Bitcoin is definitely a bubble, but is not a “Ponzi” Scheme, according to a World Bank report by Kaushik Basu, who is a World Bank chief economist and author.
In his new report, titled “Ponzis - The Science and Mystique of a Class of Financial Frauds” Basu makes a distinction between Ponzi schemes and bubble economics, which pushed the price of Bitcoin up sharply based solely on speculation.
“Trouble started when people began speculating that the value of Bitcoin would rise, thereby raising the demand for Bitcoin and making the value-rise a self-fulfilling prophesy. In other words, what we witnessed recently in the Bitcoin phenomenon fits the standard definition of a speculative bubble,” wrote Basu.
In a classic Ponzi scheme, older investors are paid returns based on money that comes from new investors. The situation quickly becomes a game of ‘musical chairs‘ which unravels when the supply of new investors dries up. The term Ponzi scheme came into use after scams by Charles Ponzi where he “promised clients a 50% profit within 45 days, or 100% profit within 90 days” were revealed in the 1920s.
Bitcoin did not follow the same pattern, but was instead a ‘victim‘ of aggressive speculation.
“Contrary to a widely-held opinion, Bitcoin is not a deliberate Ponzi. And there is little to learn by treating it as such,” write Basu flatly.
Unfortunately for some investors the distinctions may not make much of a difference. Bitcoin still requires a fresh supply of investors in order to achieve price appreciation. Many of those who invest in Bitcoin will do so because they perceive an opportunity exists for them to make higher returns than in traditional investments. This could create a ‘naturally occurring Ponzi‘ as Basu referred to in an earlier piece about Bitcoin.
Central banks continue to have a tough time categorizing Bitcoin, primarily because it offers a philosophical divergence from their normal standpoint.
Investors should view Bitcoin as a ‘risky’ investment, but in many ways, the risk is no greater than what most people have become accustomed to in tumultuous stock and real estate markets. There are no guarantees that most investments will provide high returns. Just remember to never invest more than you can afford to lose.
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