Is bitcoin

IS A BITCOIN A SCAM?

Feb 2018

Is bitcoin one humongous scam or Ponzi scheme? Before I answer that question, let’s look at the four typical characteristics of a Ponzi scheme.

First of all, there must be a promoter for the scheme. It may be a single individual or a corporation.

The key point here is that there is a single party promoting (and thus benefiting from) the scheme. The second characteristic is the promised return.

To attract gullible investors the scheme will promise unrealistic sky-high returns. The saying “if it is too good to be true, it probably is” always applies in this scenario.

The stick approach is where the investor loses a portion of his investment if he withdraws early.

Conversely the carrot approach entices the investor to stay in by promising even higher returns the longer he keeps the funds invested.

Finally the “too-good-not-to-share” approach requires the investor to find a new investor to take over his investment. In short, he needs to look for new fools to buy him out.

Yes, the Ponzi scheme’s liquidity is at the mercy of the promoter’s whim and fancy.

Thus we come to the fourth characteristic. Ponzi schemes require a constant flow of new investors (read: new money) to fund the payout to early investors.

Before the promoter vanishes into thin air, a small number of EARLY investors DO actually get to cash out and enjoy the ridiculous returns. This is done intentionally by the promoter to “instill” confidence in the scheme as these early investors will help to bring in new investors.

Let’s apply these four characteristics to Bitcoin. The decentralised nature of bitcoin means that there is never a single party promoting bitcoin.

One may argue that there are plenty of people promoting the virtues of bitcoin.

However these are all unrelated parties, akin to different investment advisers promoting the virtues of gold as an investment.

What about returns?

Yes, bitcoin has provided spectacular profits to some investors in the past year.

However these profits were never promised in the first place. In fact people have lost money trading bitcoins, in spite its meteoric rise. This is due to the extreme volatility of the price.

Does bitcoin have sufficient liquidity that is, can you get out? All the recent headlines about regulators and banks freezing the accounts of crypto-related transactions have given the impression that it is hard-to-get-out once you are in.

However, nothing could be further from the truth. The decentralised nature means that there are so many alternatives for selling bitcoins, although not all are convenient.

Finally, are bitcoin investors who are late to the party effectively funding the early investors’ profits?

On that note, bitcoin may sound similar to a Ponzi scheme.

Then again the same can be said of investors who entered the markets at the peak of the dotCom bubble or the housing bubble.

This is a zero-sum game.

I would be remiss if I did not acknowledge the existence of numerous proven scams out there that uses or references Bitcoin.

To counter that point, note that these scams never actually put money into bitcoin, merely hitching a ride on the bitcoin bandwagon and hype.

Prior to the emergence of cryptocurrencies, Ponzi schemes already existed. These schemes claim to use special techniques to generate spectacular profits from various asset classes such as commodities or real estate. Do you hear anyone labelling real estate as a Ponzi?

That said, I must make the point clear that one can easily lose a fortune putting hard earned money into either bitcoins or a Ponzi scheme. Nevertheless, bitcoin is not a scam or Ponzi scheme, as outlined by the points above.

Chong Jin Yoong, CFA, is a financial markets trainer and consultant.

Readers can learn more about whole bitcoin and cryptocurrency saga at a talk organised by The Star on Feb 10 entitled “Bitcoin: Dive in or stay away?”

 

InvestSmart