About 6000 bikes are expected to be available for hire from early 2010, with riders able to pick them up and drop them off at 400 locations spread across central London.
The scheme will be based on the popular Velib bike hire program in Paris, where there are now about 20,000 regular users.
London's bikes will be available for hire in an area stretching from Regents Park in the north to the Houses of Parliament in the south and from Kensington High Street in the west to the Tower of London in the east.
London Mayor Boris Johnson, a dedicated cyclist, said he hoped the scheme would inspire more people to pedal.
"I have long held the view that a cyclised city is a civilised city; but if we are to get more Londoners onto two wheels rather than four we need to provide the facilities to help them do so," he said.
"I believe that the work we are carrying out can make the capital a city of cyclists, where to use two wheels is common not curious."
Tourism bodies welcomed the scheme, saying the bikes would help visitors explore London.
The number of cyclists in London has surged by about 90 per cent in the past eight years, with an estimated 500,000 cycle journeys made each day across the city.