How I’ve Learned to Stop Midwitting and Love the Ponzi
Or how everyone gets Ponzis wrong, especially when talking about crypto.
The word “Ponzi” has an incredibly negative perception in our society due to its association with scams. But I’ve gradually come to a more nuanced understanding of it all. I hope that sharing it here will equip you with the tools to find “good” ponzies and separate them from the “classic” sense of the word.
If you’re curious, Carlo Ponzi was an Italian guy who emigrated to the US and became famous for running an ancient BitConnect. He’d offer “investors” an amazing opportunity to double their money in 30 days by “arbitraging” postal coupons between Italy and the US.
Italian postal coupons were much cheaper, but still provided the same functions as those from the US. The postal coupon scheme may have even had honest beginnings. Like many arbitrage opportunities it supported almost zero volume (basically it required entire boatloads of coupons to work even at the initial scales of the ponzi).
But our boy Carlo here never had any real issue, for a while. People would reinvest any profits they obtained from the scheme and thus kept it going. Eventually it grew to today’s equivalent of about $200 million TVL (inflation-adjusted). His company was called SEC, Securities Exchange Company.
Coincidence?
This was all in 1920, btw. Well before today’s SEC
Modern Ponzis
We may give a lot of flack to our boy Carlo here, but the concept of paying for one’s withdrawal with another person’s deposit is everywhere.
It’s quite ironic that his home country is running a multi-decade Ponzi scheme in the form of its pension fund. For my American friends, pensions in most European countries work on a do ut des basis — you pay pension contributions while working, and when you retire the government returns them to you.
The math works out with a break even point of roughly 20 more years of life. If you live more than that after retiring, the state will likely give you more money than you contributed.
And this is great, right? You don’t need to worry about making good investments and whatnot, you’ll just live out however many years you have left.
The problem comes when you realize that there are no major sovereign wealth funds in Italy. Quite simply, your pension deposit today pays for a boomer’s pension withdrawals. In theory… In practice if the population is growing, a chunk of it can go to fund the Italian state.
The system was introduced in 1967, because of course it was.
Italy’s pension fund is just one of many such Ponzis. And calling it like that makes it all sound like a scam, like the government is screwing over its people by deferring the eventual judgement day.
It is, don’t get me wrong.
But if that graph turned out to be flat or rising in the future, the Ponzi would hold. Because even if the underlying mechanism is the same, the pension fund still relies on a core of real value, and it plays a realistic gamble. We could even apply a kind of formal definition:
Ponzi: misleading deposit-for-withdrawal scheme, has no chance/desire to stabilize.
Investment: deposit-for-withdrawal gamble, high-risk maneuver with realistic stabilization path.
Wait, what?
Ponzis truly are all around us. People like to cite examples such as the South Sea stock bubble and the Tulip craze as historic examples of them, often to draw parallels with crypto. Yet stock investment and commodities are still here with us, what gives?
The difference between Ponzi and Investment is one of parameters and quantities, not fundamentals.
In other words, the difference between South Sea and Facebook stock only lies in how realistic it is that after X time, there will be a depositor who will cover 100% of your withdrawal by buying your stock.
For a crypto example, the difference between staking ETH and farming an “efficient Pool 2 with no impermanent loss” (i.e. buying AMPL, staking OHM) is simply in the percentage of dilution.
For ETH, the staking return is relatively low, so the effect of people depositing money into ETH only to withdraw staking returns is weak. For AMPL, this effect defines 95% of its price action. So AMPL is a Ponzi, but only because of its enormous rebase yield and the fact that it is utterly and completely useless for anything else (Don’t think AMPL is unique in this regard though).
Are ETH or Bitcoin Ponzis?
That’s a great question.
Ponzis that turn into Investments
You know how crypto does nothing except for being tradable? Yeah sure decentralized payments, great. Try to live off crypto and tell me how that went. And how much you’ve spent in transaction fees.
Payments were the initial promise of crypto, the main narrative driver. That changed over time to the point where the most widespread coins just can’t be used for anything that is not related to trading or supporting the trading industry. Trading and buying crypto assets in the hopes of the number going up is literally the only source of income for the entire industry.
This used to be painful to see. Crypto in 2021 was all ponzis of some form. Almost no aspiration if not for serving future ponzis to come, or whatever.
But now I gradually accepted the way of the Ponzi, and here is why.
The Great Experiment
The problems of using crypto for payments I outlined above are caused by two factors:
Lack of usage and network effects
Insufficiently advanced technology
These factors existed ever since Bitcoin’s genesis block and continue to this day. A trillion dollar industry has been unable to solve its fundamental problems in over 10 years.
Do you think there was ever a chance it could be solved by 20 people lurking on Bitcointalk?
The speculation and the innumerable Ponzis that got us here (starting from the OG, Bitcoin) made crypto into a $1 trillion slush fund (maybe less now but I feel optimistic). It now has the resources to solve all its problems and provide real value to its users, and that value can go well beyond the initial vision of digital cash.
Without the Ponzi, it would’ve been impossible to devote the hundreds of millions of dollars we are spending to improve blockchain throughput, reach adoption with mainstream payment rails, and get people to learn and love crypto.
It just can’t happen without money, or at least a promise of making more money.
I’ve often mused about this dichotomy between traditional startups and crypto. In startup land, you work and build a product until you get to exit and dump on a “greater fool” some years later. You build products to reach markets.
In crypto, you build markets to build products.
The fact that most crypto products are a ponzi of some form is kind of a feature, not a bug. It helps bootstrap value and fund the next big thing. Even those in crypto who publicly condemn the ponzis have often gotten to where they are with one.
But here, we need to add an important disclaimer:
If you think the ponzi is all there is to making a successful crypto project, you’re in for a rough ride.
Ponzis all collapse if they can’t build the railway in front of them fast enough.
Look, Ponzis are an efficient funding mechanism, all power to you for raising tons of cash. But after you’re done celebrating, you’ve got to build something. Indeed, it’s better if you have a good idea of what you’re building before you begin the Ponzi. You won’t have much time to stumble your way through shit ideas afterward.
P.S. I finally mustered the time and courage to post something on this newsletter. I promise that it will be absolutely irregular, random and sometimes controversial. Subscribe at your own peril.