FT: Bitcoin is the greatest Ponzi scheme ever

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FT has a great article from Robert McCauley, a non-resident senior fellow at Boston University’s Global Development Policy Center and associate member of the Faculty of History at the University of Oxford about how Bitcoin may end up being not just the greatest Ponzi scheme ever, but worse on a social level – an actual negative sum game.

Here are the highlights, go to FT to read the full article:

Bitcoin is off its all-time high of $69,000 set on November 9, 2021.. And yet, even at the current price of $49,000, guests on financial TV news continue to tout it as the best-performing asset of the last N years, where N can be just about any number from one to ten.

They also increasingly judge it as a credible investment in its own right. This contradicts the longstanding sceptical view by many economists and others that what bitcoin really is, in effect, is a Ponzi scheme. Brazilian computer scientist Jorge Stolfi is one voice who has contended this. His view is based on the following observations:

  1. Investors buy in the expectation of profits.
  2. That expectation is sustained by the profits of those that cash out.
  3. But there is no external source for those profits; they come entirely from new investments.
  4. And the operators take away a large portion of the money.

First, bitcoin doesn’t have the same endgame as a Ponzi scheme. Second, it constitutes a deeply negative sum game from a broad social perspective.

On the first count, it’s worth assessing how it compares to the original scheme devised by Charles Ponzi. In 1920, Ponzi promised 50 per cent on a 45-day investment and managed to pay this to a number of investors. He suffered and managed to survive investor runs, until eventually the scheme collapsed less than a year into it. In the largest and probably the longest running Ponzi scheme in history, Bernie Madoff paid returns of around one per cent a month.

By contrast to investments with Madoff, Bitcoin is bought not as an income-earning asset but rather as a zero-coupon perpetual. In other words, it promises nothing as a running yield and never matures with a required terminal payment. It follows that it cannot suffer a run. The only way a holder of bitcoin can cash out is by a sale to someone else. Bitcoin’s collapse would look very different to that of Ponzi’s or Madoff’s scheme.

On the second count, another big difference between bitcoin and a Ponzi scheme is that the former is, from an aggregate or social standpoint, a negative sum game. To the extent that real resources are used up to make bitcoin run, it is costly in a way that Madoff’s two- or three-man operation was not.

In a crash, the holders of bitcoin will collectively have lost what they have paid the miners for their bitcoin. This sum may be not far from the sum originally invested with Madoff, after accounting for inflation. But bitcoin holders will have no one to pursue to recover this sum: it will simply have gone up in smoke, a social loss.

The holders of bitcoin would then only wish it had been a Ponzi scheme.