Cryptocurrency or cryptocon?

Profile picture for user denis_pombriant By Denis Pombriant October 29, 2017
Summary:
Cryptocurrencies and their bastard child initial coin offerings are sprouting like weeds. They have a faint whiff of a Ponzi scheme.

charles ponzi
Charles Ponzi

Usually, they are polite and ask first. Many offer to pay something for the ability to publish an article on one of my blogs. Not these guys. A company called dentacoin (to which the editors will not allow a link) just sent be a cook-booked article with the dubious title, Create Your Own Blockchain Cryptocurrency in an email. Apparently all I need to do is add water; the article ends with “I look forward to see this article published in your media.” I might look forward to it too except that it would happen over my dead body and my eyes would not be registering light.

Where to begin? Does it occur to anyone that proliferating cryptocurrencies might lead to complete gridlock as people try to figure out what equals what? Perhaps they’ll all be capable of conversion to US dollars, Euros, British Pounds, Chinese Yen or (name your favorite currency here) but that would obviate the point of a new currency, wouldn’t it? Speaking of the Euro, wasn’t its whole point to reduce the madness and friction associated with changing money at a border? Ed's note: yes. 

I’ve determined there are two problems with cryptocurrencies. One is that they are a Ponzi scheme and Ponzi schemes don’t work when they are the norm, they have to be unique or nearly so, and even then... Second, a crypto currency isn’t a currency, it’s an economy, and a badly behaved one at that. Let’s take these in turn.

Ponzi scheme

According to Wikipedia, Charles Ponzi

…promised clients a 50% profit within 45 days, or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the United States as a form of arbitrage. In reality, Ponzi was paying earlier investors using the investments of later investors. While this swindle predated Ponzi by several years, it became so identified with him that it now bears his name. His scheme ran for over a year before it collapsed, costing his “investors” $20 million.

Ponzi schemes are not unpopular or relegated to ancient history. Indeed, history is riddled with stories of flimflam men bilking people out of their savings. Again Wikipedia has a whole page of tiny type dedicated to all of the people both in the US and abroad who have set up and run schemes that have lasted in some cases decades.

Bernie Maddoff might be the best known con artist of recent times. His scheme ran for many years and engulfed his own family members. When it ended abruptly in 2008 losses were estimated at $65 billion, which qualifies it as the biggest investor fraud to date. There have been many others and they have many things in common aside their perpetrators being sentenced to long terms at Club Fed. Madoff got 150 years.

Other things in common include a get rich quick promise that relies on the greater fool theory. Simply stated it means that we believe there is always some other person out there who will pay us more for what we have than we paid for it. This is the rationale of bubbles. We just experienced a real estate bubble in which people assumed they could get adjustable mortgages with low introductory rates because they could flip the property at a profit in a year or two. When the real estate market cooled as markets do from time to time, there were suddenly no greater fools than those holding the mortgages.

Very often in Ponzi schemes it becomes obvious in hindsight that keeping the scheme going would at some point involve more people than live on the planet at a given moment. That’s the down side of the greater fool theory. What’s really interesting about cryptocurrencies and their ICO’s or initial coin offerings is that they behave in just the way you’d expect a Ponzi scheme to roll out.

In the beginning there are no users and the first people into the con are the ones who get the big profits because these returns are based on the “investments” of the next generation of fools. As time goes on making a return gets harder and harder. It’s also terrifying to know that with blockchain there’s no central authority, no single throat for the feds to choke when they close in to stop the operation. The distributed ledger turns all of the participants into criminals and victims at once.

So in some ways it’s not surprising that cryptocurrencies are proliferating or that someone wants me to write a glowing story about them.

Economy

If a cryptocurrency was a real currency we’d have to be concerned about how it behaves in the world, i.e. in a real economy. A currency doesn’t simply hang around like, say, a tulip bulb; it works. How fast does it turn over? How much of it is out of action in a bank account?

Who regulates it when liquidity is low and more is needed to keep the economy functioning? If the answer is no one then does the crypto-economy just freeze up?

Such things have happened before with real money.

These aren’t trivial questions if for instance you need to buy milk and bread on the way home and you don’t have the cash in your pocket.

So as an economy, crypto-anything leaves a lot to be desired.

Supporters of cryptocurrency have told me that the benefit of such monetary units is that they are not part of any government, that they help people leap across regulatory chasms that hold people back from fuller participation in the economy. Spare me.

I am not one who thinks government can do no good or that mob intelligence is equivalent to the wisdom of crowds. Take your pick.

My take

Scams are as old as humanity. The ancient Greek historian, Herodotus, documented one or two. It seemed his specialty as he documented human foible.

Perhaps it says something about a coming of age in the tech sector that a whole branch of technology, blockchain, has evolved to illuminate and over-ride the grey areas of legality.

Ironically, blockchain might be the best output of the whole cryptocurrency fad because it has application in all kinds of security related situations.

But cryptocurrency seems at best a solution without a credible problem to solve; at worst it fits into a depressingly regular pattern of human behavior. So, no, I won’t be posting anything salutary about the topic any time soon.

Image credit - Charles Ponzi via Wikipedia, Businessman in blockchain cryptocurrency concept © Elnur - Fotolia.com

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