Will the Real Ponzi Please Stand Up?

A comparison of crypto and stocks

Ignoring the Hype and FUD

For those that follow the crypto and stock markets, 2018 turned out to be a wild ride. My foray into crypto investments started back in January of 2018 right as the so-called “bubble” of the bull market burst and began its severe decline.

We can’t all be so lucky, right?

Although I had been investing in the stock market for some time and felt comfortable enough in that domain, I had no idea what I was getting into when I decided to invest my first sum of money into Bitcoin, and I’m sure many who invested during this time will echo these same sentiments.

My poor timing into the crypto market and its continual decline were depressing, to say the least. However, it gave me a valuable opportunity to remove myself from all the hype and noise, and begin to research Bitcoin and the other thousands of cryptocurrencies that now exist.

I realized that there was some true merit to all the hype, and that most of the hype was focused around Bitcoin and the other top cryptocurrencies, while very little was said of the potential of lesser-known “gems” that offered real-world solutions to problems faced by supply chains, energy infrastructure, financial institutions, governments, and so much more.

If we focus too much on price, we lose sight of everything else that is happening in the space.

During the 2018 period, I also became familiar with the concept commonly referred to as “FUD” (Fear, Uncertainty, and Doubt), in which individuals or organizations purposefully spread misinformation around a particular subject or product in hopes of influencing others.

As I researched crypto more and more, I observed how many articles and videos spread FUD about the crypto space. This is not uncommon for new technologies and a healthy amount of skepticism is never a bad thing. As this (now comical) video illustrates, the internet had its fair share of skepticism and misunderstanding before it completely revolutionized all of our lives.

The adoption of new technologies typically follows an S-curve pattern, as shown in the figure below. Most would probably agree that crypto and blockchain technologies are most likely somewhere in the early adopter phase with some applications getting much closer to widespread adoption (i.e. the early majority and late majority phases).

Typical S-curve pattern of adoption for new technologies and innovations.

In the early stages of innovation, it is also not uncommon for there to be extreme volatility within the given space. This volatility may present itself in numerous forms, but the most common and easiest to understand, are the rise and fall of companies and/or assets tied to said companies. The “dot-com bubble” is an apt example of how this volatility can manifest. Many internet-focused companies lost significant value in their stock prices in early 2000 after several years of stellar growth and several shut down due to insufficient capital investments.

NASDAQ Composite from 1994 to 2005; “dot-com bubble” burst in early 2000.

If we now look at Bitcoin’s recent fall from grace in early 2018, we begin to see a very similar pattern emerge.

Bitcoin price from 2016 through 2018. Source: TradingView.com

Therefore, it can be said that the steep decline in Bitcoin prices in 2018 is primarily a result of extreme volatility (due to extreme hype) associated with the new asset class, and not some coordinated manipulation of the price (although some manipulation is bound to exist when liquidity is low).

Furthermore, the steep decline in the Bitcoin price and other cryptocurrency prices does not mean Bitcoin is “dead”, as other reports would suggest. On the contrary, I would argue that 2018 was a small blip on the path toward mass adoption for Bitcoin and other cryptocurrencies, and the logarithmic chart of Bitcoin prices supports that view.

Logarithmic Bitcoin price chart from 2012 through 2018. Source: TradingView.com

There are many other metrics that we can look at to see how the adoption of crypto and blockchain technologies is faring, such as the number of blockchain wallet users or number of crypto ATMs installed. With almost every metric, we either see linear or exponential increases meaning that adoption is indeed occurring, and quickly.

If we focus too much on price, we lose sight of everything else that is happening in the space.

Increasing blockchain wallet users.
Increasing number of crypto ATMs worldwide. Source: https://coinatmradar.com/charts/growth/

Furthermore, I believe that this major correction was much needed in order to weed out fraudulent projects in the crypto space (I’m looking at you, Bitconnect) and projects that simply don’t have enough of a use case to be widely adopted. Just as was the case with the “dot-com bubble”, only those projects with adequate funding, solid use cases, and regulatory compliance will succeed in the long run and become the next Amazon or Google of the crypto space.

The Biggest FUD of All

With all that said, I’d like to delve a bit deeper into what I believe is the biggest FUD of 2018. There were several articles written last year questioning whether Bitcoin should be considered a Ponzi Scheme on the basis that it was just a bubble and did not have any intrinsic value. Many famous economists, investors, and entrepreneurs like Paul Krugman, Warren Buffet, Charlie Munger, and Bill Gates came out in stark opposition to the crypto space calling it either “worthless”, or as Buffet put it, “rat poison squared”.

So, are they right? Should everyone involved in crypto and blockchain technologies simply abandon it now, and save us all from further grief and disappointment?

Let me first say that I certainly don’t claim to be smarter than any of these men and they all should be lauded for their accomplishments, which should not be diminished based on their various opinions. However, we should be skeptical of any idea or opinion, regardless of the credentials of the person, and we should be wary of accepting things on blind faith.

In this case, I think it is worth questioning the claims that Bitcoin is a Ponzi Scheme and is essentially worthless. First, we should be clear on our terms, so when I use the term “Ponzi Scheme”, it will refer to “[…]an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors,” as defined by the U.S. Securities and Exchange Commission. In other words, a Ponzi Scheme just shuffles money between investors and the so-called growth or returns come from new money entering.

The primary argument for Bitcoin not being a Ponzi Scheme is simply that it was never designed to be an investment in the first place. It was created to serve as a conduit for peer-to-peer transactions without involving any intermediaries like a centralized bank. For some countries with hyperinflation of their native currency (i.e. Venezuela and Zimbabwe), Bitcoin can even serve as a relatively safer store of value, which is why Bitcoin adoption in those countries is proceeding at an even faster rate.

However, regardless of its actual use case, that will never stop investors from speculating on the asset price. If Bitcoin’s price increases in USD value, then that is simply a result of more investors buying Bitcoin than selling, and cannot be directly attributed to anything with the Bitcoin protocol or other external factors.

Therefore, I would actually agree that an investment in Bitcoin could be construed as a Ponzi Scheme, especially when there are several individuals out there claiming you can make millions by buying and trading Bitcoin.

Nevertheless, this should not take away from its actual use case of being a form of “digital cash” that you completely control. In this sense, it is definitely not worthless and is actually proving to be quite valuable for people living in countries that are experiencing tough economic times, in which the only thing becoming worthless are their own currencies.

Stocks are the Bigger Ponzi

Let’s turn our attention for a second to another, more established asset class, stocks. When you buy a share in a company, you are supposedly buying a stake in the company, which is officially recorded on a stock certificate. So, you buy your share in Company XYZ and now what can you do with it?

Can you receive dividends by holding the share? In a few cases, yes, but most don’t offer dividends these days (even though that’s how stocks were originally intended to function when they were created¹).

Can I vote on company-specific matters with my share? Again, in most cases, no, and even if you can, the company can always issue more shares to drown out your vote.

So, essentially, you don’t actually receive anything by owning a share in Company XYZ besides a piece of paper that says you do.

Additionally, just like how the Bitcoin price cannot be directly correlated with any specific changes to the Bitcoin protocol or other external factors, stock prices cannot be directly correlated with the performance of the company.

Many seem to believe that if a stock price goes up, it must be because the company had solid quarterly revenues and earnings. However, that does not seem to explain Tesla’s stock performance that went from $20 a share to over $380 from 2010 to 2017, during which time period they lost $4.3 billion¹. The simple reason why the Tesla stock gained so much during this time is that more investors decided to buy shares of Tesla than those who sold their shares.

Some financial analysts might say the increase in stock price can be attributed to future earnings growth of the company, but then that, of course, would sound very similar to a Ponzi Scheme, wouldn’t it? Since the company isn’t paying dividends or sharing their profits with the investors, then all the gains must come from new investors.

The reason this is important to bring up is that the wise old men mentioned previously that were bashing Bitcoin and calling it worthless or a Ponzi Scheme seem to be contradicting themselves if they’re also investing in stocks. Warren Buffet has no problem calling Bitcoin worthless, yet why should Berkshire Hathaway (which he owns) be valued at nearly $300,000?

What does owning Berkshire Hathway stock actually get you?

What value does it create for the world?

Answer: Absolutely nothing.

It is merely a Ponzi asset in a larger Ponzi Scheme known as the stock market. Therefore, these men should be careful about what they label as a Ponzi Scheme or as worthless, since their own assets could be called the same.

Furthermore, we should be cognizant of the fact that all these men made their fortunes on centralized systems and products, so anything claiming to be decentralized, as is the case for Bitcoin, could be seen as a threat to their businesses and fortunes.

In closing, I think there is a strong argument to be made that cryptocurrencies are far less of a Ponzi Scheme than traditional equities are, and can provide actual value through specific use cases that stocks and other equity instruments simply lack.

If we look beyond Bitcoin to other cryptocurrencies in development, some are offering dividends, access to platforms with real utility, and decentralized systems for almost anything you can imagine. If they succeed, and I believe a few will, then we may look back a decade from now at the video of Charlie, Bill, and Warren talking about Bitcoin much like we now view those who were skeptical of the Internet in the ’90s.

Disclaimer/disclosure: I currently hold Bitcoin and other cryptocurrencies. All opinions expressed in the article are my own. The content provided is for informational purposes only and should not be construed as financial advice. Do your own research and invest at your own risk.

Additionally, I am, by no means, saying don’t invest in stocks or crypto just because they may be considered Ponzi assets, but just understand that neither should be considered a “safe” investment, and that we’re probably better off using the term “gambling” rather than “investing” for these types of assets.

[1] Tan Liu. The Ponzi Factor: The Simple Truth About Investment Profits. QuantStyle Publishing, 2017.



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