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Bitcoin Ponzi scheme: Investors be warned

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5th Feb 2018
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It’s seems odd, amid the swirling techno-mysticism and futurism of cryptocurrency, to hear the phrase ‘Ponzi scheme’ being uttered.

That’s old money, right? Charles Ponzi was a hardscrabble conman way back in the American roaring 20s, after all. But turns out Mr Ponzi’s scheme has more widespread applicability than even he knew.

BitConnect, one the largest bitcoin exchanges (that is, a marketplace), has shut down after numerous allegations of it being a Ponzi scheme. Basically, a Ponzi scheme is a scam where a con artist pays old investors a return generated by the money from new investments.

Despite being named after Charles Ponzi, the scam’s most famous applicant is Bernie Madoff. The scheme works well when it’s constantly being infused with new investment, but when flow stops -- perhaps due to a historic financial crash, as in Madoff’s case -- the scheme falls apart.

BitConnect’s closure seems to conform to this trajectory. The anonymously run exchange focused heavily on customer acquisition. It incentivised investors to promote it in a multi-level marketing structure with an uncanny resemblance to HerbaLife.

Many critics had attacked BitConnect in the past, but its business model was able to withstand any criticism thanks to the historically high prices during the Bitcoin mania that struck late last year.

January has seen a sudden market downturn, however: Bitcoins lost about 40% of their value over the past six weeks. As the American economist Paul Krugman observed, “if bitcoin were an actual currency, that would be the equivalent of a roughly 8,000% annual inflation rate”.

These losses meant BitConnect’s model could no longer sustain itself -- à la the classic Ponzi scheme. The anonymous founder (or founders) behind BitConnect remain defiant though, blaming bad press, cyber-attacks and regulators for the closure.

The excuses will mean little to the investors who have lost their money. To BitConnect’s many long-time critics, it’s yet another harsh reminder that despite its virtual properties, the crypto landscape is as populated by hucksters and charlatans as traditional finance.

If it sounds too good to be true, well, it probably is, Nicholas Gregory, the founder of CommerceBlock, told AccountingWEB. “[Schemes like BitConnect] are no different than someone knocking on your door selling timeshares, there’s no free meal. But people are attracted to that. They’re no better than timeshares or penny stocks.”

The safest inlet into bitcoin, Gregory said, is through the community. “Join the community and spend time understanding it,” he advised. ”There’s no such thing as a free meal.”

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By Justin Bryant
05th Feb 2018 15:02

Warren Buffet summed this bubble up perfectly recently when he said if he could buy a 5 year put option on any crypto currency at current prices he would do so as a no-brainer, but of course no-one is dumb enough to sell you such an option.

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Replying to Justin Bryant:
Francois
By Francois Badenhorst
05th Feb 2018 15:50

Hey Justin, thanks for the comment. Haha yeah, a put option in the crypto market would be a zany bet. Especially with how violently volatile the market seems to be (take Bitcoin's price in January).

More generally, I really like the bit in the Paul Krugman piece where he speaks about Robert Shiller's work "naturally occurring Ponzi schemes": "As Robert Shiller, the world’s leading bubble expert, points out, asset bubbles are like naturally occurring Ponzi schemes. Early investors in a bubble make a lot of money as new investors are drawn in, and those profits pull in even more people. The process can go on for years before something — a reality check, or simply exhaustion of the pool of potential marks — brings the party to a sudden, painful end."

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