This is an invited article by Robert McCauley, Non-Resident Senior Research Fellow at the Center for Global Development Policy at Boston University and Associate Fellow of the History Faculty at the University of Oxford. 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 flash crash of $12,000 during the first weekend of December as leveraged position accounts were closed. And yet, even at the current price of $49,000, TV financial news guests continue to tout it as the best-performing asset of the last n years, where n can be any number from one to ten. . they also increasingly see it as a credible investment in its own right.
This contradicts the long-standing skeptical view of many economists and others that bitcoin is really, in fact, a ponzi scheme. Brazilian computer scientist Jorge Stolfi is one voice that supported this. his point of view is based on the following observations:
Investors buy with the expectation of making a profit.
This expectation is supported by the profits of those who charge it.
but there is no external source for these benefits; come entirely from new investments.
and the operators take a lot of money.
it all rings true, right. But by calling bitcoin a ponzi scheme, critics arguably are being too kind in two ways. First, bitcoin does not have the same end as a ponzi scheme. Second, it constitutes a profoundly negative check and balance from a broad social perspective.
on the first point, it is worth evaluating how it compares to the original scheme designed by charles ponzi. In 1920, Ponzi promised 50% of a 45-day investment and managed to pay it off to several investors. he suffered and managed to survive investor leaks, 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. offered to charge participants in his program both the initial amount “invested” and the “return” on it. as a result, the regime could and did suffer a stroke; the great financial crisis of 2008 caused a cascade of acquisitions of participants and the collapse of the plan.
but the resolution of the madoff project has extended beyond its collapse due to the remarkable and ongoing legal proceedings. these outlived madoff himself, who died in early 2021.
Many do not know that a bankruptcy trustee, irving h. Picard has stubbornly and successfully hunted down those who took more money out of the show than they put in. He even managed to trace money in offshore dollar accounts, defending the controversial extraterritorial reach of US law all the way to the US Supreme Court. of the $20 billion in acknowledged initial investments in the program (which victims said were 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 investing with madoff, bitcoin is not purchased as an income-producing asset, but as a perpetual zero coupon. in other words, it promises nothing as current performance and is never due with a required terminal payment. it follows that he cannot have a stroke. the only way a bitcoin holder can get paid is by selling it to someone else.
the collapse of bitcoin would be very different from the ponzi scheme or the madoff scheme. one possible trigger could be the collapse of a large stablecoin, i.e. ersatz US dollars that have sprung up to provide a tranche of cash for cryptocurrency transactions. these “unregulated money market funds” were sold as dollar substitutes with safe assets matching their outstanding debts. Given the lack of regulation and disclosure, it’s not hard to imagine a large, stable currency “breaking money,” as happened with a regulated money market fund that held paper. lehman in 2008. this could disrupt crypto ecology so much that there could be no bids for bitcoin. the market could be closed indefinitely.
In this case, there would be no long-term legal effort to expel those who cashed in their bitcoins early to redistribute their earnings to those who hold bitcoins. holders of bitcoins would have no rights over those they bought before and sold.
In its cash flow, bitcoin is more like a penny stock pump-and-dump system than a ponzi scheme. In a pump-and-dump system, traders buy fundamentally worthless stock, talk about it, and perhaps trade it among themselves at rising prices before dumping it on those who are attracted by the gossip and price action. . Much like the pump and dump system, bitcoin taps into the sheer desire for capital gains. shoppers can’t stand to see their friends get rich overnight: they suffer from an acute fear of missing out (fomo). Either way, bitcoin makes no promises and cannot end up at the end of a ponzi scheme.
Regarding the second account, another big difference between bitcoin and a ponzi scheme is that the former is, from an aggregate or social perspective, a negative sum game. To the extent that actual 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 cut 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 money” is the income of madoff and bitcoin miners, but these are very different in economic terms.
Along with bitcoin and other cryptocurrencies, the game consists of naming 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 probably not the case, there is a real cost.
what cost? As of 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 at about 30 million dollars a day, which pays mainly for electricity.
with today’s higher bitcoin prices, the hole is growing faster. around 900 new bitcoins per day requires more than $45 million per day in electricity. So the negative sum in the bitcoin game amounts to tens of billions of dollars and amounts to more than a 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 onto 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 acknowledge its uniqueness in fad history. As a subject of speculation, bitcoin is unprecedented in the sense that none exists. this postmodern fad offers high prices for entries in 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 a career.
In the event of a crash, bitcoin owners will have collectively lost what they paid miners for their bitcoins. This amount may be close to the amount initially invested with Madoff, after accounting for inflation. but bitcoin holders will have no one to sue to recover this sum: it will simply vanish, a social loss. only then would bitcoin holders wish it was a ponzi scheme.
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