

“There is a public demand for and interest in private currencies from various groups of people. Some wish to hold private currencies in the expectation that they will not diminish in purchasing power as state money has; some wish to conduct illegal activity; some wish to be part of a movement against increasing state control of economic and personal behaviour; and others just want better money.”

But the Bitcoin Revolution might possibly be the first successful private currencies implemented on a global scale and consequently could very well challenge the current economic paradigm. Under the present system, the banks essentially have total control over the economy, which they maintain through a symbiotic relationship with the government.

Understanding why this is important is fairly simple. One of the largest income earners for banks is the fees generated during money transfers. In other words, customers are charged interest and merchants have to pay a discount rate to use bank issued electronic money.

This is only possible if the banking industry has the cooperation of the government, which relies on reporting from banks and employers to successfully levy taxes of various types, which are used to fund government.

The report, however, has a favorable stance towards Bitcoin in general mentioning that private currencies could increase competition and should not be regulated:

“The experience of contemporary private monetary systems shows that the only regulation they need is that by the market itself: in the provision of money as with the provision of other goods and services, the best outcomes are achieved by free competition. It is therefore important that more widespread adoption of private monies is not inhibited by the state. Such a response by the state would reduce consumer choice, reduce the competitive pressure on the state to maintain the quality of its currency and undermine financial freedom.

“Competition against the central bank should therefore be welcomed, not least as it would pressure the central bank to improve the quality of the currency it provides.”

But Bitcoin, as a private currency, is not controlled by either the banks or the government and, more importantly for its future, is completely decentralized. The same definition applies to several others but all alternative currencies do not possess a decentralized nature. An example is Linden Dollars, which are used in the game Second Life.

The reason why this distinction is important can be found in the history of private currencies, specifically the Liberty Dollar and Digital Gold Currency (DGC). In both cases the government was basically silent on the issue until they began to be widely used. Once this threshold had been reached, the government not only made the currencies illegal but prosecuted the founders.

But Bitcoin, and its imitators, have two advantages that those currencies unfortunately lacked. Bitcoin has extremely powerful security features that give users nearly complete privacy in their transactions although this largely depends on the steps the user takes to mask his tracks. This is one reason why the difference between coins like Bitcoin and Linden Dollars is so vital.

Linden Dollars are the product of one company and if it extends itself into the retail market place, or Second Life begins paying salaries in the currency, the government can actually charge them with counterfeiting as was the case with Liberty Dollars. The decentralized nature of Bitcoin creates a situation where no single target exists for legal action.

With this in mind, the report is proposing that private currencies be embraced as this would uphold free market ideology. Moreover, the report even suggests three ways of achieving this:

“One fairly obvious reform would be to repeal repressive regulation against private currency – such as the current US prohibition against the private issue of coins. A second useful reform would be to ensure that courts will enforce contracts made in any currency, private, official or foreign, so long as the parties involved have entered into them freely. Thirdly, transactions in any private or foreign currency should not be put at any tax disadvantage relative to transactions in the local official currency: the guiding principle should be a level playing field.”

The IEA report did not go as far as to say that Bitcoin would dominate, however. In fact the reports author, Kevin Dowd, expected that another altcoin would arise with superior features to Bitcoin. But Dowd's report was also clear that cryptocurrencies were probably here to stay and, at least for the next few years, a lot more of these private currencies would enter the marketplace and many would fizzle out because of fierce competition until only a few top coins are left standing. And, according to the general sentiments of the report, the government should stand clear of the action and let the market regulate itself.