Bitcoin: The Postmodern Ponzi

The world is an increasingly strange place and one of my favourite quotes about the times we’re living through is that we’re all all in a superposition of being both overwhelmed and underwhelmed. The enormity of current events and possibility for seismic change is overwhelming while the reality of stagnation and societal sclerosis seems pointlessly underwhelming. Nowhere is this feeling more omnipresent and palpable than within the tech industry.

Like many people I’ve written a bit about fintech and the influences the new right-wing populism is having on financial markets, and there are some truly unprecedented things occurring that are going to reverberate through the next decade in technology. Every leftist think piece for the four years has beaten to death the notion that narrative and reality have become divorced and that the modern condition is that we’re adrift in a world in which sense making and power are indistinguishable. I won’t elaborate on that again, but I can’t help but see this phenomenon present in nearly all discussions within our industry about cryptocurrency.

I’ve been involved in a fair amount of commentary and debate on this topic (disclaimer: I’m not a fan) and I am truly shocked by the degree to which political ideology completely dominates perspective on this topic. The old guard is changing in technology and if you think liberalism dominates decision-making in our industry then you’re fairly disconnected from the reality on the ground. Cryptocurrency is the canary in the coal mine warning us about the level of poison from the upward trend of an anarcho-capitalist ideology best manifested in a technology which is nearly lossless conversion of waste into money with complete disregard for human costs or environmental externalities.

It’s hard to even communicate about the intellectual center of cryptocurrency, because so much discussion is framed in terms that have no meaning (i.e. “decentralized”, “blockchain”, etc) and the technical obscurantism and mystique is an inescapable and intrinsic part of the investment thesis. The word postmodernism is itself an indefinable term of art that refers to a philosophical set of ideas that diverge from modernism, one that rejects large historical narratives, objective value systems and coherent ideologies. I claim the economic structure of the bitcoin movement can be most aptly described as a postmodern Ponzi1. In a world where even the very existence of the virus that has halted civilization can be questioned who’s to say what is and isn’t a scam or whether bitcoin mining is boiling the oceans — trust me I’m lying.

A classical Ponzi scheme is a financial fraud run out of smoke-filled rooms of old men shuffling money around bank accounts and manipulating accounting statements to continuously pay out new investors from old investors while maintaining the illusion of returns. In economic terms investing in a Ponzi scheme is a negative-sum game and is a form of gambling like poker or roulette. Gambling is consumption and, unlike in productive enterprises, nothing of value is created from the process. There is a fixed pool of money and each person who makes a profit necessarily makes it from someone else who loses. Any single winner is necessarily paid out by multiple losers. Negative-sum games do not, in aggregate, generate wealth or utility and instead simply redistribute input funds to different participants. There is a negative expected return from engaging in this class of activity.

In Bernie Madoff’s twenty year scheme many investors absolutely made money, and investing in Ponzi schemes at the right time can indeed make you very rich. Some people also become disgustingly wealthy from playing roulette, however the majority do not and you’ll never hear about the ones who lost everything. This is the essence of why Ponzi schemes are illegal and considered a form of fraud, they are a form of gambling that depends on information asymmetry and collusion where the rest of society bears the costs and negative externalities of cleaning up the mess to right the victims when the music inevitably stops and there are no more chairs.

Bitcoin is no different. Purchasing a bitcoin is buying an entry in an accounting database, an extraordinarily expensive collection of bits. It has no manifestation in the real world, produces nothing, has no assets, income, customers, cashflow or dividends. The net present value of bitcoin is zero and can never be non-zero. It’s value is purely from a form of recursive speculation, a delusion that more victims will come to speculate in the speculation thus perpetuating the scam and driving the speculated “value” higher. It is a futures contract with an underlying on human gullibility, a bet that there will be more fools in the future to pay out present fools. Einstein once said “Two things are infinite: the universe and human stupidity; and I’m not sure about the universe” and in today’s the strange upside-down world you can now invest in Einstein’s thesis and it’s called bitcoin.

A store of value cannot be based purely on faith in an inexhaustible pool of fools willing to pay monotonically more for something indefinitely. It should be intuitively obvious to every school child that this game of musical chairs can’t and won’t continue forever. Reality has a way of asserting itself and at some point this scheme will exhaust the pool of fools who will be left hodling a pathetic share in the collective delusion of a non-currency that is completely useless in the real world. Bitcoins are completely unsuitable for monetary purposes, they sustain no economic activity, are unsuitable to transact in as a unit of exchange, and can can never perform any function beyond an empty speculative bubble.

This new class of scam diverges from that classical Ponzi in a significant and legally important way. Instead of the smoke-filled rooms we have the haze of post-truth obscurantism induced by our new media landscape that feeds on illusion, distrust in experts and confusion as a means to obscure the underlying mechanism of the wealth redistribution scheme. This is the essence of why we call this fraud a ‘postmodern’ scheme, sophisticated investors completely understand mechanism of the fraud and all operations are done in public, but the fraud depends on the collective ignorance and/or overconfidence that individuals will be able to time their market exit properly while others will not. This is no different than the fallacy of gamblers who somehow believe their spin of the roulette wheel is somehow blessed by luck.

The distinction between bitcoin and other tokens is inconsequential so long as they share the same underlying economic structure of peddling a get rich quick investment based on technical obscurantism. The only distinction is that other crypto assets simply have different wealth redistribution mechanisms and different externalities they dump on society for their continued existence. The economics of cryptocurrency are fundamentally unsound, and the story is as old as the Ponzi scheme itself: money for nothing out of nothing, just get in early and don’t ask where it comes from.

Let it be said that our system does allow many equally dubious schemes to function within the law, many of which are a net drain on civilization. Amway is an $8.4 billion multilevel-marketing company that legally operates in the US and which the courts have consistently ruled is not a pyramid scheme. And Amway isn’t a pyramid scheme, right? Investing in bitcoin shares many of the same characteristics but instead of convincing your friends to become distributors of nutritional supplements, it depends on software developers perpetuating a narrative that some perpetually just-over-the-horizon disruptive software that will generate vast wealth for early buyers through unspecified means.

In fairness, not everyone involved in cryptocurrency is a scammer, just like not everyone involved in multi-level marketing is a scammer. Nevertheless, multi-level marketing schemes are a scam; there is a fundamental economic problem at the heart of the business model. However many people are simply desperate, swept up in the craze, trend following or simply ignorant of the underlying economic structure. There are even more who are genuinely convinced by specious arguments tied to stories they simply want to believe in, and that can be a powerful force for post-hoc rationalisation of fantasies. It is difficult to get a man to understand something when his paper wealth depends upon him sustaining the illusion of that wealth.

We can take solace in knowing that any postmodern Ponzi scheme is just as unstable as its classical forms, these houses of cards will collapse just like all others that have come before it. There is no escaping the base economic reality that more money leaves the ecosystem in the pockets of insiders than can ever be paid out to even a tiny fraction of the fools who buy in. It is an unsustainable bubble that will pop leaving us with some profound questions to ask about the ethics of digital assets and will likely create much needed 21st century version of the Blue Sky Laws.

However today cryptocurrency is nothing more than an ecosystem of thinly veiled gambling products that is preying on the vulnerable, perpetuating economic inequality and deepening the existing problems in our society. It is time for us in the software engineering profession to decide how history will tell the story of our participation in this madness. If we choose to make short-term decisions based on indifference and greed then history will not judge us kindly.

  1. I’m not the first person to coin this term, although this paper uses it in a different but similar context.