A growing number of commentators are noting that investing in a crypto-asset, such as, for example bitcoin or stablecoin is in reality no different to investing in a 'get rich quick' Ponzi scheme. Its noted that decentralised finance (DeFi) based on blockchain technology has created a massive shadow banking system. There are signs that this industry unfolds as interest rates increase. 

Following the EU's plans to licence cryptocurrency companies, the UK has launched an inquiry into the Crypto-asset industry. The question is whether they are too late to regulate DeFi?

A Ponzi scheme?

Ponzi scheme is a pyramid scheme under which no cash is generated by the scheme's investments, it operates on the basis that investors are 'rewarded' with cash that is invested in people below them in the chain. Once people stop investing the scheme crashes as there is no longer any source of cash to reward those higher in the chain. The first people in a Ponzi scheme may do well, but the last to invest lose their cash. 

Your ability to make a profit on your investment of a crypto-asset such as say, bitcoin depends purely on your ability to sell it at a price greater than you paid for it. Your investment is incapable of creating money profits in its own right as cash inflow is entirely the cash paid by the person who buys your crypto-asset from you.

Of course, you can also make money from crypto-assets by scamming others in a simple 'pump and dump' rouse, phishing or just disappearing. Software developer Molly White's timeline/blog. Web3 is Going Just Great records on a daily basis, "Only some of the many disasters happening in crypto, decentralized finance and non-fungible tokens". At the time of writing this, she has logged tens of billions of dollars in crypto failures. News agency Bloomberg in writing about the recent failure of crypto lender Celcius put the cost of the ongoing financial crash at some £2 trillion to date.

Isn't crypto just like any other investment?

No. Unlike what we would normally think of as investments, the only asset in the term 'crypto-asset' is the hope value that its owner maintains. Its value depends on how effective the marketing is for the next 'get rich quick' scheme.

Although an investment is an asset that you purchase in order to generate either income or capital or both, there are some fundamental differences. If you invest in say currency, such as a $, Euro or £1 that currency is backed up by the relevant government's reserves. An investment in a share in a company provides you with an actual stake in that company: allowing you to participate in profits or capital as a shareholder. An investment in fine wine, precious metals or land and property provides you with ownership of that underlying tangible asset. An investment in a non-fungible digital artwork gives you both ownership of the artwork (however generated) and its source code.

An investment in say bitcoin, provides you with a chunk of code in a blockchain ledger. That chunk of code does no more than exist on that ledger, it has no other intrinsic value other than hope value. You hope that someone will keep talking up the value of the code so you can sell it for more than you paid for it. You cannot insure it, it will also be worthless in the event of a power failure. 

Are not many crypto-asset launches just like High-Yield Investment Programmes (HYIP)?

Yes.  A High-Yield Investment Programme (HYIP) is (according to Wikipedia), "Aa type of Ponzi scheme, an investment scam that promises unsustainably high return on investment by paying previous investors with the money invested by new investors." It's impossible not to draw comparisons, just look at some of the examples in Molly's Web3 timeline

But, isn't blockchain infallible?

No, aside from the crippling power costs that it takes to maintain the algorithms whirring in its distributed ledger, cryptoassets operate as decentralised assets. There is supposed to be transparency in blockchain technology. The trouble is that blockchain is not transparent and due to the mixing of deposits, in the event of fraud or collapse of your wallet provider you will never ‘find’ your transactions. Few truly understand the technology and the unregulated nature of DeFi has created what can only be described as a new shadow banking system.

What about stablecoins?

Stablecoins are supposed to be crypto-assets that are allegedly backed up by other assets, their supply might be set by algorithms, depending the type of crypto-asset. Ignoring the fact that it might therefore be a lot more logical to ignore the stablecoin and just simply invest in the other assets, the stablecoin is purely a vehicle to create ever more complex derivatives. The derivatives of crypto-assets are potentially even more volatile than the underlying asset: who remembers sub-prime loans and the effect of mass default on the financial system in 2009?

Who also shares these views?

It really is the 'Wild West' out there: type 'crypto Ponzi scheme', 'crypto failure', 'stablecoin failure' or 'DeFi shadow banking' into any search engine for current results.

"EU agrees to tame 'Wild West" Cryptocurrency companies will need a licence and customer safeguards to issue and sell digital tokens in the European Union under groundbreaking new rules agreed by the bloc to tame a volatile "Wild West" market.
Reuters News, July 1

"Investing in crypto is just like what investing in Madoff's fund in the 1990s would have been --- if he had openly admitted, since the beginning, that there was no portfolio, no stock or options trading, not even a small cash reserve."
Jorge Stolfi @JorgeStolfi on Twitter. Jorge Stolfi is Computer Science professor, State University of Campinas (UNICAMP). The negative opinion of this computer science professor motivated more than 1,500 experts to send a letter to the US Congress to warn about the risks of cryptocurrencies.

"A Ponzi scheme is a zero-sum enterprise. But bitcoin is a negative-sum phenomenon that you can’t even pursue a claim against." 
https://www.ft.com: Robert McCauley, a non-resident senior fellow at Boston University’s Global Development Policy Center and an associate member of the Faculty of History at the University of Oxford.

“The distinction between bitcoin and other tokens is inconsequential so long as they share the same underlying economic structure of peddling a get-rich-quick investment based on technical obscurantism. The only distinction is that other crypto assets simply have different wealth redistribution mechanisms and different externalities they dump on society for their continued existence. The economics of cryptocurrency are fundamentally unsound, and the story is as old as the Ponzi scheme itself: money for nothing out of nothing, just get in early and don’t ask where it comes from.

Latest research from HMRC

  • In July 2022 the UK government has published some research into Individuals holding crytoassets: uptake and understanding.
  • Ownership of crypto assets is most lijkely to be by young men in Asian and Black ethnic groups. Most people surveyed hold less than £100 in assets, although the same number preferred not to provide details of their holdings.
  • A key reason for holding cryto is as  ‘fun investment’. A point that I take as not unsurprising based on the fact that every time you buy crypto you are betting that the market will go up and the market is so volatile that no one can really predict what it will do next.

External links:
 Treasury Select Committee's inquiry into the Crypto industry and HMRC's consultation, 'The taxation of Decentralised Finance involving the lending and staking of cryptoassets – call for evidence'

HMRC's research findings on Individuals holding crytoassets: uptake and understanding.


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