Just three weeks ago Bitconnect announced it was shutting down after being accused of running a Ponzi scheme. Techcrunch chronicles Bitconnect’s decline noting how the term “pyramid scheme” was not an unfair assessment as to what was going on:
“Bitconnect was an anonymously-run site where users could loan their cryptocurrency to the company in exchange for outsized returns depending on how long the loan was for. For example, a $10,000 loan for 180 days would purportedly give you ~40% returns each month, with a .20% daily bonus. Bitconnect also had a thriving multi-level referral feature, which also made it somewhat akin to a pyramid scheme with thousands of social media users trying to drive signups using their referral code.”
Typically a Ponzi scheme is characterized by first by promising large, unrealistic returns such as the ~40% monthly return. The promise of these sorts of returns largely regarded as both suspicious and impossible, even under even the most aggressive market conditions.
Another point of critique aimed at Bitconnect was the fact that those who sign up for its service are encouraged to share its affiliate marketing and affiliate links. If you look online for any discussion of BitConnect you will find the comments riddled with affiliate links. The reason for this is that those who spread the affiliate links were allegedly to be rewarded with higher returns on their original deposit if the link they posted is later used to sign up a new customer. Best Bitcoin Exchange chronicles how one user is reported to have lost over $400,000 in the demise of Bitconnect. And many others have made a legal challenge in a class-action lawsuit about their losses in this market.
All this, however, begs the question that many of us have been asking for some time: are cryptocurrencies an elaborate Ponzi scheme?
Agustin Carstens, General Manager of the Bank for International Settlements (BIS) has recently denounced bitcoin as “combination of a bubble, a Ponzi scheme and an environmental disaster,” the last point referencing the amount of energy required for mining these currencies. Raising questions about bitcoin’s efficiency and legality and its replicability, querying if the replication of the Bitcoin model would eventually lead to the debasement of all cryptocurrencies rendering them all potentially valueless.
Carstens also points to problems of trust associated with cryptocurrencies: “The tried, trusted and resilient modern way to provide confidence in public money is the independent central bank.” While acknowledging that this currency was intended as an “alternative payment system” he warns that without government surveillance this currency is extremely volatile, “a poor means of payment and a crazy way to store value.” Yet, while Carstens praises the protections that banks extend to consumers and investors, he does this in almost complete oblivion to many of the historical moments when these “protections” utterly failed or were resisted by both Wall Street and the banking system.
Think back to 2008, when millions were hurt by excessive risk-taking leading to financial crisis which was largely chalked up to be the result of the failure from Wall Street to Washington DC where, on the one hand, irresponsible risks were taken, and on the other, Washington didn’t have the authority to properly monitor or limit the potential damage to the nations largest firms. So when the crisis finally hit, there were no tools to address the failing financial system without putting the tax system at risk. The creation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 subjected banks to more stringent regulation by the federal government and held Wall Street accountable for its own mismanagement. Here are the three principle reforms in the Dodd-Frank Act that the Obama administration ushered into law:
Taxpayers will not have to bear the costs of Wall Street’s irresponsibility: If a firm fails in the future it will be Wall Street – not the taxpayers – that pays the price.
Separates “proprietary trading” from the business of banking: The “Volcker Rule” will ensure that banks are no longer allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers. Responsible trading is a good thing for the markets and the economy, but firms should not be allowed to run hedge funds and private equity funds while running a bank.
Ending bailouts: Reform will constrain the growth of the largest financial firms, restrict the riskiest financial activities, and create a mechanism for the government to shut down failing financial companies without precipitating a financial panic that leaves taxpayers and small businesses on the hook.
So where people are reading the financial markets as creatures that are highly regulated, recent history tells quite a different story. Many regard the Dodd-Frank Act as a feeble regulation and most who are familiar with proposed legislation since 2010 which has attempted to challenge the protections to whistleblowers, such as the “Whistleblower Improvement Act” of 2011 which would have required financial industry whistleblowers to report their concerns internally before taking them to government regulators. Thankfully, this bill died, but we cannot pretend that economic regulations in other sectors are significantly better than what is happening in the world of cryptocurrency as many countries have already banned such products and many others already imposing modest regulations and taxation.
As bitcoin price has fluctuated greatly in recent months, we must wonder if this change in appraisal is, even in part, due to how these cryptocurrencies are presented, marketed, and largely uncontrolled by most conventional forms of oversight and regulation. Lionel Laurent has recently drawn an interesting parallel between cryptocurrencies and the S&P futures markets noting: “The past 24 hours have shown a surprising resemblance between Bitcoin’s behavior and the world’s more established financial markets. A chart of Bitcoin’s price plotted against S&P 500 E-Mini futures shows how both moved in similar formation when the selloff reached a trough and a mini-rebound began.” Having analyzed how the bitcoin and S&P 500 Index have a correlation of 0.7 (0 being the weakest and 1 the strongest). Over the past year, this correlation is 0.8. Laurent maintains that the world market fluctuations have shown remarkable resemblance over the period of Monday’s historic losses to the Dow’s 500-plus point gain on Tuesday, noting a particular similarity “when the selloff reached a trough and a mini-rebound began.”
Independent business editor, Josie Cox, has already announced the impending demise of bitcoin and Nouriel Roubini, professor of economics at New York University, claims that bitcoin is “the mother of all bubbles.” And many are couching the cryptocurrency plunge as the beginning of its end with some claiming that it is taking down other currencies with it. Earlier this week, Lloyds Bank has banned the use of its credit cards from purchasing cryptocurrency as have more banks in the UK and the US. But Cox’s notion that “[i]f something’s too good to be true, it probably is” doesn’t really apply to the entire spectrum of financial markets, even far outside the bitcoin sector. At least not in the way that the financial sector wants people to invest in era where everything could easily be characterized as a “bubble.”
Not so many years ago, we heard the same over the dotcom bubble and although there are some significant similarities, there are as many differences between these two paradigms.
And there are as many signs that the crypto bubble will burst as it will not. Eastman Kodak Co. recently signed up for the blockchain which is not an illogical move given that of the 32 publicly traded firms worldwide that use “blockchain” or “crypto” to describe its business, their share prices rose 218,000 percent since January 2016. For example, other sorts of investments like stock in a company with a solid history and leadership, might seem more stable (and often are), history is replete with moments of stock being perilously as unstable as bitcoin.
There are even those speculating that even if cryptocurrency were to fail, it has revolutionized the way investment functions, providing for more transparency and integrity, not less according to the World Economic Forum. And for all the accusations made of bitcoin being a Ponzi scheme, there is still no proof that bitcoin made promises of spectacular profits. To the contrary, many have made and lost money due to the volatility of its price. As for the accusations of bitcoin’s lack of liquidity, the decentralized nature of bitcoins means that there are various ways to sell bitcoins, even if not always convenient.
My verdict here is that cryptocurrency is a “natural” extension of the trading ethos that has existed for decades on Wall Street with a twist: this currency has merely reflected the current human condition by taking on contemporary millennial, anthropomorphic qualities such multi-tasking, lack of attention span, and hyper-emotive personality. Its volatility is not only the sign of the times, it is a litmus test of our economic and ethical responsibility to society.