by Greg Barker
Thursday, 28
April 2022
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10:15

Is crypto just one big Ponzi scheme?

Elites have started saying the quiet part out loud
by Greg Barker
Mike Novogratz infamously likened Bitcoin to a pyramid scheme

This week we witnessed the latest — and perhaps more striking — sign that crypto might not be the future of finance. On Tuesday, Sam Bankman-Fried, founder of FTX, a huge crypto exchange, opened a can of worms by describing “yield farming” — crypto’s makeshift alternative to traditional bank lending — as a Ponzi scheme.

“You start with a company that builds a box,” he said in the latest episode of Bloomberg’s Odd Lots podcast, and “maybe for now actually ignore what it does or pretend it does literally nothing … pour another $300 million in the box and you get a psych and then it goes to infinity … then everyone makes money.” 

A stunned guest host and journalist Matt Levine replied with the following: “that was so much more cynical than how I would’ve described farming. You’re just like, ‘well, I’m in the Ponzi business and it’s pretty good’”.

Yes, this actually happened. Here was the most prominent figure in the crypto space, on an extremely renowned financial podcast, openly admitting a major part of the crypto ecosystem was a sham. 

Defining whether or not something is — or has become — a Ponzi scheme has been long forgotten; it involves working out if an investment’s underlying structure creates a negative-sum game. With regulated securities, such as stocks and bonds, investors receive a combination of interest payments, dividends, and cash flows, making these, at the very least, a zero-sum endeavour. With crypto, however, investors receive none of these, only benefiting from a potential rise in price — the so-called greater fool theory.

This disparity, among other things, has led many financial commentators to describe even the number one crypto, Bitcoin, as a negative-sum Ponzi scheme (one FT story suggested it was even ‘worse’ than that). If Bitcoin’s ecosystem collapses, funds can’t be returned to holders because its price going to zero means there’s nothing to recover. But with a Ponzi scheme, funds can be recovered and returned to investors. Following the collapse of the infamous Madoff Ponzi scheme, 14 out of 20 billion dollars initially invested have been recovered from offshore accounts.

For now, Bitcoin’s Ponzi status is irrelevant. Bankman-Fried has simply joined the increasing list of crypto’s nobility who’ve accidentally gloated about profiting from dubious financial structures. Mike Novogratz, CEO of Galaxy Investment Partners, infamously likened Bitcoin to a pyramid scheme, despite how his company’s primary function is cryptocurrency investments. Meanwhile, outlets in the crypto media have also embraced Ponzinomics, like CoinDesk publishing an article with a lede reading: “Yes, it’s a Ponzi scheme. But who cares?” Not the regulators, it seems.

These candid brags are akin to those of the subprime era, when contemptible realtors wrote risky loans to the vulnerable, knowing they could never make payments, and sold these off to the banks. In a scene from the now-classic movie The Big Short, fictional hedge fund manager Mark Baum and his crew interviewed a couple of dubious agents, who jokingly divulged they were leaving “the income section blank” to underwrite a greater number of mortgages. During a brief intermission, Baum asked his associate why these realtors were so admitting.

“They’re not confessing,” he replied. “They’re bragging.”

It’s now clear that we’ve entered a similar bragging phase in the crypto bubble. When will this bubble burst?

Greg Barker is an independent journalist and quant, who also writes under the name Concoda. You can find him on Substack and Twitter at @concodanomics.

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polidori redux
polidori redux
22 days ago

Crypto is not my idea of a Ponzi scheme, which is a scheme by which “profits” are paid to early investors by cannibalising the investment from later investors, and so requires an exponential increase in the number of follow-up investors to keep going: If the scheme runs to the bitter end there will not be enough people in the world to maintain the scam.
Crypto seems to me to be “a greater fool” bubble, in which you buy crypto in the belief that some bigger fool will pay you even more than you paid. In this view, it is a digital version of tulip mania, although with tulip mania you at least ended up with a tulip. I also wonder whether many of those who hold crypto also hold other speculative financial assets on credit. As and when the next serious financial downturn pops up, these holders of crypto will be forced to sell off their crypto, at whatever price they can get, in order to pay off their other debts and the price tumbles ever downwards: Those who made real money out of crypto sold them a long time ago. In addition, new investors for crypto will not be found to maintain the current price, because they too have run out of money with which to buy them
I am nobodies idea of a financial expert, and I am more than happy for wiser folk to explain where my reasoning is faulty. I mean, c’mon guys, help me become a billionaire overnight. In the meantime I hold no bitcoin, though my wife has a few tulip bulbs, and very pretty they are too.

Last edited 22 days ago by polidori redux
Jon Hawksley
Jon Hawksley
22 days ago
Reply to  polidori redux

Crypto is indeed “a greater fool” bubble rather than a Ponzi scheme.
When will this bubble burst? when this sensible comment is widely understood. The more people that point out the “Emperor wears no clothes” the better.

John Riordan
John Riordan
20 days ago
Reply to  polidori redux

In order for the greater fool theory to become certainly correct, there has to be a crash. The problem is that there already have been some crashes, yet the market has recovered.

It is also possible to describe fiat money itself as a variation on the greater fool theory in which everyone involved is a fool because we all take on faith the government’s commitment to backing the value of the intrinsically-worthless paper notes we exchange every day. The system works though because when I say “government” I really mean all of us, who have a continued stake in the success of the game in question.

The same logic of shared confidence applies to cryptocurrency as it does to fiat money and fractional reserve banking: as long as most people believe there’s a market tomorrow for the crypto they buy or own today, it will all hang together, in the same way that as long as we all don’t want to take our money out of the bank today, we know that some of us will be able to do so tomorrow.

polidori redux
polidori redux
20 days ago
Reply to  John Riordan

Fiat currency is invariably destroyed because governments cannot resist the temptation to debase the currency. I don’t think that makes it a bubble. Sorry not convinced!
I am betting that the sh!t will soon hit the fan for the biggest sh!tshow in history. I will probably park my pitiful fortune in gold, and bury my valuable cheeses in the back garden for some future archaeologist to find.

Rollo
Rollo
20 days ago
Reply to  polidori redux

You mean that same gold which also pays no interest,dividends or cash flows? And which also depends for a significant part of its value on the greater fool theory?

Chris Milburn
Chris Milburn
22 days ago

The problem with this way of thinking is that if Bitcoin is a “ponzi scheme”, then fiat currency is 10X worse, as the government can print more whenever they want, devaluing savings and salaries of citizens whenever they see fit to give themselves more money and power.
In the end, a dollar only has a value because we mutually agree it does. Whether we choose to value fiat currency or a crypto is arbitrary and has more to do with psychology and belief than anything solid and objective.

Jon Hawksley
Jon Hawksley
22 days ago
Reply to  Chris Milburn

Fiat money is a promise by a creditworthy party. Occasionally the promise is not delivered on – banks and governments do go bust. It is at risk of inflation so you need to pick your currency carefully. I do not see that it is 10x worse than crypto. Crypto is a number with no intrinsic value and no one can “choose” a value for it – if it goes out of fashion, or the computers are turned off, it is just a useless number.

Ferrusian Gambit
Ferrusian Gambit
21 days ago
Reply to  Jon Hawksley

Even the gold standard doesn’t end risk, there you need to trust the government has the gold it says it does, follow the rules of the game and you have to hope the government doesn’t end up in a war and suspends convertibility. As an ordinary citizen you have very little power in any of these situations, and bitcoin is an utopian fantasy to somehow revert the situation we’ve found ourselves in.
The truth is, once we move out of simple barter exchange or using precious metal coins like medieval gold florins directly we are at the mercy of those who build the system. And not just with currency. That system collapsed because it simply couldn’t fund the age of exploration and colonisation, and so the banks and insurance companies of the City grew up to provide insurance for ships and capital for joint stock compamies in N. America and India. Relying in the early banks on the good reputation and probity of the goldsmiths guarding the gold in exchange for certificates. This was a major trigger of the industrial revolition later. The modern state and economics, as Hobbes eloquently noted, even the way we eat is a Faustian bargain of security against trust, which is why subjugation is the norm. Even bitcoin assumes the publish open source code works as expected, but who’s to say the compiler might not he adding in surprises? See Ken Thompson’s essay ‘Reflections on trusting trust” from 1984 (!) where he details quite how easy it would be for a rogue compiler to inject code from a higher level language into assembly, indeed he may have done this himself with the C code. It’s not hard for a government to buuld a variant of bitcoin where they have a backdoor to your private keys and thus addresses.
Even if this doesn’t happen, bitcoin can be hijacked by speculators and copycats trying to cash in – which themselves may be of dubious security even if bitcoin isn’t. All of which means that eventually the clumsy brutal hand of the state has to come in a crush half it anyway, for much of the same essential reasons and brute facts of the human condition it existed in the first place.

Last edited 21 days ago by Ferrusian Gambit
John Riordan
John Riordan
20 days ago
Reply to  Jon Hawksley

“Fiat money is a promise by a creditworthy party.”

Well no, not really. The promise in question only works as long as we don’t all call upon it at once. Governments and banks do not have the capacity to pay the bearers the actual value of all the money in circulation: the value of all the cash in circulation actually depends upon everyone’s confidence in the circulation as opposed to any notional right to exchange cash for value.

“I promise to pay the bearer on demand the sum of one/five/ten/etc pound” – that’s what is (or used to be anyway, haven’t looked lately) printed on banknotes in the UK. It’s a promissory note, in other words. But have you ever tried it? To get the “pounds” that apparently sit behind this promise? Even when we were on a Gold Standard I doubt the bank would ever actually give you the gold that backed the currency if you asked: now, of course, there isn’t even that.

Last edited 20 days ago by John Riordan
nemasus
nemasus
22 days ago

Bitcoin copycats have turned this space into what it is, yes, multiple yield farming ponzis but one must make a distinction between a decentralised PoW & limited supply Bitcoin and the rest. If Bitcoin fails, all cryptos fail, but the reverse may not be the case as many crypto projects have failed already and the result has always been for funds to move to Bitcoin.

Vilde Chaye
Vilde Chaye
22 days ago
Reply to  nemasus

has anyone ever bought anything using Bitcoin?

Brian Villanueva
Brian Villanueva
22 days ago

“All money is a matter of belief” – Adam Smith
Characteristics of a money: 1. portable, 2. durable, 3. divisible, 4. uniform, 5. limited supply, 6. hard to counterfeit.
A single crypto currency meets all 4-6 by nature. Digital wallet technology allows it to meet 1 and 3. It largely fails on 2, since losing a wallet password essentially destroys the money inside it. However, as an industry, crypto suffers from a massive counterfeit problem in the form of alternatives.
Gold is a money that is hard to counterfeit. There are alternatives (silver, platinum, etc…) but only a limited number of them. Gold was the easiest to melt and cast, so it became the currency of choice throughout the ancient world. But imagine if there were hundreds of alternatives to gold, all of which had very similar properties, and new alternatives could be created at any time. Gold wouldn’t look like a stable store of value anymore; putting your money in it would be more like following the greater fool theory.
That’s crypto (as an industry): near infinite alternatives, all of which have very similar characteristics. While Adam Smith is correct, the level of belief required to back a single crypto currency is nearly religious in nature.

Ferrusian Gambit
Ferrusian Gambit
21 days ago

I’m not sure Adam Smith actually wrote that, I’ve seen no evidence he did. It’s certainly not in The Wealth of Nations or The Theory of Moral Sentiments.
Adam Smith was writing at a time when modern finance was largely limited to international trading arrangements – which were in any case of far smaller quantities than 50 years later – when “money” as we know it now was used in vastly different ways, and in any case was general called “species” in that era – for example in David Hume’s analysis of the price-species mechanism in international trade, thus I am somewhat skeptical of this quote’s provenance.

Last edited 21 days ago by Ferrusian Gambit
Andrew Aiken
Andrew Aiken
20 days ago

They don’t all have similar characteristics.
A key differentiator is the size of the network of users. Metcalfe’s Law proposes that the value of a network is proportional to the square of the number of users. A cryptoasset network is a bit more complex than a telecommunications network (Metcalfe’s paradigm) but the developer, user, and validator communities are what give the network its value- the technology alone does not.
Most cryptoassets will go to zero over time. This isn’t because the idea is without value, but rather the ordinary economics of early stage investment- most new firms fail or muddle through at best, while a few take off and become the next generation of unicorns.

Hardee Hodges
Hardee Hodges
22 days ago

I buy crypto only to buy things that require it. Seeing all coins rise as speculators arrive makes it slightly more expensive. I expect nothing out of my wallet unlike the greater fools.
The one thing that crypto has created, the blockchain, does have a lot of utility.

Saul D
Saul D
22 days ago

Crypto is akin to stamp collecting. Zero intrinsic value, but with a worth dependent on rarity. It works so long as there are other collectors willing to buy or if someone or something underwrites the token as exchangeable for something of worth.

Ferrusian Gambit
Ferrusian Gambit
21 days ago

My perspective, from actually studying bit coin, reading the white paper (imcluding the infinite gamblers ruin), the structure of transactions and so on is…

The technology was an elegant solution to a specific problem that prevented digital currencies being realistic or acceptable to the whole ‘cyberpunk’ ethos 10/20 years ago by preventing double spends without resorting to a ‘digital mint’. The original paper is quite modest and humble in its aims.

For me NFTs/smart contracts are a mundane innovation and cryptocurrencies semi-mundane. The former may have a place in ticketing systems… and cryptocurrency concepts might change how digit financial contracts work or even be adopted bybcentral banks. There may be other, quiet, mildly interesting use cases for specific problems.

That’s not what I see with this bubble. What I see is a lot of people who don’t know how it works being conned by fanatics into investing in a “greater fool” bubble. It’s more potent because many of these fanatics aren’t conning, they actually seem to believe their own BS about how it will change society, the world and government, which makes them more convincing.

In part, like the hyperloop, or VR or other mildly useful innovations, the current drought of decisively paradigm shifting innovations – none since Apple introduced the iPhone in 2007 really – and the huge spate of investment money looking for a return in an environment of low-to-zero interest rates has led to a gros exaggeration of many new technologies, to outright fraud. Bitcoin adds in a dose of this, plus appeals to the political zeitgeist and, voila, there is the perfect bubble.

The bubble will burst and then only engineers who actually need to use it will ever think about it again.

Last edited 21 days ago by Ferrusian Gambit
Stevie L
Stevie L
22 days ago

Of course yield farming is a ponzi scheme, where did you think the 7-10% interest was coming from?
To the author; ‘Crypto’ isn’t just yield farming and Bitcoin isn’t just ‘Crypto’ you need to do more research into the space – go down the top 10 coins by market cap and see what they all do/don’t do.
Hint – pay attention to the ‘max supply’

Jon Hawksley
Jon Hawksley
22 days ago
Reply to  Stevie L

I take it you are referring to the limited, essentially fixed, supply which means a surplus or deficit of buyers translates into price volatility. But since there is no fund to pay a holder does that not mean that if you hold to the bitter end you just get a fixed share of nothing? The price volatility can attract “geater fool” investors whilst it goes up but there will be fewer and fewer “greater fools” wanting to invest as more people understand there is no fund to pay them out and a rush to get out will just drive the price to zero.

Andrew Aiken
Andrew Aiken
20 days ago
Reply to  Stevie L

The 7-10% is a function of the higher risk. There’s smart contract risk, rugpull risk, and the risk of a new, not fully tested financial system.
@Jon Hawksley Many of the apps providing so-called yield farming opportunities are revenue generating & profitable. The tokens being distributed are backed at minimum by (publicly auditable) funds in the treasury, as well as by the risk-adjusted future income stream.

Last edited 20 days ago by aiken.ac
Jon Hawksley
Jon Hawksley
20 days ago
Reply to  Andrew Aiken

My comment was on the second paragraph – the top ten coins I will look at yield farming – where the revenues come from and why those sources are willing to pay that yield.

Johnathan Galt
Johnathan Galt
22 days ago

Social Security and Medicare are today Ponzi schemes, were they not a government program. Both are broke; both have trillions of dollars of future “promises” they will never have any way to pay, and both are Democrat Entitlement programs.

When the biggest fiscal crash in human history hits within the next decade, don’t say you weren’t warned.

Hardee Hodges
Hardee Hodges
22 days ago
Reply to  Johnathan Galt

As Thatcher noted “soon you run out of other people’s money”. If the US tax system can get more than 22% of GDP as revenue all will be OK, but history says it will be very hard to do.

Billy Bob
Billy Bob
22 days ago
Reply to  Hardee Hodges

The problem with quoting Thatcher is that she eventually ran out of the countries assets to sell to balance the books. The large increase in GDP during the 80’s and 90’s was almost entirely down to women entering the workforce in large numbers for the first time

Emre Emre
Emre Emre
21 days ago

This is disingenuous and misleading in several ways. Let’s try to dissect.
(1) There are different types of crypto systems, and ways of making money from crypto – and they’re very different. These are including: holding value, no-trust open-ledger settlements, smart contracts, yield farming, and NFTs at the least.
(2) Bitcoin focuses on holding value and no-trust settlements. If you think bitcoin is a ponzi scheme that does nothing, then consider this. How many times has your bank gone offline or was hacked? How many days/hours did you have to wait for your international settlement (via swift) to complete in the older times? Bitcoin is a 24/7 working international settlement system that settles in seconds, that’s publicly verifiable, and has proven itself to be more secure than most other financial institutions and systems.
(3) Smart-contracts allow for encoding behaviours that’re auditable, and can be agreed by parties. This makes it possible to have financial innovation that was not possible before.
(4) A crypto-coin doesn’t have to be negative or zero-sum game. Crypto allows for different ways of running an organisation (such as a a distributed autonomous organisation – DAO) and that organisation can do anything they want. It’s disingenuous to claim this applies only to crypto somehow – we had companies such as WeWork losing money month after month without ever a hope of recouping that get wild valuations in the stock market – does this mean a stock market is a ponzi scheme? Furthermore, due to its public nature, all of the financial transactions in a crypto eco-system can be inspected and seen by everyone at any given time. How can finance be more transparent than that? No one is stealing anything.
All in all, crypto is a financial innovation that allows for an entirely new breed of financial products and also ways of running organisations due to its public-ledger crypto-based nature.
The article reads as FUD reminiscent of hostility towards open-source software 20 years ago. Today most of internet’s software runs with open-source software developed in a distributed fashion – something completely unthinkable to most back then. I suspect we’ll see the same development about crypto.

Last edited 21 days ago by Emre Emre
Ian Barton
Ian Barton
18 days ago
Reply to  Emre Emre

I might be missing something, but you seem to be mostly referring to the benefits of blockchain technology – rather than the question of a Bitcoin’s intrinsic value.

Emre 0
Emre 0
11 days ago
Reply to  Ian Barton

The title of the article asks whether crypto is a ponzy scheme, and talks about crypto in general terms not only about Bitcoin. My first point refer to Bitcoin specifically in any case.

John L
John L
22 days ago

Sam Bankman-Fried “The most prominent figure in the crypto space”. Yeah right, the most prominent bozo in The crypto space. He and Mark Cuban can jump off of a cliff.

Of note Sam is a Biden supporter. That is all I need to know. FAIL.

Last edited 22 days ago by John L
Alan
Alan
22 days ago

A good article and many interesting comments below.
As with so many things, though, what interests me especially is that we can’t easily agree on what crypto is, or what it is not, even though it is entirely *our* own creation. On one level, the facts about it are fairly well understood. At another level, the facts are not well understood at all.
We are strange creatures, and the world is a strange place.

Last edited 22 days ago by Alan T
Andrew Aiken
Andrew Aiken
20 days ago

SBF is one of the worst people to make the case for the tokenomics of distributed governance, and the fact that Levine and Weisenthal treat him as a potential defender of it shows either their naivete or their disingenuous & tacit opposition.
Asking SBF to defend community & early adopter distribution of project governance stakes is like asking James Gorman (CEO, Morgan Stanley) to defend IB-less direct dutch auction IPOs.
Some prominent examples of apps using “yield farming” to distribute a stake in the app are Yearn Finance, Convex Finance, and Curve.
 These platforms have $2.4B, $19.7B, and $12.1B AUM, respectively. Depositors receive a stream of tokens distributed to them. These tokens are a stake in the project (crypto equivalent of “firm”) itself, and have governance rights. For example, token holders could vote themselves a share of platform profits, and they have done that in several cases (e.g., Curve, Yearn).
 When a recent website hack resulted in Badger Finance depositors having $100M BTC stolen, the token holders voted for a restitution plan to be paid out of platform revenues over two years. Assuming the plan works out as anticipated, those affected will be fully restituted.
Yield farming for Yearn ended a few months after it began in 2020. There will only ever be 36K YFI tokens. Convex has already distributed 89% of its total supply of 100M tokens.
 As these platforms run out of tokens to distribute, they transition from being apps for yield farming, and shift to innovating to attract customers, and maximizing profits to distribute to token holders.
Is a $12.1B AUM financial services platform that is profitable, with broad distribution of its tokens/shares to its most valuable & committed customers a castle-in-the-clouds proposition?
I suggest not, that it may be valued like other asset management firms including non-crypto firms. The people employing such analogies for all of crypto are either ignorant, or, SBF or James Gorman for example, they rightly perceive it as a threat to their interests.
 

Ian Barton
Ian Barton
18 days ago

Silly question perhaps – how do we know there are a “finite number” of bitcoins ?
Could that suggestion be a con in itself ?

Chris Milburn
Chris Milburn
21 days ago

If crypto is a Ponzi scheme, then fiat currency is ten times as bad.
Money is only worth something because people agree it is. A dollar bill, or a hundred, really doesn’t have any intrinsic value. Gold has been the standard for 1000’s of years because it is scarce and stable. It still can lose value when collectively we stop considering it to be as valuable.
Fiat currency has become a Ponzi scheme of sorts since we came off the gold standard. The government controls the printing presses. Governments want more power and more money to spend on their pet projects. So they print it. By doing so they devalue the money of everyone who has saved some, and devalue the salaries of those who work. And they grant themselves more and more power as they do