Trust, But Verify

In the following text, I summarise my thoughts on the persistent and widespread claims comparing Bitcoin to a Ponzi scheme. 

  • Here's a very eloquent article written by Stephen Diehl, a Haskell developer, blogger, and writer. Diehl is no friend of Bitcoin or cryptocurrencies in general. 
  • Nassim Taleb, a mathematician, statistician, and investor, the author of many successful books including The Black Swan, has made similar claims on his Twitter account. Ironically, Taleb is a former Bitcoin advocate. He even penned the foreword of Saifedan Ammous' popular book, “The Bitcoin Standard.” 
  • Recently, in a viral 8 minutes video, TV host Bill Maher mocked and ridiculed Bitcoin, echoing Taleb's claim of an "open Ponzi scheme."

Ponzi schemes thrive on acute information asymmetry and the blind trust put on their operators, who usually enjoy an immaculate or sometimes unverifiable reputation on which they rely heavily to escape public scrutiny. It is this dubious formula combining ignorance and the necessity of trust that makes the dangerous promises of future unrealistic profits credible to incompetent and gullible investors. Ironically, Bitcoin was designed as a trust-less protocol. In other words, it does not rely exclusively on having anyone trusting the other network participants. Bitcoin's elegant implementation of the Proof of Work, its major accomplishment, relies on common knowledge, the shared understanding in which two or more people know something, know that the other one knows, know the other one knows that they know, and so on. With common knowledge, everyone is empowered with the ability to verify, which is why the catchphrase “Trust, but Verify” has become quite popular in the Bitcoin scene. Indeed, anyone can join the network and validate transactions, the software is open-source and available online for all to review. This power for anyone to verify, is an immense deterrent for bad behaviour; it creates an environment where the incentives align and cooperation flourishes.

Ponzi schemes are usually associated with their namesake, Charles Ponzi, or more recently, the late Bernard Madoff. Yet, only few people realise that the biggest Ponzi scheme of all times is run by the State. The Social Security scheme is, by far, the most successful Ponzi scheme in history.

The Ponzi Pyramid
The Ponzi Pyramid

Comparing Bitcoin to a Ponzi scheme is a testament to one’s ignorance of the fundamentals of this novel technology and those purporting such fallacious claims are making the mistake of ignoring the basics of economics. 

It is key to understand that a voluntary transaction between consenting individuals cannot be a zero or negative sum game, on the contrary! If Alice trades one Bitcoin with Bob for $5, $500 or $50,000 or a Tesla, it's because, in this moment, she values the money or the Tesla more than the Bitcoin. Conversely, Bob values the Bitcoin more than his money or Tesla. For this reason, voluntary exchanges are always win-win transactions. Note that here, the transaction is settled immediately, and not in the future as it’s usually the case with Ponzi schemes. 

If we were to accept the affirmation that Bitcoin is a Ponzi scheme on grounds that those buying in allegedly expect to resell later at a higher price, then we would have to apply the same standard to the Real Estate Business, the Stock Exchange, and many other industries. By the same token, all those aspiring to make a profit from a voluntary transaction would de facto have to be labelled as fraudsters. Of course, this cannot be true.

Unlike Ponzi schemes that solely rely on empty promises of unrealistic future profits, with Bitcoin, you trade a good or service for a digital token with an immediate real world utility. In addition, I will argue that Bitcoin, by virtue of its decentralisation, permissionless-ness, censorship-resistance, limited supply and programmability properties, has not only repeatedly proven itself to be a better store of value over the years, but also, in moral and financial aspects, it is a far superior currency. Fiat currencies have a long track record of being extremely vulnerable to excessive inflation, debt, and more recently, negative interest rates. These are silent and insidious mechanisms of non-consensual taxation of the current and future unborn generations. Combined with the Cantillon effect, inflation creates a very unjust and lopsided society in favour of the very powerful few at the top of the social pyramid. Such a model can only arise in the absence of common knowledge.

M1 Money Supply
M1 Money Supply
Checkable Deposits and Currency Held by the 1% and the Bottom 50%
Checkable Deposits and Currency Held by the 1% and the Bottom 50%

Bitcoin has also been accused of being too volatile and therefore, not suitable as a unit of account and/or a means of payment. The claim conveniently ignores that there is a whole economy around miners where payments are made exclusively in Bitcoin. More and more companies accept it in exchange for their products and services (most notably and recently, Tesla.) Plus, with the second layer added on top of the Bitcoin network--the Lightning Network--Bitcoin is now armed with a fully functioning parallel peer-to-peer payment system that is currently being used for micro-payments of various goods at a rapidly increasing scale. The Lightning Network has the potential, on the long term, to rival the Visa payment network and become the backbone of the ‘new Internet.’

Despite all justified enthusiasm, when comparing Bitcoin with Fiat currencies, notably the US Dollar, we need to understand that we are still dealing with a nascent technology that will require several decades to realise its full potential. 

I am not one of those who believe that Bitcoin's success should be measured by its ability to completely replace Fiat currencies or even gold, at least not in the short term, especially because cash still has some advantages, for example when it comes to maintaining one's financial privacy. Rather, I envision a future where the State is deprived of its exclusive monopoly on the emission of money, and where we have several competing private currencies cohabiting symbiotically. Who knows, this could become a reality sooner than we think....

Ponzi Scheme