29 November 2021

The crypto con – why Bitcoin is nothing but a Ponzi scheme


We all want to get rich.

I have a standing order to the lottery, occasionally bet on the Grand National, stay away from poker games, and have £200 invested in a random selection of cryptos on Coinbase to see what happens. Statistics and probability dictate none of these things will make me rich, but we can all hope. If I want to get seriously rich, I will either have to invest very cleverly or invent, innovate and succeed with some new and vital good or service to create my wealth.

Alternatively, I could look to get rich by relieving other people of the burden of their money.

That’s the blunt and brutal truth behind cryptocurrencies. The message is simple – invest early and reap the rewards as the coin inevitably rises. In that respect, it’s no different from the classic Ponzi scheme; a steady flow of new entrants pays off the older members. What ill-informed participants understand is simple: buy and wait for it to rise, and they are ‘on-paper’ rich. Simple. They are urged to HODL (hold on for dear life) to juice up prices of the scarce coins – if everyone is holding in a hot market, then of course prices will rise, and ‘greater fools’ joins the rush to participate because prices are rising.

The greater fool has been a tragic figure through financial history. He’s the guy who buys an over-valued asset hoping he can sell it on to someone even dumber. He was the last man to buy tulips at the height of the frenzy, bought the Southsea Bubble at the top, Railways in 1871, Florida Real-Estate in 1929, Cisco in 1999, and today is wondering whether he should buy Tesla and Ethereum.

Crypto enthusiasts develop something of the religious zealot about them in terms of their belief system. They sincerely believe scarce, digital, decentralised money is so much better than ready cash. The more they are invested, the increasingly confident they become.

The scam works because hopes fuel such devotion. A large and sophisticated ecosystem has now grown up around Crypto – all of which adds to its ‘credibility’. But it’s mostly rubbish; carefully layered nonsense, half-truths, downright lies and bogus statistics designed to support the narrative cryptos can only go higher.

The success of crypto boils down to layering – a term straight out of the regulatory playbook on financial fraud. Layering builds credibility in a con by adding successive stories to the overall narrative to give it credibility. Part of that is the ‘only clever people‘ scam: bitcoin hucksters explain the unexplainable in terms that ‘only really clever can understand this, if you don’t participate, then you are stupid.’ It’s probably the most successful con line in history.

Bingo. It has worked for crypto. Millions of people have bought the dream. Millions of us haven’t asked who is really clever and who is stupid. The young, the impressionable and the greater fools read headlines about digital gold, widespread adoption, hedge funds participating, banks are offering crypto services, well-known investors taking huge positions, and Elon Musk. If these guys are in then it must be real.

I’ve written too many times arguing that crypto is bogus, and is not money. It’s far too volatile to be a store of value, it is scarce and not a unit of account. I could explain why it can’t work as money because it is likely to prove an inflationary accelerant, equivalent to pouring petrol on a fire.

I can understand why people get caught up in the crypto scam. They want to get rich and believe what they read on their social media feeds. But, do they understand it?

Periodically, I delve into the myriad of utter rubbish that masquerades as the blockchain genius, the maths and computing logic behind cryptos. Read it yourself – it’s 10% fascinating and 90% utter garbage. Mathematical dyslexia puked out and dressed up as original thinking and ‘proof of concept’.

Don’t accept my word for it. Go read this article from Bitcoin magazine Why you should care about Taproot, the next major bitcoin upgrade. Explain what a sentence like, ‘A hash is the output of a hashing function, which takes a variable-length input and returns an encrypted result of fixed length,’ means in concise, plain English and why it will make you rich. It’s layering to give credibility to the con, with the added kicker of making you feel stupid if you can’t understand the gibberish!

The primary rule of any investment is very simple: if you don’t understand, don’t invest. Definitionally: something that has to tell you it’s money, isn’t! (Thanks Professor Mark Blyth of Brown University, for that little gem.)

Why has Bitcoin been able to run this long? I suspect it’s because modern life’s sheer bloody misery and lockdowns have made folk more susceptible and gullible. According to a recent FCA press release, ‘young investors are driven by competition and hype’. No Sh*t Sherlock. Who might have possibly thought inexperienced investors are being sold impossible tales of boundless wealth, the value of investible intangible money only really clever people understand, and that companies with zero track record or profits are sure-fire certs?

The FCA commissioned a survey of 1000 investors under 40. They found 75% of younger high-risk investors say they feel competitive when investing in high-risk products. The FCA is investing in a new ‘InvestSmart’ campaign aimed at helping consumers to make better-informed investment decisions.

The survey confirms many uncomfortable truths. Young investors see investment as a game, a gamble, and few regard it as long-term planning for the future. Young investors tend to assume they are protected and don’t understand how their savings are at risk. A majority of young investors say they are driven by competitive pressure from friends, family and acquaintances. 58% say hype on social media informs their investment choices. Only 8% of young investors expect to hold investments for more than five years.

Finally, smart financial eyes will have spotted Invesco has pulled its plans to launch a Bitcoin futures exchange traded fund (ETF) – taking the view regulatory constraints would make it too costly for investors, and suitability issues were not clear. ProShares did launch BITO, their Bitcoin Strategy ETF – and it proved the most successful ETF debut. Invesco might just have figured the reputational risk – what would happen in the event of a crypto crash?

Yet it does amaze me the SEC allowed Bitcoin ETFs based on Bitcoin futures but still won’t allow an actual Bitcoin fund because they consider Bitcoin vulnerable to fraudulent and manipulative acts and practices‘.

I am pretty sure Bitcoin and cryptocurrencies will continue to surprise us all, and that the greater fool is still to be found just around the corner. Cryptos have thrived because social media, the internet and connectivity have made it easy to disseminate the con around the global markets at incredible speed. They’ve succeeded because regulators haven’t stopped them – hat-tip to the Chinese for being ahead of the regulatory pack in that regard.

Someday, the last greater fool will want his money back, and regulators will be exposed for not acting earlier.

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Bill Blain is market strategist and head of alternative assets at Shard Capital. He writes a daily market commentary called The Morning Porridge (www.morningporridge.com).

Columns are the author's own opinion and do not necessarily reflect the views of CapX.