COLUMN: Bitcoin – the most successful ponzi scheme of all times?

An old chart showing 17th Century tulip prices in Amsterdam

Someone like me would make an ideal bitcoin enthusiast – libertarian by political persuasion, open source enthusiast, early adopter of all kinds of technologies, hater of big government and possessor of what my wife calls a ‘mildly paranoid personality’. 

Yet, try as I might, I just can’t see bitcoin as anything other than the most successful ponzi scheme of recent times. The similarities between bitcoin and ponzi schemes are hard to miss — an evangelical network that enriches each batch of joinees with money from subsequent batches.

Of course, bitcoin enthusiasts may argue that this is not a fair comparison to make, as bitcoin is not as useless as a membership of a typical ponzi or pyramid scheme. 

They may say it is a full-blown currency and can be used to pay for goods and services. They’ll also argue that it is digital gold, and unless you call gold or silver a ponzi scheme, you can’t call bitcoin one either. [Of course, there are many who consider gold and silver also ponzi schemes, but we’ll ignore them for now.]

UNFAIRNESS OF DISTRIBUTION

The biggest problem with bitcoin, and most other cryptocurrencies, is the sheer unfairness of distribution inherent in any pyramid scheme, with the commodity originating at the center and the profits travelling in the reverse direction.

To make my point clear, I’ll use two examples:

EXAMPLE 1 – LIBERNOTES

Suppose I print 22 million notes of a new currency called Libernotes, incorporating advanced, anti-counterfeiting technology into these notes. Because of the advanced technology, and the time and effort I invested in developing them, it cost me 220,000 dollars to print these 22 million notes, or about 1 cent each.

Now, suppose I offered to sell 100 of these libernotes to you for 1 dollar each, promising that soon these notes — because of their superior technology — will replace traditional currencies and their value will soon reach 1 million each, and you stand to make 1 million dollars for each dollar you invest. 

Suppose I manage to convince 100 of my friends about the superiority of my alt currency, and they together purchase 1 million out of the 22 million notes I had originally printed. 

I now find myself richer by $1 million, including a profit of $778,000 on my original investment.

Now, these friends approach others with the same marketing pitch of how these currencies are more superior and they will replace ordinary cash and so on, and offer to sell these notes at $5 each.

Some of them manage to convince others, while others don’t. But enough of them manage to do so, so that the ‘price’ of the libernotes has jumped to $5 each.

This also means that the 21 million notes that I still have left in my garage is now worth $105 million.

Even those of my friends who were not very good at marketing and sales, and therefore couldn’t sell their $1 notes for 5 dollars each, are now thrilled to find out that the ‘price’ of their notes has gone up five fold due to the marketing efforts of complete strangers.

In turn, people who got hold of the notes for $5 each now go to others with the same marketing pitch, about how libernotes are going to be the future of payments, how they will totally outshine current currencies because of their superior convenience and anti-counterfeit measures and so on. They offer to sell the notes at $10 each.

This goes on for five years, and now each note is worth $30,000. 

Meanwhile, I have liquidated most of my notes in between, partly to keep the market liquid and partly to cash in on the price increases.

I have only 7 million notes left, having sold the remaining 15 million notes at an average price of around $10,000. Thus, my initial investment of $220,000 has earned me a profit of almost $2.2 billion. 

Some of my friends, who did not sell all their libernotes, are also millionaires now.

Meanwhile, libernotes — which were supposed to be a superior method of carrying out transactions — have become a prized commodity and is traded on public exchanges.

The downside of their rising value is that nobody can afford to designate the price of anything in libernotes because of the huge daily swings in their value.

If you put up your house, worth $300,000, for sale for 10 libernotes on Monday, you might end up getting only $50,000 dollars when you manage to sell it after two weeks and reconvert the notes into dollars.

Because of this risk, nobody uses libernotes to set a price for anything, and the price of everything continues to be designated in terms of traditional currencies.

In other words, the key USP of the notes — which is what everyone based their marketing pitches on — has come undone. But guess what, no one noticed! 

Nobody seems to care that libernotes are not, and perhaps can never be, used in place of regular currencies. So many people still believe that they can be, that it doesn’t matter that they have not been.

EXAMPLE 2 – PEERPHONES

Take the second example. A company brings out a new kind of cellphone, Peerphone, that doesn’t require a traditional cellular network, or even a provider. 

It works by connecting to your neighbor’s Peerphone, which in turn connects to that of his neighbor’s and so on — creating a decentralized, mesh network. But due to technological reasons, only 22 million of them can be created.

Of course, the Peernetwork doesn’t work right now, but it will when enough people purchase such phones and switch them on at some time in the future.

After an initial period of skepticism, people are enthralled, and more and more people start buying these phones. 

The price of Peerphones go from $100 to $2000 in five years, as they are considered the future of communication, and they will help free people from the tyranny of cellphone companies. 

Of course, there are only 22 million handsets that can be part of the network, so that adds to the frenzy and FOMO.

Fast forward another 5 years, and the Peerphone maker has long since stopped production of the handsets, having made all 22 million possible, but the phones are still being furiously bought and sold in the market. 

Each phone is now worth $10,000, and there are special marketplaces where such phones are sold. 

As is the nature of market-traded commodities, sometimes the price of the phone goes up, sometimes, down. 

Many people have become millionaires from trading such phones, while some have lost their life’s savings. But the overall trend has been on the up, and the bulls believe the peerphone will soon touch $100,000 or even $1 million.

In all this hullabaloo, nobody has bothered to use their phones to actually make calls, because the phones have become so valuable that they cannot — need not — be used to make calls. Their economic value is now far more than their value as a medium of communication. They have become an appreciating asset that must be preserved in pristine condition.

Nobody cares whether the original promise of enabling carrierless communication — the prospect that kicked off all this frenzy — can realistically be achieved or not. 

Indeed, in some countries such as El Salvador, people have tried to use the phone to create peer networks, but it has hardly been as successful or revolutionary as envisioned. 

Such experiments have brought to light unexpected hiccups, such as dropped calls due to someone in the network switching off while a call was being routed and so on.

But nobody cares, because these days, nobody sells these phones on the promise of delivering carrierless communications. Now, the whole pitch is around ‘peerphone to the moon’ — how, given the current trends, peerphone will soon touch $100,000 and eventually breach the $1 million mark.

People are falling over each other to be a part of this gold rush, inspired by tales of uncles and aunties who turned a $100,000 investment into $10 million in 1 year.

So, my question is — how is peerphone, and bitcoin, not a ponzi scheme — the 21st century tulip?