- Published: Tuesday, 11 March 2014 09:16
- Written by Editor
It has become fashionable amongst those who are out to attack or discredit Bitcoin in some way, or simply do not understand it, to claim that Bitcoin is a "ponzi scheme". The latest example of many is economist Nouriel Roubini aka "Dr. Doom". There have been many others and there will no doubt be many more in an effort to suppress the rise of Bitcoin.
The reality of course is very different indeed and here is why.
First let us look at the actual definition of a "ponzi scheme" as described by Wikipedia.
A Ponzi scheme is a fraudulent investment operation where the operator, an individual or organization, pays returns to its investors from new capital paid to the operators by new investors, rather than from profit earned by the operator. Operators of Ponzi schemes usually entice new investors by offering higher returns than other investments, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the high returns requires an ever-increasing flow of money from new investors to sustain the scheme.
So a ponzi scheme is usually operated by a single person, such as the infamous Bernie Madoff, or small group of people for their own benefit. Ponzi schemes are based upon paying a high rate of interest, dividend or other financial incentive by the operators, who rely exclusively on recruiting further participants the contributions of which are used to pay the financial incentive to the other participants. Ponzi schemes are often very popular due to the much higher than normal returns that are offered - which is also a warning sign.
We can see immediately then that Bitcoin does not qualify as a ponzi scheme based upon this definition. Bitcoin is a fully distributed, peer to peer network that does not rely on any particular individual or group of individuals to set the price or offer returns, rather it is a free market where the price of Bitcoin is determined by supply and demand with no claims being made about future returns. It is clear from remarks that many are making in accusing Bitcoin as being a ponzi scheme that they believe it is the product of a small group of people who market Bitcoin aggressively to inflate the price, which is simply not true.
Ponzi schemes also rely on a steady stream of new contributors to supply new capital to pay the returns of existing participants. This is simply not true of Bitcoin, the participants in which rely on no one and are often not even obtaining for speculative or investment purposes. The exchange rate of Bitcoin is exclusively a function of supply and demand as with any other financial instrument or commodity, be it gold, corn or a currency on the forex market.
Returning to the Wikipedia definition of a ponzi scheme:
When a Ponzi scheme is not stopped by the authorities, it sooner or later falls apart for one of the following reasons:
1. The promoter vanishes, taking all the remaining investment money (which excludes payouts to investors already made).
2. Since the scheme requires a continual stream of investments to fund higher returns, once investment slows down, the scheme collapses as the promoter starts having problems paying the promised returns (the higher the returns, the greater the risk of the Ponzi scheme collapsing). Such liquidity crises often trigger panics, as more people start asking for their money, similar to a bank run.
3. External market forces, such as a sharp decline in the economy (for example, the Madoff investment scandal during the market downturn of 2008), cause many investors to withdraw part or all of their funds.
Again, Bitcoin absolutely fails to qualify as a ponzi scheme based upon any of these factors.
1. Bitcoin has no "promoter" who can vanish. Bitcoin is the sum of all of its participants equally, none of which have any claim or control over Bitcoin in any way, or have the ability to abscond with all the Bitcoin in circulation or the fiat currency equivalent.
2. Bitcoin requires nothing to perpetuate its success or price other than its very existence and availability on the open market. There may be situations that cause the price of Bitcoin to collapse for a time as we have seen in the past due various situations, often revolving around the now defunct Mt. Gox, but this does not affect the integrity of Bitcoin itself which always recovers and moves forward stronger than ever. The same applies to any financial instrument including currencies, stocks and commodities.
3. The concept of "withdrawing funds" does not apply to Bitcoin, because there is no central entity involved to withdraw funds from. Participants may choose to sell Bitcoin in the open market for cash, but again the same applies to any financial instrument.
It is absolutely clear then that Bitcoin in no way displays any of the characteristics of a ponzi scheme, and is not only completely consistent with being a financial instrument, it is more secure than a financial instrument such as stocks because a company can go bankrupt losing all investor money, whereas that is impossible with Bitcoin.
The ultimate hypocrisy is witnessed by the fact that most of those claiming that Bitcoin is a ponzi scheme actively support one of the biggest and most dangerous ponzi schemes of all - US bonds.
The US national debt is currently in excess of 17 trillion dollars and rising, most of this debt being in the form of bonds which are purchased by individuals, investment groups and foreign governments due to the attraction of higher returns. Every so often there is a vote to increase the US "debt ceiling", the primary purpose of which is to sell even more bonds to pay down the interest on existing bonds to avoid a default. This causes the debt to increase exponentially as more and more bonds need to be sold in order to pay the interest on existing bonds to bon holders. Sooner or later the US government will default and it is more than likely that bond holders will lose their entire investment. So the US debt is the definitive ponzi scheme which fits all of the definitions of a ponzi scheme.
Ultimately the entire global financial system is one huge ponzi scheme on the verge of imploding, and when it does, Bitcoin is perfectly positioned to take its place offering the world sound money for the first time, no controlled by banks, governments or any other controlling entity.
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