Ponzi schemes and cryptocurrencies

Ponzi schemes and cryptocurrencies

The Ponzi scheme sounds somehow bad. Linked to fraud and financially sophisticated theft, a Ponzi scheme is not something you would want to run into. But if you are able to avoid them, then you simply can not escape from the financial pyramid.

The Money Rule that can’t be rooted out

From its namesake, Charles Ponzi in the early 1900s, to the Bernie Madoff scam in the 1990s and 2000s, Ponzi schemes tend to be iconic, spectacular, and spectacular to come to light. Their creators take investors ‘ money under grandiose promises of extraordinary returns, pretend to invest it according to some secret and fictitious formula, and pay out the profits to early investors at the expense of the contributions of new investors.

Like a cartoon snowball speeding down a hill, Ponzi schemes work as long as the money coming in from new investors exceeds the profits (and withdrawals) for old investors. As soon as the influx of new funds slows down, the scheme falls apart.

A slightly different structure of fake financial magic is a pyramid. In the pyramid scheme, the creator recruits people to perform some intended task, and these people, in turn, recruit even more people in a long chain consisting of more and more participants, as the addition of more and more layers to the base of the pyramid supports its work. Recruitment and sponsorship are declining, and financial transactions and bonuses are on the rise. In this way, the first participants can make significant profits, and the wealth and prosperity of the people at the top of the pyramid is usually portrayed as an incentive for new recruits. These people started exactly where you were, and they, like you, came out of nothing. Already faced that?

Many people call cryptocurrencies scams and Ponzi schemes, and some of them certainly are. But the most well-established coins do not belong to this category. Indeed, they do not qualify as Ponzi schemes, as they rarely have a single initiator running the show.  These are financial pyramids. And as banal as this statement may be, the same thing happens with all successful forms of wealth, property, and other means of money.

What does “cash reserves” mean?

Once we take a step back and think about money in the context of pyramid schemes, their pyramidal nature will quickly become clear. No matter what kind of material or digital print serves as money, to get it from someone else, you first need to give up some valuable goods or services: you need to sell your things or provide some valuable work for which money is paid.

When a person first joins the money network, they become the holder of some of its tokens, selling some of their value, with someone who already held the token, with someone higher up the pyramid. Someone holds the tokens they received earlier, after giving up valuable goods and services because of them: valuable goods and services are produced more than consumed, and the difference is in people’s cash balances.

When a person holds money, they do so on the reasonable assumption that they will later be able to exchange this money for goods and services that they want to purchase. In other words, he can hold something useless, say, sheets of paper (fiat funds), and at the same time be sure that their valuable properties can be transferred to the next person. Do you get the point?

Cryptocurrencies and ponzi shemes

In an interview with CNBC, Warren Buffett amusingly said that cryptocurrencies have no value, since they do not produce anything. The funny thing is, Buffett seems to ignore all the other financial and non-financial derivatives (commodities, derivatives, insurance) that, despite not being “production” of anything, still have value. Instead, in his opinion, the reason people hold cryptocurrency is a version of the big fool theory.:

“You hope that someone else will come later and pay you a lot of money for it. But then you have a big problem.”

Many things have this property, including the property itself. Let’s say in the United States, a generation of parents paid much less for their housing than their children after them, and they are financially benefiting from the ride on the wave of housing prices of recent decades. “For those who came first, the American Dream seems like a one-time asset bubble,” Kevin Erdmann wrote in a recent issue of National Review.

“The owners of modest homes, say, in the Bay Area, who now rent them for $ 4,000 a month, or sell them for a million dollars, have not earned such wealth by creating anything. Their profits are a direct result of politicians banning developers from building new homes.”

Cash works in a similar way: you give up valuable goods and services in exchange for something that gives you benefits (for property, this benefit is home rental services, and for money, it is insurance against the inability to earn, unexpected payments or future purchases), but does not bring interest or a refund.

From an economic point of view, money savings represent the purchasing power that you have refrained from using. By keeping your cash balances, you were pushing your profits up the pyramid of the money network.

The value of network tokens – their purchasing power compared to other goods and services, is higher than before, which benefits everyone who owns the tokens. This is akin to how owning a home brings you unexpected financial benefits during a property price boom, or adding a new pyramid level benefits first-time users.

Many people in the libertarian community have long believed that gold is just money. The same characteristic of the pyramid style applies here: the more people who own gold, the higher its purchasing power, that is, what goods and services the previous holders can get for a unit of gold. Income rises through the ponzi scheme.

Crypto as a tool

Cryptocurrencies, as Mr. Buffett correctly points out, do not “produce” anything and do not bring financial profit. They, like gold, property, jewels, or rare Rembrandts, bet on the great fool’s theory that someone else will come later and pay an even higher price for them. That’s no different from the mountain of cash Buffett’s company owns – $ 128 billion, according to the Economist. It produces nothing but an interest rate below the rate of inflation that Berkshire Hathaway can get. It offers Buffett the opportunity to buy the future of his business, and not only, at lower prices.

Regardless of the format in which Buffett holds these funds, he benefits the organization that issued them: short-term government bonds held by him reduce the cost of financing for the government, or the cost of financing the bank or large legal entity in which he holds deposits. Cash allows the Federal Reserve to fund its portfolio of assets for free, generating seigniorage, and the Fed’s profits are eventually transferred to the Treasury.

In fact, Buffett’s cash, in anticipation of high prices in the future, provides free funding for the Fed and, accordingly, the government. Income rises through the money pyramid.

The term “exorbitant privilege”, coined by the French finance minister of the 1960s, describes the phenomenon that the holder of money confers on its issuer. Berkeley Professor Barry Eichengreen even gave his 2012 book on the dollar its name, because it talks about the “unfair” financial benefits received by the issuer of the reserve currency. The US could run a larger current account deficit and pay less on its debt, as foreigners were willing to keep large amounts of their currency in their bank vaults.

The same can be said of today’s Swiss National Bank (SNB). As many people want to have Swiss francs as a financial haven, and the SNB can meet their demand by producing more francs for free for themselves. They buy dollars and euros with their newly issued francs, and for monetary policy reasons, place some of these foreign exchange reserves in shares of foreign companies. According to the latest SEC data, the SNB’s US stock portfolio is worth $ 100 billion, of which only $ 10 billion is made up of Apple, Microsoft and Amazon shares.

The income stream they receive from this portfolio is transferred to the SNB free of charge by foreigners who simply want to own the Swiss franc. Think of it this way: Foreigners who previously held dollars had the option to buy Apple or Microsoft shares themselves, but chose to opt out of that option in exchange for a claim to the SNB.

When people give real goods and services to an issuer of money, that issuer receives free benefits. Too many questions, and the trust that underlies the relationship evaporates. Whether we are discussing dollars issued by the Fed, francs, rubles, gold produced by mining companies, or blockchain crypto assets, the same monetary rule applies: the value of the token you receive depends on your ability to pass it on to the next person, and on the ability of someone at each stage of the asset’s journey to distribute gifts in exchange for these tokens.

And as long as you hold money, tokens, or gold, the issuer and other holders benefit financially: free funding (seigniorage) received by banks and central banks when you hold their liabilities, or by Starbucks or Amazon when you hold their gift cards. For the new holders of the cryptocurrency, the monetary value flows to the seller one step up the pyramid, whose huge assets have increased in value.

All money and valuable items are pyramid schemes, and all holders of money and valuable items hope that the next person in line will pay more for them. This is how cash balances work, and it has always been, is, and will always be.