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Here is another one from the "you couldn't make this up" department (the ECB is a rich fount of those). The ECB is apparently worried that the digital currency bitcoins could ruin the reputation of central banks. Seriously. At least that is what they are saying.

According to Bloomberg:

An increase in the value of bitcoin, the world's largest online currency, may fuel concerns that virtual money could undermine the role of central banks.

The CHART OF THE DAY shows that bitcoin has more than doubled in the past 12 months, strengthening to $16.37 from $5.88, according to data from Mt. Gox, the world's largest bitcoin exchange. The money, issued by a decentralized network of computers, has recovered after falling to $2.14 in November 2011 from a high of $29.58 five months earlier.

Greater demand for virtual currencies could have a negative impact on the reputation of central banks, according to a report published by the European Central Bank in October last year. Since the report was released, bitcoin has risen more than 55 percent against the dollar and use of the currency has surged.

Bitpay Inc., a bitcoin payment processing company that recently raised $510,000 in an investment round, this month announced that the number of companies using its services has increased almost 50 percent to more than 2,000 since November, when blog management firm WordPress.com said it would accept the digital currency.

'I think the ECB obviously is concerned, and it's not reputational,' said Steve Hanke, a professor at Johns Hopkins University in Baltimore who helped to establish new currency regimes in countries such as Argentina and Bulgaria. 'I think it's a competitive threat. Maybe virtual currencies will be so convenient that they will pose a threat because of their ease of use.'

Virtual currencies 'could have a negative impact on the reputation of central banks' if their use grows considerably, the Frankfurt-based ECB said in its research paper. 'This risk should be considered when assessing the overall risk situation of central banks.' (emphasis added)

Professor Hanke is of course 100% correct. It has absolutely nothing to do with the reputation of central banks, it has everything to do with competition. Central banks are monopoly issuers of currency. Bitcoins threaten that monopoly, not least because the currency, although fully digital, is actually sounder than the confetti produced by central banks (and reportedly absolutely safe from counterfeiting as well). You read that right, it is a sounder currency, for the simple reason that the number of bitcoin units that can be created is strictly limited by the algorithm underlying the creation process.

Moreover, governments all over the world just hate bitcoins because their encryption allows for perfectly anonymous payment. They are the digital equivalent of cash in this respect. Nowadays governments are eager to trace every movement of money in the economy and want to put an end to all financial privacy (usually under the pretext of the war on terror, in Europe also because they are bankrupt and want to grab every euro in taxes they can find).

Cash bans are often discussed, but since government officials themselves need something untraceable that can be used for bribes and various slush funds (of certain alphabet agencies involved in the international drug trade), respectively a conduit that can be used to make tax payer funds magically disappear (see the trillions of dollars that have disappeared without a trace in the Pentagon/war racket), we think that cash is ultimately not in danger -- although its use by "normal" citizens may be restricted by law, as has already happened in several European countries the governments of which are insolvent. That was done in order to put obstacles in the way of the shadow economy. Of course there would be no shadow economy if taxation were not at levels that amount to highway robbery. Moreover, it will be impossible to eradicate it anyway.

Bitcoins are probably less useful for the particular applications mentioned above (bribes, slush funds, etc.), but they do represent competition for central bank issued money and they definitely are a thorn in the establishment's side. Expect more attacks on the currency to emerge.

In the meantime, buying bitcoins has evidently been a very good idea so far -- the currency, although quite volatile, is one of the strongest in the world:

Click to enlarge images.

Bitcoin-U.S. Dollar Rate, One Year

Bitcoin-U.S. Dollar Long Term

As an aside, the volatility of the bitcoin-U.S. dollar rate reflects political risk as well. The sharp decline in 2011 was occasioned by U.S. politicians attacking the currency verbally and threatening legislation that would outlaw it. Apparently the issue has taken a backseat for now, but as we said above, expect it to reemerge.

Central banks also worry about gold, of course, but gold is nowadays mainly hoarded rather than used for everyday transactions (due to Gresham's law), so there is a big difference.

Charts by Bitcoincharts.com.

Source: The ECB Worries About Competition From Bitcoins