I don’t think it’s ever been easier to create or participate in ponzi schemes. The average individual might think that every ponzi scheme is bad, but I always try to look for the silver lining in situations. As far as I can tell, there are just 2.
We know more about how they work and thus can talk about their mechanics within the umbrella of “Ponzinomics” — The economics of Ponzi Schemes
You can take massive risk and make money off of them in the short term.
In this letter, I’m going to talk about my experience of taking part in ponzi schemes. This includes both the times when I’ve lost, and made money.
Ponzi Schemes
Ponzi Scheme — A form of fraud in which belief in the success of a non-existent enterprise is fostered by the payment of quick returns to the earlier investors from money invested by later investors.
There is actually a lot of ambiguity in the above definition. For example, how do you know if you’re early or late to a ponzi scheme? Also, what differentiates a non-existent enterprise from one that does exist?
I’ve pondered the definition of “ponzi scheme” when considering investing in new cryptocurrencies because truth be told, a lot of cryptocurrencies are ponzi schemes.
Are All Cryptocurrencies Ponzi Schemes?
Some would say yes. I would definitely say no. I only need to point to and prove that Bitcoin is not a ponzi scheme to falsify the above statement. Bitcoin is not a ponzi scheme for the following reasons.
Bitcoin is not trying to sell you something. It doesn’t care if you buy it or not, nor does it have the ability to convince you to obtain it.
There is no central actor in charge of bitcoin, or the unit of it (BTC). Therefore there is no central benefactor that would/could extract profits from later investors.
Another way to think about this point is that those who got into gold, silver, or even corn “early” have implemented a ponzi scheme around those commodities.
This is satire and obviously false. Bitcoin is like those things.
All other cryptocurrencies
Every other instance of a cryptocurrency has a founder, a founding team, or a founding company. In almost all instances the founders have issued themselves tokens earlier than everyone else, and at a cheaper price than what the public would then buy it for.
Then, the project founders are incentivized to market and sell the tokens to the public in order to “pump the price”.
Finally, the founders “take profit” or “dump” the tokens on investors that bought the tokens later leaving them holding their bags at a loss.
Exception: Some projects have “vesting periods” for tokens issued to the founding team. While the rules for the vesting period vary, the rules drastically change the answer to the question: is this project a ponzi scheme?
For example, if all of the “founding tokens” are locked for 3 years before they can be sold on the market, then I am more inclined to call this project “not a ponzi scheme”.
Being an Early Investor
One of the perks of having ponzi schemes on the blockchain is everyone can tell when the ponzi scheme started. This makes it really easy to tell if you’re early to the game or not.
If you obtain some tokens in the first round of distribution, then you know you’re an early investor. You can simply look at any block explorer and verify this.
As an early investor, your only job is to make sure you get out of the game before the project collapses.
Honestly, this could happen at any time.
Being a Late Investor
Just because you decided to invest in a project several months after it began doesn’t mean you’re late to the game.
I’d say you’re late if you buy the top after a project has dumped, or you buy the bottom thinking that the project has some merit and you stand to make a ton of money.
In either case, you’ve been duped.
Non-Existent Enterprises
There have been a ton of projects that make a token to sell to investors wherein the project administrators have never had any intention on building the thing they promised.
This is a non-existent enterprise and by far the worst kind of ponzi scheme you can invest in. Not only because the token you bought has no value, but the project didn’t build any technology with the funding (vapourware).
This means there is no hope that that the project will be worth more in the future.
Ponzinomics
Now that we’ve defined what a Ponzi Scheme is, and laid out some of their characteristics, we can talk about the inner workings.
Most tokens (including bitcoin) have one or more of these characteristics built into them. Understanding them is crucial to valuing a project.
Token Burns
Tokens can be removed from supply to increase actual and perceived scarcity of the token.
For example, Ethereum has recently decided to start burning transaction fees which has been decreasing the total supply of tokens in circulation.
All cryptocurrencies have an implicit token burn in the sense that if a user loses the keys to their wallet, the funds are unobtainable and thus the total supply is effectively reduced.
Token burns can happen for any number of reasons, two of which we will cover below.
Incentivized HODLing
Many ponzi coins have incentivized hodling by distributing rewards to people who hold the token the longest.
Most of the time, these “rewards” are minted out of thin air and distributed to token holders.
Whoever is holding a large amount of these tokens can obviously increase their bags pretty quickly. Whoever is holding the largest bag is incentivized to continue earning lots of rewards.
However, at the same time, they’re incentivized to dump knowing they’re going to get killer profits for doing so.
Tokens that earn rewards for holding them usually are proof of stake tokens or governance tokens.
Exception: Proof of stake or governance projects that have an “unstaking” period are further away from being a ponzi scheme.
If a large bag holder wants to dump their tokens on the market, they first have to wait 21 days or longer before they can do so.
People can see when a user wishes to unstake a large amount of tokens giving other holders a heads up that there might be a dump coming.
Disincentivized Dumping
I don’t like disincentivized dumping because if a project is a good project, then I shouldn’t need any disincentive to get rid of it.
The fact that dumping disincentives exist at all is a big red flag for me. However, a project can disincentivize the dumping of tokens in a couple of clever ways. Take SAFEMOON for example.
SAFEMOON will charge a 10% tax when a user wants to sell their tokens. So if a user has $100 worth of SAFEMOON, they will only get to keep 90% of the sold amount.
The other 10% is distributed split into two parts.
5% is burned and 5% is distributed to holders of SAFEMOON as “rewards”.
This is a particularly devious ponzi tactic because it rewards holders for holding longer, and penalizes people for selling.
Despite the fantastic implementation of ponzinomics by SAFEMOON, the chart of the coin still looks like this.
This tells me that no matter how good you’ve designed your ponzinomics, all ponzi schemes fail.
All Ponzi Schemes Fail
I actually love the fact that this is true. It reinforces my other belief in life that “all lies will one day crumble under truth”.
Something that is built with the intention of extracting value from people cannot persist forever. Ponzi schemes are literally designed to fail in this sense. It’s not a matter of if, it’s a matter of when.
Since Ponzi Schemes are designed to extract value, eventually a time is reached when all the value has been extracted from investors. At this time, the project is unlikely to ever be revived.
My Ponzi Escapades
Mrugakshee and I recorded two episodes where we talk about this in detail
In one of these episodes, I talk about investing in a cloud mining ponzi scheme. It was just a textbook ponzi scheme in the sense that I was being promised high returns.
I invested in the middle of the project and got paid out about 60% of my initial investment.
Then one day the payments stopped and the website was offline. I never got the rest of my money back, nor did I go looking for it.
In 2017, I invested in a large number of ponzi schemes because quite frankly, I didn’t know any better. Here are a few (ALIS, SOCIAL, ENV).
I would even say that I was convinced to work for a ponzi scheme for a couple of years, although I was disillusioned at the time. I didn’t want to believe that what I was working on was an unethical money grab; but it was.
Parting Thoughts
If I’ve learned anything, I’ve learned that there is no use in beating yourself up if you’ve found yourself invested in one of these things. Take one of the following two paths.
Ride the ponzi scheme train straight to hell (total loss)
Exit and move on
There really are no other options. Beating yourself up and giving yourself a hard time is not going to help bring your money back, so don’t even think about it.
Investing in a ponzi scheme happens to the best of us, because let’s face it, they’re built so damn well these days.
Lastly, this newsletter wouldn’t be complete if I didn’t shill bitcoin in my parting thoughts. I love Bitcoin because I know for sure that it is not a ponzi scheme.
I know I’m not going to get rug pulled. It’s not vapourware. There was no pre-mine. It was designed with remarkably sound incentives. There are 200 million other people who own it.
I’ve learned now to keep my investments simple. Slow and steady wins the race.
Regards,
Keegan
Resources
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