Ponzi Scheme

Some time ago this FUD began to fall out of favor, but it was one of the main arguments during bitcoin’s early days. To analyze whether bitcoin is a Ponzi scheme, the first thing we need to do is understand what a Ponzi scheme actually is, and check whether bitcoin fits the definition.

A Ponzi scheme¹ is a type of financial fraud that consists of promising high returns that are paid using the investors’ own funds, creating the illusion of a successful business that does not actually exist.

The scheme’s promoter makes investors believe there is a business generating large profits, from which these high returns are paid. In reality, what the fraudster does is pay the first investors with their own invested money. Paying these high returns to early investors attracts new investors who also want to earn them. With new investors coming in, the scheme keeps running, and the new money flowing in is used to pay the returns of existing investors.

The more investors there are, the harder it becomes to pay high returns to everyone. A Ponzi scheme gives the impression of being a sustainable business as long as the funds from new investors, minus the withdrawals from investors demanding redemption, are sufficient to pay the returns of all existing investors. Eventually the scheme grows so large that net new investments are not enough to cover the returns owed. The money disappears quickly and the scheme collapses, because the rumor that someone cannot withdraw their funds leads others to want to withdraw theirs as well. The money they believed was in their account no longer exists --- it has been used to pay the returns and, of course, the handsome commissions of the scheme’s creator. A Ponzi scheme can grow slowly for many years but collapses very rapidly.

In a Ponzi scheme there is always someone --- a person or a company --- who promises high returns. Someone has to make that promise for the Ponzi scheme to begin. That person is a fraudster, because they deceive investors. A Ponzi scheme is not a risky business that goes wrong. It is, from the very start and at every moment, a scam, a fraud.

The largest Ponzi scheme in history to date was the Bernie Madoff case. Over decades, his scheme grew to exceed 60000 million dollars. His business was official and regulated. The SEC² investigated it in 1992 and found nothing. In the years that followed, the SEC continued to receive complaints and carry out periodic investigations, but it was not until late 2008, when too many clients wanted to withdraw their funds, that everything collapsed. Madoff admitted his guilt when it became clear that he had been running his Ponzi scheme for years.

When we hear that bitcoin needs to be regulated in order to protect investors, we should remember that Madoff ran his fraudulent scheme at full capacity for more than sixteen years, surviving five SEC investigations, until its final implosion.

To compare a Ponzi scheme with bitcoin, let us summarize the two key characteristics of a Ponzi scheme:

• There is a promise of high returns. This promise is made by the scheme’s promoter --- that is, the fraudster.

• The returns are paid with the investors’ own money.

Now let us ask ourselves: do any of these characteristics apply to bitcoin? As for the first: what is the promise of returns, and who is the fraudster who made it? Answering this question makes everything clear, because there is no promise. Bitcoin’s creator promised no returns whatsoever --- neither high nor low. He simply donated his invention and his software to humanity. There is nothing to be broken because there is no promise to begin with. And if there is no promise to break, there can be no deception. It is that simple. We can ask the second question, though the answer is obvious: is investors’ own money used to pay the returns? Nothing is paid out --- there are no returns to pay since nothing was promised in the first place.

Perhaps some might think this is obvious, that it does not warrant a chapter. I agree it is obvious, and perhaps this FUD does not even deserve a brief chapter --- but I have occasionally encountered an argument that confuses the appreciation of an asset with the promise of returns in a Ponzi scheme. The argument goes like this: “people who hold bitcoin want new people to buy it so the price goes up and they can make money. That’s kind of like a Ponzi scheme, isn’t it?”.

There is a conceptual error in this confusion. It is perfectly possible to invest in gold and wish that others would do the same so the price goes up --- but that does not make gold a Ponzi scheme, nor does it make the investor a fraudster. It is simply the case that any investor wants the asset they have purchased to appreciate in value. This applies to any asset, not just bitcoin or gold. It applies to silver, copper, oil, a house, a painting, a diamond, a sapphire, shares in Google, Apple, or any other company. It is perfectly natural to want demand for the assets we hold to increase so that they appreciate in value. A simple and natural fact, applicable to any person and any asset, that has nothing whatsoever to do with Mr. Carlo Ponzi.

But furthermore, even setting aside the fact that wanting your asset to appreciate so you can sell it does not make it a Ponzi scheme, bitcoin’s case is different from other assets. Someone who buys Google shares wants them to go up so they can sell and make a profit --- their goal is generally not to control Google. But the majority of bitcoiners are hodlers who are not trying to make a profit in fiat currency. They do not treat it as an asset they want to rise in price so they can sell it. They treat it as money in which to save the fruits of their labor in order to buy goods and services in the future --- not to exchange it for fiat money. The ultimate goal is not to make gains in terms of fiat currency.

Today it seems completely normal and healthy for a free society that the State and the Church are separate, that they are independent entities. But it has not always been so, and it is not even so today in some countries. Today it seems strange that money and the State could be separate, since we have never lived in such a world, and what seems normal to us is solely the product of our own experience. But it is not only possible --- it is also highly desirable if what we want is to live in a free, prosperous, and peaceful society. And this is the ultimate goal of a large part of the bitcoin community: the separation of money and the State.