Critics might phrase it in different ways, throwing terms like “Ponzi”
, and “greater fool theory
” around and of course (if you were here for the 2017 bull run and painful bear market in 2018), making that worn-out “tulip mania”
The intent is always the same: to debunk the rise of crypto as a misguided fluke at best, or a long con at worst that threatens the global financial system and hegemony of the US dollar.
For as long as Bitcoin
has had any significant value, and more so in times of turmoil, where nose-diving prices periodically make the empire resemble a teetering house of cards instead of an all-conquering empire built by a battle-hardened 300-esque horde of diamond hand
Spartans and Amazonians, the same old question inevitably rears its FUDly head again:
There is certainly no shortage of traditional finance detractors ready to weigh in with an unequivocal “Yes!”
, despite those recent quirky Superbowl ads
Famous crypto non-believers, like Berkshire Hathaway’s Warren Buffett and Charlie Munger, have respectively called Bitcoin and crypto “rat poison”
and a “venereal disease”
in recent times (the latter, only last week).
Meanwhile, crypto antagonists “Dr Doom”
economist Nouriel Roubini
and gold bug Peter Schiff
work the global crypto circuit and social media as cartoonish WWE-style heels that frequently butt heads with the Bitcoin maxis and crypto moonboys who are proclaiming the age of blockchain as Neo’s second coming (which actually came and went last year rather uneventfully) to free us from the shackles of the dysfunctional and increasingly dystopian global financial system. If only things were as simple as answering these TradFi critics with an “OK Boomer” and blaming Canada
for ending democracy as we know it.
But I digress. The $69,000 question misses the point in some ways, as the definition of a pyramid scheme, if widened enough, can include even the US dollar, which also has no intrinsic value, operating on the basis of faith alone.
A better question to ask is whether crypto will be able to ascend to that rarest of categories – things of little use that still retain value over long time scales, such as fiat currencies or precious metals.
To get to the bottom of this, let’s do the numbers, run some tests and ask the tough questions. To ultimately provide a fair assessment, it's best to first examine both the pyramid scheme and its hard fork
, the Ponzi scheme, as well as what qualities crypto
may or may not share with both.
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, a term often mistakenly ascribed to crypto, tends to prey on investors of some means, luring them with the promise of extraordinary returns. The term comes from the Italian-American con artist Charles Ponzi
, who in the 1920s duped unwitting investors in Boston with a postage stamp scam that promised a 50% profit within 45 days. This style of con, which previous to Ponzi was called “robbing Peter to pay Paul,” relies on paying out old investors their returns with the funds generated from newcomers. If everyone cashes out at once, the whole house comes down, as there is never any actual investment in a Ponzi scheme
. The most famous practitioner of this in contemporary times is, of course, Bernie Madoff
, whose fictions only unraveled after the financial crisis in 2008, ruining the lives of multitudes of duped investors in the process.
Ponzi schemes have a number of trademark characteristics, including the following:
In a typical Ponzi scheme, there is a great deal more than meets the eye. In the case of Madoff, for example, his investors believed they were involving themselves in blue-chip stocks via an array of investment techniques, such as futures contracts
and put options
. However, in reality, Madoff admitted to investigators that he had not done any significant trading since the early 1990s. Therefore, he was forced to fabricate a tremendous amount of paperwork, including fraudulent reports for his over 4,500 investors as well as tax returns with invented profits.
When it comes to crypto, the issue of secrecy is largely moot, at least in theory. All transactions recorded on the blockchain
are easily accessible to anyone who cares to look, and this has been the case since the beginning with Satoshi and his Bitcoin network
. While there are many crypto projects that lack transparency, the fundamental nature of blockchain technology ensures that there is at least a transparent path forward for those who operate in good faith.
Difficulty Cashing Out
Since the funds invested into a Ponzi scheme have not actually been placed into a revenue-generating asset, it is of the utmost importance to the scammer that there is no run on the proverbial bank; otherwise, the lights turn on and everyone can see there is nothing in the vault. In the case of the ignominious Bernard L. Madoff Investment Securities LLC, a perception of exclusivity was deliberately cultivated, so much so that investors feared if they took their money out of his fraudulent enterprise, they wouldn’t be able to get it back in. Madoff was so good at what he did that this issue was largely kept at bay during his many decades of criminality; however, in most bottom-feeding Ponzi schemes
, the issue comes to light much sooner.
Crypto doesn’t generally have this problem, unless an investor has put their funds into a token with a locked investment, which can be legitimate in many cases, though at times it can be a sign of a rug pull
. When you buy a real cryptocurrency, you are able to sell it at any time through a few clicks without having to personally interact with some sweaty scammer who pleads with you to HODL
a little longer. Of course, it’s true that if everyone dumped some particular token at the same time, the price would crash, but this could be said of any investment.
Guaranteed High Returns
A Ponzi scheme
will usually make lavish claims of unbeatable returns, often with talk of guarantees. With Charles Ponzi, his promises of 50% portfolio
growth in 45 days stood in glaring contrast to the 5% annual interest offered by banks at the time. With Madoff, he strung it out longer by keeping the returns high but not stratospheric, at an average annual rate of about 10%. However, this included bad years when the market tanked, such as right before his lucky streak ran out during the financial crisis. At that time, one of Madoff’s funds reported gains of 5.6%, while the S&P 500
was down 38% year-to-date.
In the world of legitimate crypto investing, although fortunes can be made overnight in meteoric chart movements, it’s widely understood the sector is extremely volatile, and stories of vanishing fortunes abound as well. There is no analogue to the corrupt fund manager who betrays a fiduciary responsibility to their clients by failing to invest the capital. The cash simply goes in and out of the tokens
as you direct it, all of it visible on the blockchain. While the booming crypto industry attracts many shady token offerers who may, for example, hype products in development that will never materialize, there is nothing intrinsic to crypto that guarantees such people a comfortable ride. Rather, they’re merely taking advantage of the early-stage chaos prevalent in any new and dynamic field – and particularly one where substantial regulation
has yet to arrive.
In a classic pyramid scheme
, the initial investor convinces a group of others to go out and recruit more funders, with the promise of payment for each new person they bring in. Typically, the few bricks at the top of the pyramid will get a slice of all incoming cash. The people in the layer immediately below the top may be able to pass the buck, but as the pyramid expands downward, the exponential growth requirements will quickly collide with limited demand. If each new investor has to bring in, say, six new investors to turn a profit, you don’t have to descend beyond the 13th layer before you exceed the population of the planet.
This is where it gets a little bit tricky for crypto. If the goal of any particular cryptocurrency
is to serve purely as an investment vehicle
without any actual productive use of the capital, then, yes, it meets the strict definition of a pyramid scheme. However, the strongest case for cryptocurrency has always been that it is just that – a currency, meaning it shouldn’t be judged by the metrics of a high-performing investment, even if that’s what it has often been for many adopters so far.
Is Fiat Currency a Pyramid Scheme?
The argument could certainly be made that fiat
holds many of the qualities mentioned above if viewed purely as an investment, but that would be the wrong angle of approach. Fiat meets the standards of money, and so it shouldn’t be accused of being a scam just because it arbitrarily aligns with a set of characteristics related to a different concept. Fiat delivers as a store of value
. It’s also a durable medium of exchange
, and you can put it in your pocket. It doesn’t have a limited supply, as we’ve all been so terrifyingly reminded by the Federal Reserve
over the last few years, but in normal times, there is some predictability to this aspect as well.
Is Crypto Money Too?
Let’s take as our example the earliest and still most dominant cryptocurrency by market cap – Bitcoin. The granddaddy of the crypto world would appear to meet the criteria for a store of value, given that its worth has been steadily rising despite dips
for well over a decade. You can also easily unload it, so it’s certainly at the very least comparable to something like gold. It’s also extremely portable – you don’t even need to have pockets to transport the stuff. And in the case of limited supply, well, we have a definitive idea of how many BTC will exist in 2030 compared to the murky supply of stimulus-modified US dollars.
The main area of currency qualification where Bitcoin
and other cryptocurrencies are still very much coming up short is as a medium of exchange. Nevertheless, does anyone really think that with the constantly expanding crypto community of geniuses, evangelists, and everyday people just trying to get ahead, the problem of how to spend your digital coins at the supermarket won’t eventually be solved?
So, enough with the pyramid scheme analogies. Crypto’s sustained rise is being driven by massive mainstream adoption from both retail and huge institutional investors
, the latter have carefully bided their time to enter markets.
Even Warren Buffett might finally be coming around. The staunch anti-crypto investor’s company recently invested $1 billion in Brazil’s NuBank, a well-known “Bitcoin bank
, dumping all his Mastercard and Visa shares in the process.
With all this momentum behind it, only a “greater fool” than the current generation of increasingly long-in-the-tooth detractors will continue to bet long-term against the continued ascent of crypto, despite short-term fluctuations.
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