Well I've spent the last hour or so reading about the technical aspects of Bitcoin, and have to confess that I am hopelessly confused about the technology. P2P stuff, no matter how many times I try to get my head around it, always leaves me confused.
But I have nevertheless come away with a basic understanding of the process.
Basically, Bitcoin is made-up money. That's not a worry to me. After all, the U.S. dollar is made-up money and it seems to work--not necessarily well or optimally, but it works on some level.
Indeed, Bitcoin, if successful, would demonstrate the unimportance of having a precious metal (or other commodity) backing for money. For a money to be useful, it needs to be relatively scarce and hard to create new units. That is all. Through the ages, precious metals have helped served this function nicely, but there is nothing special about gold or silver or any other commodity. With modern fiat money, the scarcity, such as it is, is established by the central bank. I find it somewhat humorous the number of "gold bugs" who have enthusiastically endorsed Bitcoin's type of fiat money. To be sure, Bitcoins are not likely to be deflated in value like the dollar since the long run number of Bitcoins is heavily constrained unlike the dollar. This gives Bitcoin an advantage over dollars on the inflation front.
The key is that the protocol limits the creation of Bitcoins according to a fairly strict mathematically-defined process with an ultimate limit of 21m Bitcoins to be reached in 2040. The Bitcoin servers create new Bitcoins at a roughly 25 per 10 minutes at present, and these can be sold or exchanged using the Bitcoin network.
Having established Bitcoin's scarcity, the next really valuable aspect of Bitcoin is the ability, through anonymous P2P, to make transactions with Bitcoin anonymously. Thus Bitcoin combines the anonymity of currency with the convenience of online transactions. Frankly, this aspect of Bitcoin strikes me being even more important as an advantage over the dollar.
Will Bitcoin be successful?
I hate to say it, but if Bitcoin becomes really successful, the Feds will kill it somehow. Remember the Liberty Dollar? While the decentralized nature of the network and the anonymous P2P exchanges will make it hard to kill, I can't imagine the Feds will let this succeed once they determine it is a threat to the dollar.
I hope I'm wrong, because having a money supply that was immune from inflation and allowed for anonymous trades would be a great thing to have.
UPDATE: Lest you think I am paranoid about the Feds' intentions, Bradley Jansen over at the Free Banking blog echoes my worry and bring some evidence to bear.
See also: Matt Ridley here, and George Selgin here.