This is a guest article by Robert McCauley, a non-resident senior researcher at the Global Development Policy Center at Boston University and an associate member of the Faculty of History at Oxford University. In this article, McCauley argues that comparing bitcoin to a Ponzi scheme is unfair to Ponzi schemes.
Bitcoin is off its all-time high of $ 69,000 set on November 9, 2021. It suffered a heart-wrenching $ 12,000 lightning crash during the first weekend of December as leveraged position accounts were closed . And yet, even at the current price of $ 49,000, guests of financial television news continue to tout it as the best performing asset of the past N years, where N can be just about any number from one to ten. . They are also increasingly seeing it as a credible investment in its own right.
This contradicts the long-held skeptical view of many economists and others that bitcoin is actually a Ponzi scheme. Brazilian computer scientist Jorge Stolfi is a voice that backed this up. His point of view is based on the following observations:
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Investors buy with the expectation of profit.
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This expectation is supported by the profits of those who cash it in.
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But there is no external source for these profits; they come entirely from new investments.
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And the operators take a lot of the money.
It all rings true true. But in calling bitcoin a Ponzi scheme, critics are arguably too kind in two ways. First, bitcoin doesn’t have the same endgame as a Ponzi scheme. Second, it constitutes a deeply negative checks and balances from a broad social perspective.
On the first point, it’s worth evaluating how it compares to the original scheme designed by Charles Ponzi. In 1920, Ponzi promised 50% on a 45-day investment and managed to pay it off to a number of investors. He suffered and managed to survive the leaks from investors, until finally the scheme collapsed less than a year later.
In the largest and possibly oldest Ponzi scheme in history, Bernie Madoff paid returns of around 1% per month. He offered to cash out the participants in his program, both the initial amount “invested” and the “return” on it. As a result, the regime was able and suffered a stroke; the Great Financial Crisis of 2008 led to a cascade of participant buyouts and the collapse of the plan.
But Madoff’s project resolution has spread beyond its collapse due to the remarkable and ongoing legal proceedings. These survived Madoff himself, who died in early 2021.
Many are unaware that a bankruptcy trustee, Irving H. Picard, has doggedly and successfully pursued those who withdrew more money from the program than they invested. He even managed to track money in offshore dollar accounts, arguing for controversial extraterritorial reach of US law all the way to the US Supreme Court. Of the $ 20 billion in initial investments recognized in the program (which victims were told to be worth more than three times that amount), some $ 14 billion, or 70%, has been recovered and distributed . Claims up to $ 1.6 million are fully reimbursed.
Unlike investments with Madoff, Bitcoin is not purchased as an income generating asset, but rather as a perpetual zero coupon. In other words, it promises nothing as current yield and never matures with a terminal payment required. It follows that he cannot undergo a stroke. The only way a bitcoin holder can cash out is to sell it to someone else.
Bitcoin’s collapse would be very different from that of the Ponzi scheme or Madoff’s scheme. One possible trigger could be the collapse of a so-called large stable currencyi.e. ersatz US dollars that have arisen to provide a cash leg for cryptocurrency transactions. These “unregulated money market funds” were sold as dollar substitutes with safe assets that match their outstanding debts. Given the lack of regulation and disclosure, it’s not hard to imagine a big, stable coin ‘breaking the buck’, as happened with a regulated money market fund that held paper. Lehman in 2008. This could disrupt the entire crypto ecology so much that there could be no bidding for bitcoin. The market could close indefinitely.
In this case, there would be no long-term legal effort to drive out those who cashed out their bitcoin early in order to redistribute their profits to those who hold bitcoins. Bitcoin holders would have no rights over those who bought early and sold.
In its cash flow, bitcoin looks more like a penny stock pumping and dumping system than a Ponzi scheme. In a pump-and-dump system, traders acquire fundamentally worthless stocks, talk about them, and perhaps trade them among themselves at increasing prices before offloading them to those drawn to the gossip and price action. Like the pump and dump system, bitcoin taps into the sheer desire for capital gains. Buyers can’t stand seeing friends get rich overnight: they suffer from an acute fear of missing out (FOMO). Either way, bitcoin makes no promises and cannot end at the end of a Ponzi scheme.
On the second point, another big difference between bitcoin and a Ponzi scheme is that the first is, from an aggregate or social perspective, a negative sum game. Since real resources are used to make bitcoin work, this is expensive in a way that Madoff’s two or three man operation was not. From a social standpoint, what Madoff took out of his diet and ultimately consumed was redistribution in a zero-sum game (the trustee sold his penthouse). Stolfi’s fourth observation above that “traders take a lot of the money” bundles Madoff and bitcoin miners’ income together, but these are very different in economic terms.
Along with bitcoin and other cryptocurrencies, the game is to name the country whose electricity consumption is equal to that of all the puzzle solvers (miners) who make transactions and receive bitcoins as a reward. Even if the price of electricity were billed to include its contribution to global warming (its “environmental externality”), which is likely not the case, there is a real cost.
What cost? In early 2021, Stolfi estimated cumulative payments to bitcoin miners since 2009 at $ 15 billion. At the price of bitcoin then, he estimated the increase in that amount to be around $ 30 million per day, which mainly pays for electricity.
At today’s higher bitcoin prices, the hole is growing faster. About 900 new bitcoins per day require more than $ 45 million per day in electricity. So, the negative sum in the bitcoin game runs into tens of billions of dollars and amounts to over one billion dollars per month. If the price of bitcoin collapses to zero, the gains of those who sold would be less than the losses of those who held that growing sum. To compare bitcoin to a Ponzi scheme or a pump and dump scheme, both of which are fundamentally redistributive, is to flatter the cryptocurrency system.
To conclude, an economic analysis of bitcoin must recognize its uniqueness in the history of fads. As an object of speculation, bitcoin is unprecedented in that there is none. This post-modern fad offers steep prices for entries on the person’s spreadsheet. A zero coupon perpetual came not as a joke but as a trillion dollar asset. Unlike a Ponzi scheme, bitcoin cannot end with a run.
In the event of a crash, bitcoin holders will have collectively lost what they paid miners for their bitcoin. This amount can be close to the amount initially invested with Madoff, after taking inflation into account. But bitcoin holders will not have anyone to sue to recover this sum: it will simply be gone up in smoke, a social loss. Only then would bitcoin holders wish it was a Ponzi scheme.
