Is Bitcoin A Ponzi Scheme? Or Worse?

Date: 12/28/2021
Author: Mr. X


It was a blatant piece of clickbait, but what I can say? I fell for it.

The Financial Times recently ran an extraordinary piece arguing that bitcoin is a Ponzi scheme worse that what Bernie Madoff carried out. Bitcoin, the author argues, is a “zero-coupon perpetual.” There’s no way to make a profit except for a holder to sell it to someone else. Author Robert McCauley says that that a lack of regulation and disclosure could lead to the collapse of a stablecoin, which in turn could collapse the whole sector.

Stablecoins are critical when it comes to facilitating cryptocurrency transactions. The theory is that those who “mint” them have sufficient safe assets to back up their value. Usually, a stablecoin is pegged to a fiat currency, normally the dollar. Thus, if you don’t have enough dollars to back the amount of stablecoin tokens you have “minted,” it’s easy to see where a problem might emerge. There have been some workarounds, notably with Terra using algorithmic decentralized stablecoins. Yet McCauley is right that if there is a major crypto collapse that isn’t directly caused by regulation designed to end the sector, it will be probably generated by a crisis of confidence in stablecoins.

This is precisely what Dr. Kent Moors warned about in August.

McCauley argues that unlike those who were fleeced by Madoff, there will be no way for bitcoin investors to get their money back. Worse, bitcoin has a cost in the form of the tremendous amounts of electricity required for bitcoin miners to undertake the “Proof of Work” necessary to accumulate BTC.

Therefore, Bitcoin isn’t just a Ponzi scheme, but a drag on the entire economy. When it collapses, it will represent a “social loss” and bitcoin investors will have only wished that it was a Ponzi scheme. “As an object of speculation,” he writes, “bitcoin is unprecedented in the degree to which there is no there there.”

Yet there are several uses for bitcoin that are simply not addressed. We don’t even need to get into the uses of blockchain technology per se, as that is a separate matter from the bitcoin cryptocurrency.

We also can point to cryptocurrencies that are using models other than Proof of Work to reduce the amount of electricity required. Ethereum, the second most important cryptocurrency and the most important when it comes to decentralized finance (DeFi), is moving to a “Proof of Stake” model, a transformation that should be finalized in 2022. The initial steps here have already been taken. Most of the more transformative claims for cryptocurrency rely upon the Ethereum blockchain or other blockchains that use a different model.

A stablecoin collapse might hurt these projects, but it wouldn’t end them. It might even force the kinds of technical solutions that will be necessary for ordinary people to start using cryptocurrency and blockchain technology for something other than speculation.

That still leaves the question of bitcoin (the cryptocurrency, as opposed to the Bitcoin blockchain) itself. What is it actually good for? Unlike the Ethereum blockchain, bitcoin is not particularly useful when it comes to developing applications. With some exceptions, the purpose of the Bitcoin blockchain is to create the bitcoin token. So what does it do?

This question was already answered by “Satoshi Nakamoto” in the initial white paper describing the concept. Describing the dependence on financial institutions “to serve as trusted third parties” to carry out electronic transactions, the pseudonymous Nakomoto outlined the transaction costs, demands for consumer data, fraud and other problems that accompany what we think of as ordinary financial transactions. We should also remember that we are operating in the United States of America, where citizens enjoy the world’s reserve currency and a system that insures deposits in banks up to $100,000. People in other countries don’t enjoy these advantages, so their need for a way of transferring funds that isn’t reliant on trust is even greater.

Even we Americans are beginning to distrust our financial institutions (along with all the other ones). It wasn’t an accident that the many disparate and even contradictory social movements that helped seed the ground for bitcoin all came out of the 2007-2008 financial crisis. Wall Street institutions that were perceived to be completely “safe” turned out to be massive conglomerates built on debt. When the crisis finally hit, the federal government bailed had to bail out those institutions that were “too big to fail” lest the entire worldwide financial system collapse.

 

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Financially, we could argue that the United States never recovered from this. Politically, we certainly haven’t. Occupy Wall Street, the Ron Paul campaign, the Donald Trump campaign, the growing support for socialism and even communism among many Americans, and the general collapse in trust all emerged out of this vague sense that “the powerful” had gotten one over on ordinary Americans. There hasn’t been much political change because national populists, socialists and various conspiracy theorists (whose theories may or may not be right) will disagree about who the “powerful” truly are. Thus, there will never be coordinated political action.

However, the sense of grievance will drive polarization, conflict, and a kind of financial nihilism. People feel that the “elite” (whoever “they” are) are getting a special deal. Furthermore, this is in the by-God United States of America, the global superpower, the enforcer of the rules-based international order, the indispensable nation, and until very recently the undisputed economic engine of the entire world. Whatever anger Americans may feel about their institutions, people in other nations may feel far more rage.

Given all that, why wouldn’t there be a demand for a digital asset that doesn’t require trusted third parties, that isn’t dependent on governments, and that can serve as a store of value? Some of bitcoin’s earliest adopters were those who quickly wanted to protect their purchasing power by putting declining national currencies into a different asset. From Argentinians desperate to protect their savings during their Great Depression at the turn of the 21st century to despairing Turks watching the lira collapse today, there will always be a need for a store of value that is not subject to hyperinflation. Bitcoin’s supply is limited, it is more easily transferred than gold and silver, and it can actually be used in transactions. This is reason enough for it to exist. We should note it is already legal tender in El Salvador as well.

Its use as a way to buy and sell goods, donate, or invest should also not be underestimated. In a situation where governments and other organizations seem increasingly determined to track and possibly restrict online activities and purchases, bitcoin and other cryptocurrencies offer a way out. That may be a reason for some governments and other organizations to try to shut it down. However, there will always be a demand for such a currency to exist.

Money is, as Jeromy Irons’s character reminds us in Margin Call, “just made up.” It serves a function. Bitcoin is serving a function fiat currencies can’t right now. If central banks develop a digital currency, particularly after a stablecoin scandal, we may see this function be replaced and bitcoin thrown in the dustbin of history. Until then, it has a role. If people have lost trust in fiat currencies and the financial system, governments should ask themselves why. Competition, after all, is what our economy is based on.

Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing.

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