Crypto may well be Ponzi and scam
But there is something very valuable it offers to a rational investor
disclaimer: I am long in crypto, albeit not very successfully so far. I am also not a certified advisor and hence nothing in this text is to be considered financial advice. DYOR*
A quote from the Jacobin, radically taking apart crypto:
Cryptocurrency is a scam. All of it, full stop — not just the latest pump-and-dump “shitcoin” schemes, in which fraudsters hype a little-known cryptocurrency before dumping it in unison, or “rug pulls,” in which a new cryptocurrency’s developers abandon the project and run off with investor funds. All cryptocurrency and the industry as a whole are built atop market manipulation without which they could not exist at scale.
Tales of Substance and Value
“Crypto is a scam!”. “Bitcoin is Ponzi”. “There is no value, no substance”.
It seems as if in the last weeks the pessimist voices got louder. Not sure it has something to do with a general plunge in cryptocurrency. Over the last weeks, around $1tn was wiped off the market capitalization. But correlation is not causality.
There also appears to be a narrative clash. Just look at articles in the very same Financial Times — Hamlet’s famous question rephrased for crypto.
As Keir Finlow-Bates wrote in his Newsletter:
Ponzi schemes! Second only to Satanistic Cults and Human Traffickers in the lexicon of evils! The subtext is that if Bitcoin is a Ponzi scheme then it must be stopped. At all costs.
Not that the discussion is anything but new. The most-memed bitcoin enemy Nuriel Roubini had been vaticinating “value of bitcoin going to 0” since 2013. Prophecy yet to materialize — so far Lindy Effect is winning the famous economist. The same goes for super-banker Jamie Diamon of JP Morgan. (ironically, his bank is exposed to bitcoin).
Admittedly, I am more of a proponent of crypto and bitcoin. But here is the thing: I am in neither camp. Neither do I see bitcoin as “Ponzi” nor I am overly optimistic about it.
I find both camps’ framings useless for investors.
Here is why.
Defining terms — what is a Ponzi scheme?
Let’s dig into the P-Word. According to SEC (my emphasis in bold):
A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise high returns with little or no risk. … Ponzi schemes require a constant flow of new money to survive. When it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse.
Ponzi schemes are named after Charles Ponzi. In the 1920s, Ponzi promised investors a 50% return within a few months for what he claimed was an investment in international mail coupons. The end of the story is summarized in the picture below.
At this point is important to understand, that a Ponzi scheme is not illegal if investors are correctly informed about that. It is intentional deceit that makes it a crime.
Let’s hear the argument!
Armed with that knowledge let's now test the main theses of pro and con camps.
is-a-Ponzi
Let’s start with the former. There are a couple of theses that usually are named. I give them a nick-name that reflect the underlying philosophy:
- Value: There is no underlying value of substance and there is no external source of revenue
- Lottery: Bitcoin is a zero-coupon. To make profits you have to sell to “a greater fool”
- Keynesian: There is no regulation behind it, and hence investors are not properly protected
- Crime: Bitcoin is used to finance criminal affairs — drugs, prostitutes, weapons…(why this argument is often used as “pro-Ponzi” is beyond me).
All these arguments are dichotomic. Define “Value” on something without underlying? Multiples, PE Ratio, DCF? All of these “fundamentals” are not considering the supply and demand side of the market (liquidity premium). There is a range of assets that have no external source of revenues — commodities. Gold, for example, has no external source of revenue, and its intrinsic value matters as long as there is rising demand for jewelry. Still, gold is considered a “store of value”. Guess that the lottery argument applies here too.
As for lack of regulation which may predestine it for the crime. The same goes for cash too. Investors protection is a strong argument, but again, who is protecting an investor from doing due diligence?
is-not-a-Ponzi
The main counterargument is that crypto is traded openly, transparently. Mechanisms of price discovery are different from black-box Ponzi pricing a la Maddoff.
Given the free float character, as Jacob Franek explains it, later investors do not pay out earlier investors directly. That is different in a Ponzi scheme.
Neither there is a central operator (“Mr. First”) by design. One may counterargue about the high concentration of bitcoins in a few “hands”. Traditional media like Bloomberg quote “outrageous 95% ownership of just 2%, which is a wrong analysis. Yet so is the general inequality in traditional assets.
In my view, those are good but not very strong arguments. Given the concentration is high, collusion between “whales” is still possible — most investors would not be aware of that. Ironically, whenever the price of bitcoin dropped suddenly, voices screaming “manipulation” grow louder. Those voices are silents on upward movement though.
Proponents acknowledge the crime argument, but argue that fiat currencies are no different. After all, your can’t blame the ax for chopping logs and heads, or?
What really matters
Bitcoin is a least not fitting into the Ponzi category. It can turn out to be a huge scam. Just like Maddoff, praised as close to King Midas himself, turned out to be a thug.
Even if it turns out so — it doesn’t matter right now.
I don’t buy the Marxist case behind GameStop. Individual investors have limited knowledge and cannot move markets. In a sense, it is a black box too. Still many do invest, each finding the fitting narrative, be it “value” or just “magical thinking”. (latter is a hidden hope to be among the first in a Ponzi scheme)
What matters is that crypto provides an additional asset class. More importantly, currently, this asset class is close to venture capital. Most successful funds and endowments are heavily overweight on this asset type.
From the chart above one can see that close to 40% (!) of funds assets are in non-public assets. The reason is simple: in the low-interest rate regime, finding sources for above-average returns in public is nearly impossible. Thank you, FED!
And so, forget about Ponzi or not. It may well be. Yet any venture has alleviated risks. The good thing is that retail has now this instrument to enrich the beaten 60/40 portfolios.
That's what is important
