- Part 1: there is no single “price,” the market is horribly inefficient
- Part 2: Know Your Customer/Anti-Money Laundering laws
- Part 3: Bitcoin is not a Ponzi scheme! It just works like one
“a fish bowl with no food in it that fish keep jumping into because they heard it’s an all-you-can-eat buffet. And for the meanest fish, it is.” (Syd Midnight)
So you bought into the bubble. It’ll be fine, you can’t lose! And if it pops you’ll just hold!
Whoops! The price just went from $19,000 to $11,000. What do you do now?
Bitcoin doesn’t have an economy as such. So there’s a lot of Bitcoin paper “wealth” that can never be realised.
How Bitcoin bubbles get money from new hopefuls to old holders
The @Buttcoin Twitter posted an explanation late last year of how the Bitcoin market works in practice, and why the old investors who just cashed out tell the new ones to just hold, or, as they put it, “HODL”:
Important note for all the newcomers to Bitcoin: the old timers don’t care about you. They actively laugh and mock you when the price drops. They want your money but hate that you’re here.
Whenever there’s a drop or crash, if you dare ask why the market is acting how it does, you’ll get routinely mocked and told you don’t “get Bitcoin”. That a 40% drop in value is nothing new and why are you newcomers even worried about incurring massive losses?
If you bought in at $19,000, you paid for someone else to cash out. And now that person will call you an idiot if you panic about losing your money. They’ll say you’re not smart enough to wait and slowly watch your “stable store of value” rot for years until the next bubble.
Why should they hold? You’re basically telling people “please don’t let the price drop, just sit and wait for new suckers to arrive”. No one buying in 2017 believes Bitcoin will replace fiat.
That’s why people call Bitcoin a Ponzi. Every time this bubble inflates, new people get drawn in and get left holding the bag FOR YEARS until it heats up and inflates again and they can finally sell without losing their shirt.
The pool of money does not grow: money out=money in
Bitcoin is not the bloodflow of a functioning economy — there’s no circular flow of income. You can buy very few things with bitcoins — even the drug market is abandoning it, as transaction fees go through the roof. Bitcoin doesn’t have its own economy.
A stash of bitcoins isn’t a useful pile of capital that you can invest in profitable economic activity and grow the wealth with — all you can do is sell them again. For all practical purposes, Bitcoin works only in terms of the conventional currency system.
This makes Bitcoin a zero-sum investment — the actual money coming out can never be more than the actual money coming in. (Or a bit less, as the miners cash out their reward from each block mined to pay for their electricity.) X amount of actual money goes into Bitcoin — the same amount of actual money, X, is immediately returned to a different person. This is all that happens.
This is, again, why “market cap” is a misleading and useless number. If someone bought a fraction of a bitcoin at $19,000 per BTC, that doesn’t make anyone else a “Bitcoin billionaire” whose bitcoins could be sold at $19,000 each — the total actual money recoverable from the system hasn’t gone up.
Try realising any substantial fraction of those paper billions and watch the price crash — the actual money doesn’t exist for everyone to cash out. At some point, there will be a rush for the exits, and most can’t possibly make it out with their “gains.”
People invest in the hope of profit. This means that more money has to come into the system — new people have to join the scheme. This is obvious to everyone “investing” — they have to recruit.
Eventually the scheme runs out of new “greater fools,” the bubble pops, and a lot of people are left holding the bag.
Old investors are paid with money from new investors — the key characteristic of a Ponzi scheme. Functionally, this is a pyramid scheme — even as it has no specific operator. As evilweasel on Something Awful puts it:
bitcoin distributes those tokens to early adopters precisely to get them to evangelize. it’s an automated pump and dump or “honest ponzi” scheme.
the central innovation of bitcoin is pretty much the “honest ponzi”. it functions by giving the early adopters a very direct monetary incentive to evangelize it automatically.
Well, it’s not technically a Ponzi …
The problem with calling Bitcoin a “Ponzi scheme” or “pyramid scheme” is that a Ponzi conventionally has a mastermind at the top, making the money.
Bitcoin doesn’t have that. (And Bitcoiners are very big on this as a reason not to call it a “Ponzi”!) Satoshi Nakamoto appears to have been completely sincere in setting up Bitcoin.
Even given Nakamoto’s extensively documented political aims for Bitcoin — an anarcho-capitalist reimplementation of the gold standard, with banker conspiracies along for the ride — he was disconcerted at just how rabid the fans got about the possibility of profit. He even asked them to hold off on video card mining because it would spoil things for getting everyone involved.
Nakamoto abandoned the project around 2011, and his million-bitcoin stash hasn’t moved since then. But his followers continue the push.
Preston Byrne outlines how Bitcoin works as a headless Ponzi, which he calls a “Nakamoto scheme”:
The Nakamoto Scheme is an automated hybrid of a Ponzi scheme and a pyramid scheme which has, from the perspective of operating a criminal enterprise, the strengths of both and (currently) the weaknesses of neither.
The Nakamoto Scheme draws strength from the same things which make pyramids and Ponzis so compelling, in that it promises insane investment returns, can be accessed by the man on the street with almost no effort at all, and recruits individual participants as new, self-interested evangelists of the scheme.
It has no current weakness in that the regulators, blinded by lobbying from the Valley, have seen these schemes as futuristic and cutting-edge rather than what they really are: victim factories, which in the next crash will produce hundreds of thousands of howling investors with little formal legal recourse due to four years of inaction on the regulators’ part.
Bitcoin as Ponzi platform
Bitcoin is also a popular platform for Ponzis and Ponzi-like schemes. The story of Pirateat40 is detailed in chapter four of the book, but “high-yield investment programmes” were stupidly popular in the early days. And it’s attracted experienced Ponzi operators such as Sergei Mavrodi of the MMM scheme of the 1990s, who started new schemes based around bitcoins.
Later cryptocurrencies haven’t done any better — when Ethereum took cryptocurrency and added smart contracts, the very first contracts people wrote were chain letters, lotteries and automatic Ponzi schemes.
Something about cryptocurrencies attracts, not just starry-eyed naïfs, but the sort of starry-eyed naïf who thinks that Ponzis, chain letters and other blatantly fraudulent financial schemes are actually a good idea.
And where there are naïfs with stars in their eyes, there are scammers to prey upon them. It’s a new paradigm!
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David, will you still be writing something specific about Coinbase?
yeah, I just have a half-finished draft that isn’t very good and I was getting nowhere with. Then I wrote this and realised it fit in much better with the series. Worse is trying to work out something to write about Peter Thiel, Bitcoin and … Urbit.
“For all practical purposes, Bitcoin works only in terms of the conventional currency system” is one sentence that completely sums up what I’ve been taking paragraphs full of examples to explain. The thing that makes even few bitcoin transactions that DO remain end up being expressed as “350USD of bitcoin”, that compounds into the issue of “as quoted by whom?” and “how do I decide if I got shorted or not?”
I recommend the link as well:
https://www.coindesk.com/bitcoin-still-needs-fiat-currency-wont-change-2018/
it’s Tim Swanson – who’s done a ton of bitcoin and blockchain stuff – explaining in small words to bitcoiners that they’re not achieving an independent economy in the foreseeable future. In the bitcoin press, too.
In my opinion, the most suspicious thing in Bitcoin is the drastic asymmetry between ease of buying and difficulty of selling. this is something we don’t see in legitimate markets, and especially not in a market which supposedly has a demand surplus that constantly pushes prices up. We do see similar things in Ponzi schemes where the organizer tries his best to delay and convince you not to cash out, and in Pyramid schemes where by definition you can’t cash out your initial investment unless you make a special effort and recruit other victims.
When you add this to the facts that most of the trade volume is concentrated in few large unregulated exchanges that work closely with a few large mining pools, it’s not hard to hypothesize what’s really going on here.
This is true for any market. Admit it, don’t be a hypocrite. Even if there’s some kind of economy behind security, once the price for it drops beyond some psychological level, everybody will rush to sell, company behind it will go broke and if it grows into a chain reaction banks will liquidate, resulting in a global financial crisis. We were there, we saw it. Don’t say it cannot happen. Cryptocurrency has very solid and practical value and purpose. People believe in it. That’s the most precious value there could ever be. It definitely got overvalued, but that’s what humans always do for everything. So assume it being normal. Once it consolidates and settles, it will serve its purpose well. Long after all fiat currencies become obsolete.
I believe my 80 Yugo is worth 1,000,000 USD. Because believing is the most precious value…. Crypto is another idea that works great in a perfect world, with everything held constant. Why would anyone sell/trade their bitcoin for a depreciating asset, if everyone’s presumed assumption at the time is that it is only going to appreciate? Additionally you are not running from Uncle Sam, or almost any other country on this planet. Government has a unquenchable thirst for revenue. They want their tax money, and they will get it. Too bad many so many people don’t like to report their earnings of profits from cyrpto on their tax returns. Can’t wait for the audits to come 3 years from now, with incurring penalties which drive people into bankruptcy.
Well, this Yugo is probably worth more than it was three years ago:
https://youtu.be/hw2tqa8JcTE
The same Yugo, three years ago:
https://youtu.be/n4ejyV27VP8
Will this particular Yugo’s value outperform Bitcoin? Only time will tell!
I don’t care what you say, statist. Baldcoin is awesome!
TO THE MOOOOOOOOOON
Tether’s star is rising! You can see the network effect at work right here:
https://www.reddit.com/r/DarkNetMarkets/comments/7qz1s2/the_markets_should_start_using_usdt/
Using a censorable unit of account for drugs, what could go wrong?
The one thing I can’t quite get past is how all these 1000’s of brilliant minds (not according to you perhaps) in the crypto space are wrong and you, are right?
Perhaps you need to examine the evidence more, instead of assuming “this is complicated computer magic I don’t understand, I’ll just trust them.” Could work!
There are many more thousands of brilliant minds who have never entered the crypto space for exactly the reasons David is describing.
“This is, again, why “market cap” is a misleading and useless number. If someone bought a fraction of a bitcoin at $19,000 per BTC, that doesn’t make anyone else a “Bitcoin billionaire” whose bitcoins could be sold at $19,000 each — the total actual money recoverable from the system hasn’t gone up.”
Isn’t it the same with conventional stock trading dynamics? Pardon my ignorance but can’t see the difference.
On a side note, David, enjoyed reading. Keep it up.
It’s also quite a rubbery figure in stocks – but there, arguing a company is “worth” its stock market cap is a meaningful and useful number, e.g. you’d need something in that range if you wanted to mount a takeover bid, or if its total assets are more than that number there’s a problem, or whatever. Also, if AAPL went to 1c/share, the business does something so it’d be worth buying.
Applying a term that’s slightly useful in one area to an area where it isn’t useful is just cargo-culting jargon to come up with a number that’s useful in headlines.
I don’t remember seeing this in cryptos before 2016 – when did the term “market cap” enter cryptocurrency discourse?
(this is why I need to write a post expanding on “market cap” …)
This is all very useful information. Even the miners are not guaranteed a return on investment and the false rising cost theory is very Scam O Rama. The first Bitcoin cost .000000001 cent in electricity to compute and validate the transaction for which the miner was paid 25 Bitcoins while the last Bitcoin will cost an infinite number of dollars to mine in electricity and never pay out anything. I am guessing since there will only be 21 million Bitcoins and and payouts drop in half every four years. I fear the last blockchain will include compute the value of pi until it repeats. Otherwise who will be left to verify transactions when there would be no more Bitcoin to mine? Therefore, trust is involved and Bitcoin undermines its own credibility without blockchain verification at minimum.
Good point … What WILL happen ? It might be that the last twenty coin mined take years, and knowing it’s value, it will become, surely, too expensive to mine? And then, as you say, if they are all mined, who will keep the transaction records going?
I ran a node for over a year, and got NO reward. Not paying the people who keep the infrastructure going seems a little risky when the chain needs the nodes.
Congratulations on the prices in the article becoming accurate again