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Is Bitcoin a Ponzi Scheme?

With the dramatic ups and downs seen in the cryptocurrency markets, many investors have become interested in Bitcoin. Some of them ask themselves whether Bitcoin is in fact a Ponzi scheme. We will discuss that here.


What is a Ponzi Scheme

A Ponzi scheme, very similar to a pyramid scheme, is a system in which the profits of existing investors come from the money new investors are putting in.

A common feature of a Ponzi scheme is that profits are usually guaranteed by the people running the scheme. However, the whole thing is a scam. First, because returns cannot be guaranteed.

And second, and most importantly, because the money we invested has not been put into any productive use. It only served to pay off earlier investors. As a result, there is no potential for our money generating any returns.

Let us an example to illustrate it: I invest $,1000 today with the promise of receiving $1,200 within a money. However, my $1,000 has been used to pay off people who had invested before me. The only way for me to receive that $1,200 is by new people coming into the scheme and me receiving their money.

Obviously, those new investors were also promised attractive returns in the future, so more and more investors are needed just to keep the system from collapsing and the scam from being exposed.

Characteristics of a Ponzi Scheme

According to the SEC (Securities and Exchange Commission), the regulating entity in charge of major financial markets in the United States, there are 7 characteristics that most Ponzi scams have. Let us see what those are and if they are applicable to Bitcoin:

1) High returns with little or no risk

While it is true that Bitcoin has historically had very high returns, there has also been a lot of risk. In fact, Bitcoin is an extremely volatile asset, and on multiple occasions, its price has fallen by more than 80%.
Applicable to Bitcoin: No.

2) There are always gains and never losses

As we have just discussed, Bitcoin has suffered several very strong drops since its creation in 2009. Hence, we can either make or lose money investing in Bitcoin.
Applicable to Bitcoin: No.

3) The investment is not officially registered

Because Bitcoin was the first cryptocurrency to be created, and this was over a decade ago, there is little regulation in this regard. However, this is slowly changing as the asset class grows.
Applicable to Bitcoin: Partially, but for logical reasons.

4) Unregistered sellers

If we invest in Bitcoin, we will buy it from someone who is selling it. And once we own the Bitcoin, we are free to sell to whenever we want. There can companies running scams pretending to have Bitcoin to sell without having it, which would be like someone selling fake gold. But Bitcoin is traded by multiple participants in a free market.
Applicable to Bitcoin: No.

5) Complex or opaque investment strategy

It is true that Bitcoin can be difficult for many people to understand. It can be more complex than other more traditional investments. But Bitcoin is not an investment strategy. It is a digital asset, and it is possible for investors to perfectly understand how Bitcoin works.
Applicable to Bitcoin: No.

6) Problems with investment documents

Bitcoin is a digital asset, not an investment strategy, so there are no documents or accounts that we should analyze.
Applicable to Bitcoin: No.

7) Difficulty receiving payments

If we buy Bitcoin, we are free to sell it whenever we want. And, if we sell, we will receive the cash from the buyer directly. If we buy and sell Bitcoin on an exchange, we will have to pay trading commissions, but should have no issues withdrawing our money.
Applicable to Bitcoin: No.

Could we consider Bitcoin a Ponzi Scheme?

Bitcoin is not a Ponzi scam. In fact, we have analyzed the 7 characteristics of a Ponzi scheme, and realized Bitcoin does not fit into the description.

Bitcoin is a digital asset. It is a decentralized network that allows its users to transfer Bitcoin between them. According to the network’s protocol, once all Bitcoins have been mined (there are still a few to be mined), there will only be 21 million of them. And that figure will not increase in the future.

In this sense, the price of each Bitcoin (or fraction of a Bitcoin) reflects the value of that network. If we buy an entire Bitcoin, we know that we own one out of a total of 21 million. Put it differently, our share of the network would be one 21-millionth.

If the price of Bitcoin goes up, it is not because it is a Ponzi scam. It is only because the number of people interested in being part of that network grows. Simple supply and demand. But Bitcoin makes no promises to anyone. And we can certainly lose a lot of money investing in it.

Regardless of whether people buy it because they believe in the future of the network, or simply to speculate and try to make a profit, gains from Bitcoin are no different from those we can make by investing in gold, silver or any other asset.

Both Bitcoin and precious metals are non-productive assets. However, they are assets that many investors want to own because of their characteristics and scarcity.

In fact, even with productive assets, such as stocks and real estate, it is possible to make capital gains if we sell an asset at a higher price than we paid for it. And in such a case no one would think that stocks or real estate are Ponzi schemes. Neither is Bitcoin.

Is Bitcoin a good investment?

That is another discussion. Bitcoin is not a Ponzi scam, but that does not mean everyone should invest in it. The returns it has experienced since it was created have been extraordinary, but there have also been periods of sharp declines. Managing our emotions is key if we want to invest in Bitcoin.

I am not going to recommend that you buy or not buy Bitcoin. The only thing I always recommend, if you are interested in any subject, is that you try to understand and learn as much as possible.

If would like to read about potential future scenarios for Bitcoin, I analyze them in the following post:
What is the Future of Bitcoin? – 6 Possible Scenarios

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Published in Bitcoin


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