Is Crypto a Ponzi Scheme or Worse Than a Ponzi Scheme?

Is crypto a Ponzi scheme? This question arises naturally because of cryptocurrency’s nature and the continued common occurrence of Ponzi schemes. In 2019, overall detected Ponzi schemes in the U.S. rose by 30 percent. In 2020, that figure appeared to have dropped. Still, analysts believe the lower numbers say more about how pandemic interfered with government efforts to detect this type of fraud than any declining popularity with fraudsters.

With the types of fraud that the SEC investigates, for instance, Ponzi schemes still top the list, though they also look into such other nasty activities as fake investment promotions and CDs.

Is Crypto a Ponzi Scheme?

Financial Times published a guest post about the comparison of crypto to Ponzi schemes by a Boston University senior fellow named Robert McCauley. According to McCauley, comparing crypto to Ponzi schemes gives Ponzi schemes a bad rap. He acknowledges the logic of some blockchain experts, like Jorge Stolfi, a computer scientist from Brazil who outlined various characteristics that might apply to a Ponzi and cryptocurrency: 

• Investors buy into the plan with the expectation of making a profit.
• Initially, the project meets expectations by delivering profits to investors who cash out.
• The plan’s management withdraws a large percentage of the profits. The program lacks any mechanism to grow profits beyond new investments.
• The project’s originators scoop up a large portion of the money.

If it’s the original Ponzi scheme by Charles Ponzi or Bernie’s Madoff’s fund, the largest Ponzi scheme in recorded history, these kinds of pyramid frauds eventually suffer from lost confidence and runs, initiating a collapse.

Charles Ponzi’s historical scam lasted less than one year. Madoff’s investment scheme lasted longer, but as of now, investigators have recovered and returned at least 70 percent of the $20 billion invested. Either way, during these two infamous Ponzi schemes, investors did see returns on their investment, and some people cashed out before they fell to recoup their original investments plus profits.

Though some crypto projects pay returns these days, crypto like Bitcoin doesn’t promise earnings. Instead, investors mostly purchase this digital currency to profit when that “asset” increases in value. Thus, the holder has to sell their cryptocurrency to somebody else to benefit. Therefore, holders can’t blame some central figure if they need to sell for a loss or can’t find a buyer.

Why is Crypto Different Than a Ponzi Scheme?

Crypto won’t suffer a run on the scheme’s assets in the way that the most famous examples of Ponzi schemes eventually collapsed. Nobody will investigate the flow of money to track down and help people recover assets without a central authority to blame for the collapse or to claim sovereignty over the actions. A likely trigger for the failure of Bitcoin and other cryptos might come from the so-called stable coins, like Tether, that currently prop up value.

Stable coin organizers told investors they backed their assets with real-world assets, like cash, but subsequent investigations have found these original claims grossly exaggerated. If the bubble bursts for stable coins, expect to see a lot of the air leak out of cryptocurrency as well. Cryptocurrency founders and early investors might have cashed out early with fantastic profits, but the remaining bag holders won’t have a good legal option to pursue their exploiters.

Primarily, crypto and traditional Ponzi schemes differ in critical ways. Bring in leveraged assets, people taking out loans to buy crypto, and the funny business of exchanges selling coins they don’t actually have, and the potential damage moves from limited and possibly recoverable losses of a Ponzi scheme to limitless and probably unrecoverable losses from crypto.

Cryptocurrency: Ponzi Vs. Pump and Dump

So yes, Crypto shares features with Ponzi or pyramid schemes. For instance, the initial asset has no or meager intrinsic value. Increases in monetary value come from new money competing for an artificially scarce investment. Promoters talk it up, and early investors make some profits, driven mainly by new money willing to buy at inflated prices.

Still, careful analysts would probably compare crypto more to a pump and dump penny stock scheme than a Ponzi scheme. In this case, traders buy low-worth to worthless stocks, pump them up by promoting them as more valuable than they are, and then sell high. Sometimes, early investors also get a chance to cash out with a profit. Eventually, the pump deflates, so most investors are left holding worthless bags. 

Is Crypto a Pump and Dump and Not a Ponzi Scheme?

In cryptocurrency’s world, a pump and dump generally goes by the name of a rug pull.  Promoters pump up the value and glamor of their digital tokens, drive up the price, and then sell when they can. Most investors (or suckers) get left with very little or no value at all.

Despite its volatility, Bitcoin hasn’t earned the title of a rug pull, at least, not yet.  Still, the nature of Bitcoin and the other more long-lasting cryptocurrency may explain why pump and dump schemes proliferate this space. Once people accept the value of something without value, it’s hard to tell the difference.