Over the past decade, countless critics have pointed the finger at Bitcoin as nothing more than a cleverly orchestrated Ponzi scheme.

Detractors like Brazilian computer scientist Jorge Stolfi argue that the leading decentralized cryptocurrency has all the makings of a scam named after Italian fraudster Charles Ponzi.

The question of whether or not cryptocurrency in general is spawned by these scams remains one of the most debated topics in the cryptocurrency industry and can be seen as a major obstacle to the broader acceptance of bitcoin (BTC) as a payment method. valid.

What is a Ponzi scheme?

To understand the central themes of this statement, we must first look at what characterizes a Ponzi scheme. There are several criteria that try to illustrate its key aspects.

According to the legal definition Provided by the United States Securities and Exchange Commission (SEC), a Ponzi scheme consists of four key components.

A Ponzi scheme is an investment fraud that involves the payment of alleged returns to existing investors from funds contributed by new investors.
Ponzi scheme organizers often solicit new investors with the promise of investing funds in opportunities that supposedly generate high returns with little or no risk.
With little to no legitimate profit, Ponzi schemes require a steady stream of money from new investors to continue.
Ponzi schemes inevitably collapse, most often when it becomes difficult to recruit new investors or when large numbers of investors request their funds back.

Breaking down the SEC’s definition in layman’s terms, a Ponzi scheme is a fraudulent operation that distributes money raised from new investors as profit to existing investors.

More specifically, it’s about a set of new “recruits” paying into a system to keep a profit flyer going. In a typical scheme, a new recruit “invests” a certain amount and the head of the scheme, also known as the top of the pyramid, pays previous “investors” with the new money.

This type of scam typically promises high rates of return to attract new investment, which you rely solely on to sustain yourself.

Stating his argument for calling Bitcoin a Ponzi scheme, Bitcoin skeptic Stolfi adapted the SEC definition to include additional requirements:

People invest in it because they expect good returns.
This expectation is based on the payment of said profits to those who choose to collect.
There is no external source of income for those payments.
The benefits come entirely from new investment funds.
The operators take a large part of this money.

Here, Stolfi adds that the operators of a Ponzi scheme generally make the most money compared to those who managed to profit from the scheme. Outside of these definitions, other common characteristics of a Ponzi scheme can include a lack of transparency around how the money invested is handled and the difficulty in getting paid.

Is Bitcoin a Ponzi Scam?

Application of SEC rules

Using the SEC’s definition of a Ponzi scheme, we can see that things don’t quite line up when drawing parallels with bitcoin.

First, there is no “promise” of high rates of return when investing in BTC. Bitcoin has a well-documented history of being a highly volatile asset, with prices on the rise. Y plummeting in very short periods of time. Any expectation of profit, therefore, can be said to be purely speculative and likely based on past asset price performance.

Second, while it’s hard to refute the fact that existing bitcoin investors can profit by selling to new buyers, advances in the decentralized finance (DeFi) sector now allow bitcoin holders to earn rewards on their held assets. through participation. Third, institutional investors have been seen to hold large amounts of bitcoin on their balance sheets as an economic hedge, not simply as a speculative asset.

Addressing the last part of the SEC definition, bitcoin cannot crash in the same way that traditional Ponzi schemes do. The nature of bitcoin trading is such that in order for people to withdraw from the market, they would have to sell their BTC to other investors. In the end, there is no “head” of the pyramid and no base. Instead, you have a standard ledger familiar to anyone with experience in standard financial operations.

Of course, if a large enough number of investors dumped their bitcoins on exchanges and fewer people bought them, prices would naturally fall. However, the BTC that people owned would continue to exist and the network would continue to function as long as a minimum number of volunteers maintaining the network were active. It would not simply dissolve as Bernie Madoff’s infamous Ponzi scheme did in 2008 when investor liquidity fell and Madoff was unable to pay his would-be investors.

getting critical

Critics claim that investors buy bitcoin primarily as a speculative asset that they believe will earn them more money over time. Since new money flows into the market, driving up bitcoin prices and allowing existing investors to sell at a profit, they argue that this satisfies the fundamental component of a Ponzi scheme as defined by them and the SEC.

Many critics also say that because miners can earn newly minted bitcoins for helping protect the network, which they invariably sell on the secondary market to cover operating costs and make a profit, they can make the most money.

But if we take a closer look at these statements, we can see a number of problems.

The claim that an expectation of profit is sufficient to constitute a Ponzi scam fails because all investors buy assets with at least some expectation of a return on their investment. Nobody buys anything with a view to losing money.

However, many retail investors sell bitcoins at a loss during sharp market declines, or remain stuck in the market at prices lower than they originally paid. This can be seen and tracked on block explorers thanks to the completely transparent nature of bitcoin transactions. In other words, there is no promise of profit in the market.

The idea that miners make large amounts of money ignores the fact that mining is a competition that requires a substantial investment of time, money, and equipment. With mining, a single participant is selected to propose a new block and earn rewards every 10 minutes, while the rest of the mining network is left empty-handed.

The rewards earned by miners must be used to cover operating costs before profits can be distributed. Often even the largest teams struggle to break even due to frequent volatile market movements.

Anecdotally, during the first half of 2022, several major mining companies in the United States were forced to sell large amounts of their bitcoin reserves and operating equipment just to stay afloat. Core Scientific Inc., Riot Blockchain Inc. and Marathon Digital Holdings Inc. collectively reported more than $1.3 billion in losses after the bitcoin market plunged 60% in June from its annual opening.

other factors

The exceptionally transparent nature of the Bitcoin blockchain – the system of record used to record all transactions sent over the Bitcoin network – means that anyone can see all the activity taking place at any given time.

A classic Ponzi scheme, on the other hand, must hide or disguise its cash flow to prevent investors from discovering its fraudulent nature.

Also, to prevent the scheme from collapsing, most Ponzi schemes make it difficult to collect. Bitcoin, however, can be traded through a wide range of highly liquid exchanges and peer-to-peer platforms at any time of the day.

Better education may be the key to resolving this longstanding debate. As a new asset class that operates in a completely different way than traditional finance, it’s understandable why many are wary of bitcoin and the nascent technology that powers it. Having overcome a number of technical, regulatory and adoption hurdles during its short lifespan, there is hope that it will become increasingly clear that Bitcoin is not a Ponzi scheme or a fraudulent operation.

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This post Breaking crypto myths: “Bitcoin is a Ponzi scheme”

was published first on https://blog.kraken.com/post/16623/busting-crypto-myths-bitcoin-is-a-ponzi-scheme/

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