What do you do with memecoins? Apparently you collect them, says the SEC

I have no idea if memecoins like dogecoin and fartcoin should be legally defined as securities, and thus come under the purview of securities regulators like the Securities Exchange Commission (SEC). Securities law is confusing. But what I do know is that the SEC's latest notion that memecoins are simply "collectibles" that people buy for "entertainment, social interaction, and cultural purposes" is naive, even dangerous.

Here is the SEC's statement:

Source: SEC

The SEC's wording is dangerous because it effectively whitewashes memecoins into the same relatively benign social-economic bucket as baseball cards, postage stamps, and Roman coinage. Memecoins don't belong there. Dogecoin and its ilk are not collectibles—they belong to the same bin (a much more dangerous bin!) as HYIPs, chain letters, ponzis, bubbles, MLMs, memestocks, lotteries, pump and dumps, and casino games. 

I don't think I'm alone in saying that I'd be okay if my 11-year old kid wanted to carefully build a collection of culturally-significant items they could fuss over after school. Comic books? Pokemon cards? Fossils? Sure, that's all good. But I'd be appalled if they went to a casino to play slots or threw away their allowance for HYIPs and MLMs. By characterizing memecoins as mere collectibles, and not as the gambling/ponzis devices they actually are, the SEC is anointing them as suitable for everyone, including our kids. It's gross that any government agency would do this.

To me the differences between memecoins and collectibles are obvious, but for those still reading, including anyone at the SEC, here's my logic:

Almost no one buys memecoins with the same earnest obsessiveness as a collector. Spend any amount of time in ancient coin collecting forums and you'll see what a true collecting mentality looks like, the immense amounts of sifting, classification, and curation that it entails, and the knowledge of cultural minutiae: "Why is Constantine II facing left on this coin, but facing forward on in this one?" By contrast, dogwifhat, SPX6900, $Trump, Pepe, Shiba Inu and other memecoins don't toggle the same grading and taxonomizing parts of our brains, nor do they invoke our instincts to build complete sets of culturally meaningful items. It's just frenetic buying, selling and number-go-up. And that's because ancient Roman coins and memecoins are fundamentally different economic goods. Memecoins are for the most part pure financial gambles with a facade of culture. Roman coins are cultural objects to the core, with a touch of financialization.

As its justification for classifying memecoins as collectibles, the SEC relies on the fact that memecoins are "inspired by internet memes, characters, current events, or trends." Think Dogecoin's shiba inu theme, or fartcoin's fart meme. This somehow uplifts them into having the status of cultural artifacts.

This is silly. If you read about the history of chain letters, for instance, you'll see that their originators often linked their letters to some sort of theme or meme. Even so, we would never say that chain letters are collectors items. Las Vegas slot machines often have themes (i.e. fruit, El Dorado City of Gold, or ancient Egypt), but let's not fool ourselves: having a theme doesn't transform a slot machine into something other than a slot machine.

No, memecoin buyers—like chain letter participants and slot machine players—want to make money, quickly. Plain and simple. That a get-rich-scheme adopts a meme doesn't redeem or transform that scheme into a collectible. The meme is a mere superficiality that serves to differentiate one gambling machine from another. It's not something that most buyers actually believe in.

I get that the line between collectibles and speculation isn't always clear—sometimes an item can be both. I lived through the early 1990s comic book collecting boom, and I can tell you that things got a little ponzi-ish. When 14-year old me bought all five covers of X-Men #1, I was only 50% motivated by a collector's maniacal desire to complete a set, the other 50% being a gamble on price. However, at the end of the day policy requires us to draw lines and make categories. For the most part, comic books have functioned as collectibles, not gambling, and deserve to be classified as such, and thus regulated as such. As for memecoins, while there are probably a few people who diligently collect sets of memecoins, for the most part they are all gambling and ponzi-ishness. And that's how they should be treated by policy makers—not as mere postage stamps.  

I'm not saying the SEC should be in charge of overseeing memecoins. If the SEC wants to wipe its hands clean of memecoins, that's fine, I guess. Some other agency will have to take charge. But why is the SEC whitewashing memecoins as it is exiting the building? By using its platform to advertise memecoins as mere collectibles, the SEC just made them seem harmless. That's reckless.

After twelve years of writing about bitcoin, here's how my thinking has changed

What follows is an essay on how my thinking on bitcoin has changed since I began to write on the topic starting with my first post in October 2012. Since then I've written 109 posts on the Moneyness Blog that reference bitcoin, along with a few dozen articles at venues like CoinDesk, Breakermag, and elsewhere.

An early bitcoin optimist

I was excited by Bitcoin in the early days of my blog. The idea of a decentralized electronic payment system fascinated me. Here's an excerpt from my second post on the topic, Bitcoin (for monetary economists) - why bitcoin is great and why it's doomed, dated November 2012:

"Bitcoin is a revolutionary record-keeping system. It is incredibly fast, efficient, cheap, and safe. I can send my Bitcoin from Canada to someone in Africa, have the transaction verified and cleared in 10 minutes, and only pay a fee of a few cents. Doing the same through the SWIFT system would take days and require a $35 fee. If I were a banker, I'd be afraid." [link]

I was relatively open to Bitcoin for two reasons. First, I like to think in terms of moneyness, which means that everything is to some degree money-like, and so I welcome strange and alternative monies. "If you think of money as an adjective, then moneyness becomes the lens by which you view the problem. From this perspective, one might say that Bitcoin always was a money," I wrote in my very first post on bitcoin. Second, prior to 2012 I had read a fair amount of free banking literature—the study of private money—so I was already primed to be receptive to a stateless payments system, which is what Bitcoin's founder, Satoshi Nakamoto, originally meant his (or her) creation to be. 

A lot of bitcoin-curious, bitcoin-critics and bitcoin-converts were attracted to the comments section of my blog, and we had some great conversations over the years. My bitcoin posts invariably attracted more traffic than my non-bitcoin ones, all of us scrambling to understand what seemed to be a newly emerging monetary organism.

My early thoughts on the topic were informed by having bought a few bitcoins in 2012 for the sake of experimentation, some of my earlier blog posts describing how I had played around with them. In 2013 I wrote about the first crop of bitcoin-denominated securities market (which I dabbled in)—predecessors to the ICO market of 2017. I also used my bitcoins to buy altcoins, including Litecoin, and in late 2013 wrote about my disastrous experience with Litecoin-denominated stock market speculation. In Long Chains of Monetary Barter I described using bitcoin as an exotic bridging currency for selling XRP, a new cryptocurrency that had just been airdropped into the world. I didn't notice it at the time, but in hindsight most of these were instances of bitcoin facilitating illegal activity, i.e. unregistered securities sales, which was an early use case for bitcoin.

Although Bitcoin excited me, I was also critical from the outset, and in later years my critical side would only grow, earning me a reputation among crypto fans as being a salty no-coiner. In a 2013 blog post I grumbled that playing around with my stash of bitcoins hadn't been "as exciting as I had anticipated." Unlike regular money, there just wasn't much to do with the stuff, my coins sitting there in my wallet "gathering electronic dust."

 "...the best speculative vehicles to hit the market since 1999 Internet stocks."

What my experimentation with bitcoin had taught me was that the main reason to hold "isn't because they make great exchange media—it's because they're the best speculative vehicles to hit the market since 1999 Internet stocks." But that wasn't what I was there for. What had tantalized me was Satoshi's vision of electronic cash, a revolutionary digital payments system. Not boring old speculation.

In addition to my practical complaints about bitcoin, I also had theoretical gripes with it. The "lethal" problem as I saw it back in my second post in 2012 is that "bitcoin has no intrinsic value." Over the next decade this lack of intrinsic value, or fundamental value, would underly most of my criticisms of the orange coin. Back in 2012, though, the main implication of bitcoin's lack of intrinsic value was the ease by which it might fall back to $0. As I put it in a 2013 article:

"Bitcoin is 100% moneyness. Whenever a liquidity crisis hits, the only way for the bitcoin market to accommodate everyone's demand to sell is for the price of bitcoin to hit zero—all out implosion" [link]

But if the price of bitcoin were to fall to zero then it would cease to operate as a monetary system, which would be a huge disappointment to those of us who were fascinated with Satoshi's electronic cash experiment. Adding to the danger was the influx of bitcoin lookalikes, or altcoins, like litecoin, namecoin, and sexcoin. In theory, the prices of bitcoin and its competitors could "quickly collapse in price" as arbitrageurs create new coins ad infinitum, I worried in 2012, eating away at bitcoin's premium. The alternative view, which I explored in a 2013 post entitled Milton Friedman and the mania in copy-paste cryptocoins,  was that "the earliest mover has superior features compared to late moving clones," including name brand and liquidity, and so its dominance was locked-in via network effects. Over time the latter view proved to be the correct one.

The "zero problem"

Despite my worries, I was optimistic about bitcoin, even helpful. One way to stop bitcoin from falling to zero might be a "plunge protection team," I offered in 2013, a group of avid bitcoin collectors that could anchor bitcoin's price and provide a degree of automatic stabilization. In a 2015 post entitled The zero problem, I suggested that bitcoin believers like Marc Andreessen should consider donating $21 million to a bitcoin stabilization fund, thus securing a price floor of $1 in perpetuity. 

No fan of credit cards, in a 2016 post Bitcoin, drowning in a sea of credit card rewards, I suggested that bitcoin activists encourage retailers that accept bitcoin payments to offer price discounts. This carrot would put bitcoin on an even playing field with credit card networks, which use incentives like reward points and cashback to block out competing payment systems.

My growing disillusionment

By 2014 or 2015, I no longer saw much hope for bitcoin as a mainstream payments system or generally-accepted medium-of-exchange. "For any medium of exchange to displace another as a means for buying stuff, users need come out ahead. And this isn't happening with bitcoin," I wrote in a 2015 post entitled Why bitcoin has failed to achieve liftoff as a medium of exchange, pointing to the many costs of making bitcoin payments, including commissions, setup costs, and the inconveniences of volatility.

In another 2015 post I focused specifically on the volatility problem, which stems from bitcoin's lack of intrinsic value. If an item has an unstable price, that militates against it becoming a widely used money. After all, the whole reason that people stockpile buffers of liquid instruments, or money, is that these buffers serve as a form of insurance against uncertainty. If an item's price isn't stable—which bitcoin isn't—it can't perform that role. 

Mind you, I did allow in another 2015 post, The dollarization of bitcoin, that bitcoin might continue as "an arcane niche payments system for a community of like minded consumers and retailers." I even tracked some of these arcane payments use cases, such a 2020 blog post on retailers of salvia divinorium (a legal drug in many U.S. states) falling back on bitcoin for payments after the credit card networks kicked them off, followed by a 2021 post on kratom sellers (a mostly-legal substance) doing the same. But let's face it, a niche payments system just wasn't as impressive as Satoshi's much broader vision of electronic cash that had beguiled me in 2012, when I had warned that "if I was a banker, I'd be afraid." 

The dollarization of bitcoin

By 2015 a lot of my pro-bitcoin blog commenters began to see me as a traitor. But I was just changing my thinking with the arrival of new data.

Searching for Bitcoin-inspired alternatives: Fedcoin and stablecoins

Bitcoin's deficiencies got me thinking very early on about how to create bitcoin-inspired alternatives. By late 2012 I was already thinking about stablecoins:

"What the bitcoin record-keeping mechanism needs is an already-valuable underlying asset to which it can be tethered. Rather than tracking, verifying, and recording the movement of intrinsically worthless 1s and 0s, it will track the movement of something valuable." [link]

Later, in 2013, I speculated about the emergence of "stable-value crypto-currency, not the sort that dangles and has a null value." These alternatives would "copy the best aspects" of bitcoin, like its speed and safety, but would be linked to "some intrinsically valuable item." A few months later I predicted that "Cryptocoin 2.0, or stable-value cryptocoins, is probably not too far away." This would eventually happen, but not for another few years.

My dissatisfaction with bitcoin led me to the idea of decentralized exchanges, or DEXs, in 2013, whereby equity markets would "adopt a bitcoin-style distributed ledger." That same year I imagined central banks adapting "bitcoin technology" to run its wholesale payments system in my post Why the Fed is more likely to adopt bitcoin technology than kill it off. In 2014 I developed this thought into the idea of Fedcoin, an early central bank digital currency, or CBDC, for retail users.

If not money, then what is bitcoin?

By 2017 or so, even the most ardent bitcoin advocates were being forced to acknowledge that Satoshi's electronic cash system was not panning out: the orange coin was nowhere near to becoming a popular medium-of-exchange. This was especially apparent thanks to a growing body of payments surveys (which I began to report on in 2020) showing that bitcoin users almost never used their bitcoins to make payments or transfers, preferring instead to hoard them. So the true believers pivoted and began to describe bitcoin as a store-of-value, or digital gold. It was a new narrative that glossed over Satoshi's dream of electronic cash while trying to salvage some monetary-ish parts of the story.

I thought this whole salvage operation was disingenuous. In 2017 I wrote about my dissatisfaction with the new store-of-value narrative, and followed that up with a criticism of the digital gold concept in Bitcoin Isn’t Digital Gold; It’s Digital Uselesstainium. (The idea that store-of-value is a unique property of money is silly, I wrote in 2020, and we should just chuck the concept altogether.)

But if bitcoin was never going to become a generally-accepted form of money, and it wasn't a store-of-value or digital gold, then what exactly was it? 

I didn't nail this down till a 2018 post entitled A Case for Bitcoin. We all thought at the outset that bitcoin was a monetary thingamajig. But we were wrong. Of the types of assets already in existence, bitcoin was not akin to gold, cash, or bank deposits. Rather, it was most similar to an age-old category of financial games and zero-sum bets that includes poker, lotteries, and roulette. The particular sub-branch of the financial game family that bitcoin belonged to was early-bird games, which contains pyramids, ponzis, and chain letters. Here is a taxonomy:

A taxonomy showing bitcoin as a member of the early-bird game family

Early-bird games like pyramids, ponzis, and chain letters are a type of zero-sum game in which early players win at the expense of latecomers, the bet being sustained over time by a constant stream of new entrants and ending when no additional players join. Pyramids and ponzis are almost always administered by thieves who abscond with the pot. Bitcoin, by contrast, was not a scheme nor a scam. And it was not run by a scammer. It was leaderless and spontaneous, an "honest" early-bird game that hewed to pre-set rules. Here is how I described it in a later post, Bitcoin as a Novel Financial Game:

"Bitcoin introduces some neat features to the financial-game space. Firstly, everyone in the world can play it (i.e., it is censorship-resistant). Secondly, the task of managing the game has been decentralized. Lastly, Bitcoin’s rules are automated by code and fully auditable." [link] 

This ponziness of bitcoin was actually a source of its strength, I suggested in 2023, because "it's tough to shut down a million imaginations." By contrast, if bitcoin had an underlying real anchor, like gold, then that would give authorities a toe hold for decommissioning it.

Bitcoin-as-game gave me more insight into why most bitcoin owners weren't using bitcoin as a medium-of-exchange. Its value as a zero-sum bet was overriding any functionality it had for making payments. In a 2018 post entitled Can Lottery Tickets Become Money?, I worked this out more clearly:

"Like Jane's lottery ticket, a bitcoin owner's bitcoins aren't just bitcoins, they are a dream, a lambo, a ticket out of drudgery. Spending them at a retailer at mere market value would be a waste given their 'destiny' is to hit the moon." [link]

If bitcoins weren't like bank deposits or cash, how should we treat them from a personal finance perspective? Feel free to play bitcoin, I wrote in late 2018, but do so in moderation, just like you would if you went to Vegas. "Remember, it's just a game."

Bitcoin is innocuous, don't ban it

By 2020 or 2021, the commentary surrounding bitcoin seemed to be getting more polarized. As always there was a set of hardcore bitcoin zealots who thought bitcoin's destiny was to change the world, of which I had been a member for a brief time in 2012. But arrayed against them was a new group of strident opponents who though bitcoin was incredibly dangerous and were pushing to ban it.

A vandalized 'Bitcoin accepted' sign in my neighborhood

I was at odds with both sides. Each saw Bitcoin as transformative, one side for the good, the other for the bad. But I conceived of it as an innocuous gambling device, one that only seemed novel because it had been transplanted into a new kind of database technology, blockchains. We shouldn't ban bitcoin for the same reason that we've generally become more comfortable over the decades removing prohibitions on online gambling and sports betting. Better to bring these activities into the open and regulate them than leave them to exist in the shadows.

Thus began a series of relax-don't-ban-bitcoin posts. In 2022, I wrote that central bankers shouldn't be afraid that bitcoin might render them powerless. For the same reason that casinos and lotteries will ever be a credible threat to dollar's issued by the Fed or the Bank of Canada, neither will bitcoin.

Illicit usage of bitcoin was becoming an increasingly controversial subject. Just like casinos are used by money launderers, bitcoin had long become a popular tool for criminals, the most notorious of which were ransomware operators. My view was that we could use existing tools to deal with these bad actors. Instead of banning bitcoin to end the ransomware plague, for instance, I suggested in a 2021 article that we might embargo the payment of ransoms instead, thus choking off fuel to the ransomware fire. Alternatively, I argued in a later post that the U.S. could fight ransomware using an existing tool: Section 311 of the Patriot Act. Which is what eventually happened with Bitzlato and PM2BTC, two Russian exchanges popular with ransomware operators that were put on the Section 311 list.    

Nor should national security experts be afraid of enemy actors using bitcoin to evade sanctions, I wrote in 2019, since existing tools, in particular secondary sanctions, are capable of dealing with the threat. The failure of bitcoin to serve as an effective tool for funding the illegal Ottawa protests, which I documented in a March 2022 article, only underlined its low threat potential:

"Governments, whether they be democracies or dictatorships, are often fearful of crypto's censorship-resistance, leading to calls for bans. The lesson from the Ottawa trucker convoy and Russian ransomware gangs is that as long as the on-ramping and off-ramping process are regulated, these fears are overblown." [link]

Other calls to ban bitcoin were inspired by its voracious energy usage. In a 2021 blog post entitled The overconsumption theory of bitcoin, I attributed bitcoin's terrible energy footprint to market failure: end users of bitcoin don't directly pay for the huge amounts of electricity required to power their bets, so they overuse it. No need to ban bitcoin, though. The way to fix this particular market failure is to introduce a Pigouvian tax on buying and/or holding bitcoins, which I described more clearly in a 2021 blog post entitled A tax on proof of work and a 2022 article called Make bitcoin cheap again for cypherpunks! 

Lastly, whereas bitcoin's harshest critics have been advocating a "let it burn" policy approach to bitcoin and crypto more generally, which involved leaving gateways unregulated and thus toxic, I began to recommend regulating crypto exchanges under the same standards as equities exchanges in a 2021 article entitled Gary Gensler, You Should be Watching How Canada is Regulating Coinbase. Yes, regulation legitimizes a culture of gambling. But even Las Vegas has stringent regulations. A set of basic protections would reduce the odds of the betting public being hurt by fraudulent exchanges. FTX was a good test case. After the exchange collapsed, almost all FTX customers were stuck in limbo for years, but FTX Japan customers walked out unscathed thanks to Japan's regulatory framework, which I wrote about in a 2022 post Six reasons why FTX Japan survived while the rest of FTX burned.  

So when does bitcoin get dangerous?

What I've learnt after many years of writing about bitcoin is that it's a relatively innocuous phenomena, even pedestrian. When it does lead to bad outcomes, I've outlined how those can be handled with our existing tools. But here's what does have me worried. 

If you want to buy some bitcoins, go right ahead. We can even help by regulating the trading venues to make it safe. But don't force others to play.

Whoops, You Just Got Bitcoin’d! by Daniel Krawisz

Alas, that seems to be where we are headed. There is a growing effort to arm-twist the rest of society into joining in by having governments acquire bitcoins, in the U.S.'s case a Strategic Bitcoin Reserve. The U.S. government has never entered the World Series of Poker. Nor has it gone to Vegas to bet billions to tax payer funds on roulette or built a strategic Powerball ticket reserve, but it appears to be genuinely entertaining the idea of rolling the dice on Bitcoin.  

Bitcoin is an incredibly infectious early-bird game, one that after sixteen years continues to find a constant stream of new recruits. How contagious? I originally estimated in a 2022 post, Three potential paths for the price of bitcoin, that adoption wouldn't rise above 10%-15% of the global population, but I may have been underestimating its transmissibility. My worry is that calls for government support will only accelerate as more voters, government officials, and bureaucrats catch the orange coin mind virus and act on it. It begins with a small strategic reserve of a few billion dollars. It ends with the Department of Bitcoin Price Appreciation being allocated 50% of yearly tax revenues to make the number go up, to the detriment of infrastructure like roads, hospitals, and law enforcement. At that point we've entered a dystopia in which society rapidly deteriorates because we've all become obsessed on a bet.

Although I never wanted to ban Bitcoin, I can't help but wonder whether a prohibition wouldn't have been the better policy back in 2013 or 2014 given the new bitcoin-by-force path that advocates are pushing it towards. But it's probably too late for that; the coin is already out of the bag. All I can hope is that my long history of writing on the topic might persuade a few readers that forcing others to play the game you love is not fair game.

Why bitcoiners should learn to accept bitcoin's ponzi nature as a good thing

When I describe bitcoin as a type of ponzi or pyramid, idealistic bitcoiners usually view this as an attack on the nobility of the bitcoin project. But they shouldn't. Bitcoin's ponzi nature is one of its greatest strength.

Imagine that you are trying to bootstrap an unorthodox and potentially illegal asset, one that you are marketing (or mis-marketing) to the world as a new monetary system. The standard way to get your asset to have a positive price is to have some funds in a vault somewhere and then link that new asset to whatever is held in the vault. Examples include failures like e-Gold and Liberty Reserve. Neal Stephenson's gold-backed currency in Cryptonomicon is another that followed this script.

It is this underlying intrinsic anchor that imbues the overlying novel asset that you are trying to kickstart with its original positive price.

The problem with this approach is that if the asset is illegal-ish, then to shut it down the authorities need only locate the underlying source of value and confiscate it. With the backing gone, it's game over.

Instead of relying on the tangible world of vaults and backing, bitcoin's creators got their asset to have a positive value by taking a non-tangible route through people's mindscapes. The original two dozen or so adopters began to play a self-referential mind game which went a bit like this: "If I think Joe will buy bitcoin at a higher price in the future because he thinks Susan will buy at an even higher price, for the reason that she thinks that I will buy even higher up, then I'll buy some bitcoin now."

This circular process, a ponzi game, worked. Very early on, bitcoin was imbued with a positive value. The mind game has since grown from a few dozen players to hundreds to thousands to millions, but the self-referential logic of a ponzi continues to be the basis for bitcoin's price.

It's easy to confiscate gold or shut down a bank account. These things are tangible and have actual physical locations with addresses. But it's tough to shut down a million imaginations participating in a collective illusion. First, there's a million of them. And second, imagination isn't something that authorities can fine or confiscate. People's dreams and delusions, their mental gymnastics and schemes, are all locked safely in their skulls.

And so the authorities very quickly gave up and let the bitcoin ponzi game play out, which probably wouldn't have been the case if bitcoin's creators had gone the non-ponzi route and tried to establish an anchor to real world assets.
 
In sum, bitcoin is resilient because its source of value is ponzi logic playing out in millions of people's heads. Bitcoin idealists may bristle at the idea of being associated with a ponzi, but they should embrace it as a strength.

How to stop Forsage, Meta Force and other smart contract pyramid schemes

Serial smart contract pyramid schemer Lado Okhotnikov

 

[This is a republication of my latest opinion piece from CoinDesk.]

Last week the U.S. Securities and Exchange Commission (SEC) charged 11 individuals with creating and marketing Forsage, the world’s largest and longest-running smart contract-based pyramid scheme.

Alas, Lado Okhotnikov, the ring leader of Forsage and rumored to be based in the Republic of Georgia, remains at large. And while the original Forsage smart contracts are nowhere near as popular as they once were, they continue to welcome new money, SEC be damned.

Worse, Okhotnikov's new smart contract pyramid, Meta Force, continues to grow. Over $42 million in DAI stablecoins have been deposited into Meta Force by unwitting investors since the alleged scam debuted a month ago.

Smart contract pyramid schemers like Okhotnikov prey on the weak and vulnerable. What can we do to better fight them?

A quick history of smart contract-based pyramids

A pyramid scheme is an illegal business model where returns to existing investors are generated from newly recruited investors' money or fees. They are ultimately unsustainable because the supply of new investors is finite.

Pyramid schemes have existed for centuries. But pyramid schemers quickly realized the benefits of blockchain technology. MMM Global, a pyramid that tore through Nigeria, India, China and other developing nations through 2014 to 2016, used bitcoin (BTC) for payments. A group of researchers who studied the pyramid found that, at its peak, MMM Global was processing $150 million per day.

The advantages of bitcoin are clear. While authorities can shut down a pyramid scheme by leaning on its payments processors or bank, the Bitcoin blockchain can't be turned off.

The rollout of Ethereum led to the next big innovation in pyramids: the smart contract pyramid scheme. In addition to relying on blockchains for payments, this type of alleged scam built its pyramid apparatus on the Ethereum blockchain using smart contracts.

There are advantages to using a smart contract to run a pyramid. The entire back office structure can be automated using code, which makes administration easier for the scammer. It also allows the pyramid to be marketed as an "honest" Ponzi; that is, because it is implemented by code rather than by hand, it can be said to always run correctly.

Furthermore, because that code is public, it can – in theory, at least – be audited by users.

Smart contract pyramids are safer for the scammer to run than traditional pyramids because they afford a degree of anonymity. And while the authorities can shut down a traditional pyramid by visiting the office out of which it operates, building it on Ethereum makes it much harder to stop.

Smart contract pyramids soon became endemic to Ethereum. A 2019 study by a group of Italian researchers cataloged 184 smart contract pyramids in play at the time.

Most of these were quite small. It was Lado Okhotnikov's Forsage that broke the mold. Forsage's first Ethereum smart contract, x3/x4, would process almost $240 million in payments in 2020. At one point it was Ethereum's second busiest contract, after tether.

Ethereum gas fees would soon rise, forcing alleged pyramid alleged scammers like Okhotnikov to migrate to cheaper blockchains. Over the next few years Okhotnikov launched five other smart contract Ponzis on the Tron and Binance Smart Chain blockchains. Recently, scammers have begun to move back to Ethereum thanks to level 2, or subsidiary blockchain, systems that have lowered costs. In Okhotnikov's case, he has set up his newest pyramid, Meta Force, on the Polygon Network.

A forensic analysis of Forsage

Thanks to the transparency of blockchains, Sarah Meiklejohn and other researchers carried out a precise analysis of Forsage’s payouts and losses, focusing on the $240 million Ethereum x3/x4 contract.

While the founders boasted that the system was transparent and open source, it took the researchers weeks of effort to understand the code, which meant that almost no Forsage participants could have actually audited the smart contract. So much for transparency.

Meiklejohn et al. found that the system had been coded at the outset to benefit only a few people. For instance, participants had to buy slots that offered the right to get payments from new recruits. After recruiting three participants, a slot would be blocked and the recruiter had to pay fees to reopen it and receive payment. The organizers’ slots, however, were coded to be exempt from this rule.

The SEC found that Okhotnikov had coded one of his subsequent pyramids, Ethereum xGold, to divert a portion of investor funds to a wallet that was not associated with a Forsage ID. This contradicted Okhotnikov’s representation that all funds were paid out to investors. By 2022, that address had diverted over 1,000 ETH.

In the end, Meiklejohn et al. report that 1 million Forsage accounts lost money, a remarkable 88% failure rate. The top 1,000 users made 50% of all profits. Okhotnikov and his fellow cofounders capitalized by positioning themselves at the top of the pyramid. The SEC accuses them of owning the best five spots in the x3/x4 Forsage pyramid, the topmost of which earned 5409 ether (ETH), well over $1 million, according to Meiklejohn et al.

Okhotnikov and his colleagues aggressively marketed their scams on social media. Forsage's official YouTube channel, which is now dedicated to the new Meta Force pyramid, currently has over 47,000 subscribers. The most popular Forsage video, which is in Hindi, has been viewed 384,000 times. This is despite YouTube's terms of service having a blanket ban on marketing pyramid schemes.

In their paper, Meiklejohn and her colleagues traced the location of most of the victims of Forsage to developing nations, in particular Nigeria, Philippines and Venezuela. This reveals these alleged scams for what they are: a way for a few rich people to steal from the poor and vulnerable. They need to be stopped. But how?

What can be done?

Because smart contract pyramids are built on censorship-resistant blockchains, they can't be attacked at the root, nor can they be undermined indirectly by removing them from the payments system.

Writing on CoinDesk, Lex Sokolin has proposed that white hat hackers organize to find vulnerabilities in smart contract pyramids and bring them down. It's a nice idea, but so far white hat hackers haven't shown much interest in chasing after pyramids.

Perhaps the most effective way to hurt smart contract Ponzis is by attacking their reputation. The SEC's charges will certainly help on this front. Now when a potential victim searches for Okhotnikov or one of his "investment" products, they'll have the opinion of the world's largest securities regulator to rely on.

The good news is that the SEC's actions seem to have had an effect. The rate of deposits to Okhotnikov's newest (alleged) scam, Meta Force, which has already attracted $42 million in deposits, began to decline the day after charges were announced. On YouTube, a nervous Lado Okhotnikov described the SEC’s charges as slander and defamation.

But we needed the SEC to begin its attack long ago. Publishing a cease and desist early on, like securities regulators in Montana and the Philippines did, would have helped tarnish Okhotnikov's reputation before his alleged scams could hurt more people.

Regulators like the SEC should try to harness the transparency of blockchains to their advantage. It's possible to see these things popping up and monitor how big they get, so regulators can very quickly mobilize resources to combat them.

The SEC should also consider fighting like with like. Smart contract Ponzi scams spread through garish videos on YouTube. Alas, the SEC didn't post its charges to its YouTube channel. A catchy video about Forsage would go much further than a terse tweet.

Finally, influential blockchain personalities like Ethereum co-founder Vitalik Buterin and Binance CEO Changpeng Zhao should step up and speak out against smart contract Ponzis when they crop up. They may not wish to do so, because admitting the problem may attract negative attention to the technology. But addressing these scams as early as possible will not only reduce damage to innocent people, it will also limit damage to the long-term reputation of blockchains.

Thoughts on the relationship between corruption and crypto adoption

[This is a re-post of an article I wrote for CoinDesk last week. The IMF recently found that corrupt countries tend to have high crypto adoption. In my article I suggest that this is because citizens of undeveloped countries are using crypto to dodge broken institutions controlled by corrupt elites. I cite Cuban crypto remittances as an example of this. But we shouldn't idealize crypto as a tool for emancipation. A big chunk of crypto usage is unproductive. Their corrupt institutions crushing them, people in undeveloped nations see in frenetic crypto prices a potential escape, a last-chance financial gamble. But this escape is illusory. Undeveloped nations require genuine institutional change, not more gambling opportunities.]

Don't Blame Crypto for Corruption
An IMF study suggesting crypto is facilitating corruption is off target via CoinDesk

Is crypto fueling corruption? The International Monetary Fund (IMF) seems to think so. Using crypto usage data from Statista’s Global Consumer Survey, a group of IMF researchers recently found that countries with high crypto adoption tend to be perceived as corrupt.

As to why this relationship exists, the IMF team suggests that crypto is being “used to transfer corruption proceeds." With crypto facilitating corruption, their advice is the product needs to be regulated, the idea being that regulation – especially know-your-customer requirements – will end graft.

The IMF has this one backwards. Crypto doesn't fuel corruption. Rather, whatever underlying malaise is fueling corruption is probably also fueling crypto adoption.

Why Nations Fail

In "Why Nations Fail: The Origins of Power, Prosperity, and Poverty," economists Daron Acemoglu and James Robinson offer an explanation for why some nations seem to function well and are relatively free of corruption, like Canada and Sweden, and others do not, like Nigeria and Syria.

It isn't geography or culture that determines success, say the authors, but institutions. By institutions they mean the rules that govern and shape economic and political life: property rights, contract enforcement, licensing standards, financial regulation and more.

Inclusive institutions create the incentives necessary to harness the energy and entrepreneurship of all members of society. Extractive institutions do the opposite. They create a non-level playing field and narrowly concentrate access and benefits for those with political power.

Acemoglu and Robinson offer the city of Nogales, which straddles the U.S.-Mexico border, as an example. “The inhabitants of Nogales Arizona, and Nogales Sonora share ancestors, enjoy the same food and the same music, and … have the same culture,” write the authors. But those on the northern side are prosperous while those on the south suffer from poverty. They suggest this is because U.S. institutions are more inclusive than Mexican ones.

Under Acemoglu and Robinson’s framework, corruption is a by-product, or symptom, of extractive institutions. A profusion of bribes is the return flowing to the small set of politicians, bureaucrats and soldiers who have managed to seize control of a country’s gears.

Regulating crypto is important but it won't fix corruption

Which returns us to crypto. Solving a problem like corruption requires the tearing down of underlying institutions that abet the graft-addicted elites, and their replacement with institutions that actually work for the people. The IMF's prescription for fixing corruption – crypto regulation – is just a cosmetic change. It does nothing to alter the sick institutions driving corruption, poverty and inequality.

If the IMF's prescription is inadequate, I’d suggest that its explanation for the correlation between crypto and corruption is wrong, too.

Instead of crypto fueling corruption, as the IMF seems to think, it's the other way around; the very same extractive institutions that drive corruption are fueling crypto usage. Put differently, the reason we see high rates of crypto adoption in undeveloped nations where elites rig the rules of the game is not because those elites are dealing in crypto bribes, but because the suffering masses see crypto as a form of escape.

Why do people adopt crypto as a reaction to bad institutions? There are two opposing camps. I'll call them crypto-as-redemption and crypto-as-tragedy.

Crypto-as-redemption

For advocates of the crypto-as-redemption viewpoint, the correlation between corruption and crypto adoption is a sign that crypto is acting as a redeeming force. Citizens in corrupt countries are using it as a hack around the extractive institutions that subjugate them.

Take Cuba for instance, a country long bedeviled by extractive institutions. Most Cubans lack connections to the ruling regime. This makes it very difficult to make ends meet, and so they are reliant on remittances from Cuban family members living in the U.S.

But the regime extracts its pound of flesh. Remittances made through Western Union have historically been routed through a set of Cuban-military linked financial companies, which take a cut of around 5%-10% of each remittance for themselves. By avoiding the regime’s intermediaries, crypto provides Cubans with the chance to get better exchange rates.

Crypto also offers a route when those intermediaries cease working altogether. In 2020, the Trump U.S. presidential administration placed sanctions on the military-linked companies involved in remittances, making it difficult for Cubans to send in dollars at all. Some Cuban-Americans turned to couriers, or "mulas," to physically transport cash to relatives. Others used banks in Europe, which were still willing to interact with non-sanctioned Cuban banks.

Crypto emerged as one of these alternative remittance channels. With Western Union down, Cuban Americans could send crypto directly to their relatives who converted it into Cuban currency to buy food and pay bills. For Cuban recipients who don’t want to handle crypto directly, tools like BitRemesas allow local traders to bid for the right to deliver these remittances in person as cash or to their bank account.

And thus crypto became a redemptive force in Cuba, helping fill in the cracks when institutions stop working for people.

Crytpo-as-tragedy

The crypto-as-tragedy view takes the opposite view. Most developing nations' crypto usage isn't very redemptive at all. Instead, crypto is a last-gasp gambling venue for the desperate.

Take the case of Nigeria, a country beset by extractive institutions and corruption. Citizens who want to advance in life have fewer options than in the West. They are excluded from many of the official channels that lead to financial advancement: gainful employment, genuine business opportunities and investment. Desperate, they've turned to the only available channel for advancement: get-rich schemes, Ponzis and hyper-volatile crypto.

According to Statista crypto adoption data, Nigerians are the most likely of all nationalities to say they used or owned cryptocurrency. Nigeria also happens to be the world capital of the Ponzi scheme. Starting with MMM in 2016, waves of Ponzis have torn through the country including Ultimate Cycler, Icharity Club Nigeria, Get Help World Wide, Givers Forum, Twinkas, Crowd Rising and Loom.

Surveys show that more than half of Nigerians have either participated in a Ponzi or know someone who has. Many are unemployed students, which isn't surprising given Nigeria's 33% unemployment rate. In one survey of Nigerian Ponzi investors, 60.3% cited harsh economic conditions as their reason for joining Ponzi schemes.

For a young Nigerian with few prospects for advancement, a cryptocurrency that promises to moon by 100 times serves the same purpose as a Ponzi scheme like MMM.

If Nigeria’s failed institutions are driving a culture of long-shot financial bets, these bets aren't genuine escapes. Volatile zero-sum games allow citizens to temporarily dissipate their desire to escape their lot in life, but they don't create any real economic value. The elites that control institutions in undeveloped nations may even welcome these sorts of financial games. Not only do they not threaten their control over national resources – they may also distract people from their plight.

And that's why crypto usage is tragic. It is a symptom of an underlying sickness. But just as Nigeria’s Ponzi schemes do nothing to solve the actual problem, neither does its rampant crypto speculation.

Which view is correct, crypto-as-redemption or crypto-as-tragedy?

Both crypto-as-redemption and crypto-as-tragedy counter the simplistic IMF connection between crypto and corruption, suggesting a deeper explanation for the relationship.

Both stories are accurate, to a degree. There are some neat non-speculative crypto use cases where the stuff is being used as a life hack to help those living in dysfunctional nations, such as the example of Cuban crypto remittances. At the same time, a big chunk of developing nation usage involves crypto serving as the focal point for the gambling impulses of the downtrodden, not as a useful life hack or an agent of change.

In its purest form, the crypto-as-redemption view elevates crypto to more than just a personal hack for those coping with bad institutions. Crypto is a peaceful revolution. It sneaks in like a Trojan horse and destroys the extractive institutions that bedevil less-developed nations, setting them free.

While crypto can certainly be a good life hack, this hyper-idealization of crypto is dangerous. It gives people the mistaken idea that a product that serves their gambling instinct can somehow solve the developing world's problems.

To reform the institutions that keep citizens of poor nations, crypto won’t cut it. Deep change requires real work.

Is money a ponzi?

 Matt Levine entertains the possibility that all money is a ponzi:

"But of course crypto people will happily tell you that fiat currency is the biggest Ponzi scheme of all, and they are not really wrong are they?"

Here is my discussion with some crypto folks on Twitter making that claim.

I disagree. Here is a short (930 words, 3 minutes) blog post explaining why money is not a ponzi.

Aneroid is a small town in Saskatchewan. It has 100 inhabitants. Selma, one of the town's 100 inhabitants, starts a ponzi.

By ponzi, I am referring to a general class of economic phenomena that can only exist if additional people continue to join up. Under these schemes, old investors are paid with new investors' funds. Once the incoming flow of new entrants dries up, the ability to pay out funds to existing participants comes to an end. The scheme ends. This family of economic phenomena includes not only ponzi schemes but also pyramids, chain letters, MLMs, HYIPs, speculative bubbles, and Nakamoto schemes.

Out of the above options, Selma opts to go with a chain letter. She drafts one up on paper and sells a copy to her friends Tom, Sally, and Alice for $10. (I'm replicating the basic design of the notorious 1970s Circle of Gold chain letter). The letter requires the recipient to send $10 to the person at the top of the list, copy the letter (removing the name from the top of the list and writing one's own name at the bottom), and sell it on to three friends for $10.

Selma's chain letter proves to be popular. 99 inhabitants of Aneroid eventually buy a letter, send $10 to the person at the top of the list, and resell it.

But when Jack, the 100th inhabitant, buys a letter and sends $10 to the person at the top, he finds that he can't resell it. Everyone in Aneroid has grown tired of the game. The chain letter stops propagating, the flow of money ceases, and the whole enterprise dies. Jack $10 copy is worthless.

Does money have the same ending as Selma's chain letter?

Enter the Bank of Aneroid. 

The Bank of Aneroid is the town's sole issuer of banknotes. The Bank lends a $10 banknote to Selma secured by a $15 lien on her property. Selma spends the $10 note at Frank's hardware store who spends it at the grocery store etc etc, until it ends up in the hands of Jack. But to his dismay Jack finds that, for whatever reason, no one will accept the $10 note.

Alas, poor Jack. His $10 banknote now seems as worthless as his $10 chain letter.

Lucky for him, it isn't. Unlike a chain letter, Jack can return the $10 note to the original issuer, the Bank of Aneroid, for redemption.

Recall that the Bank of Aneroid owns Selma's $10 property-secured IOU. When Jack walks into the Bank and asks to have the note redeemed, the Bank of Aneroid makes good on its promise by selling Selma's debt in the debt market for $10 worth of gold or central bank money. It then pays this amount to Jack. The Bank of Aneroid then destroys its $10 note.

(Alternatively, the Bank of Aneroid can tell Selma to repay her $10 loan, the proceeds being used to pay Jack. Or the Bank can take the more extreme measure of seizing Selma's property and selling it in order to make good on its promise to redeem Jack's $10 banknote.)

As you can see, what I'm describing is not a ponzi scheme. That is, the Bank of Aneroid's $10 banknote isn't valuable because a new buyer keeps arriving to take it off of the previous owner's hands. It is valuable because the original issuer, the Bank of Aneroid, will always repurchase its note using its resources, i.e. its portfolio of loans.

Careful readers will protest at this point. "C'mon JP, you're talking about redeemable bank money. Of course that's not a ponzi. It's the non-redeemable stuff, fiat money, that's a ponzi!"

But I'd argue that the same principles apply to fiat money. I'm going to define fiat money as a banknote that can't be redeemed on demand by its holder into an underlying instrument, perhaps gold or government money. 

In our example, let's modify the Bank of Aneroid so that it issues fiat banknotes, not redeemable ones. Apart from that, everything remains the same. Now when Jack takes his unwanted $10 banknote back to the Bank of Aneroid for redemption, the bank refuses to convert it into an underlying medium.

Jack's $10 won't be worthless like the $10 chain letter, though.

"Sorry Jack, we can't redeem it," says the bank manager. "Our banknotes are non-convertible fiat notes. But Selma's $10 loan is due next week. To pay us back she's going to need your $10 note. Why don't you talk with her?"

And so Jack walks over to Selma's house and offers to sell her the $10 note. And Selma will buy it since she'll need it to repay her $10 debt to the Bank.

So in the end, Jack's $10 banknote is valuable—not because a ponzi process props it up—but because the bank that originally issued it reaccepts it. The support that a bank offers to its banknotes is more obvious when a banknote is immediately redeemable by its issuing bank at par. But even an non-redeemable fiat banknote has an underlying linkage back to the issuer that helps support its value.

By contrast, a chain letter (or any other ponzi-like instrument) lacks this connection and only has value as long as a new player emerges.  

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PS. This note is for Ethereum fans.

Another way to think about the question of fiat money is to bring in some stablecoin analogies. The Bank of Aneroid's non-redeemable fiat notes are equivalent to Rai or MakerDAO's Dai (before Maker introduced the PSM). 

Rai and pre-PSM Dai are fiat monies. Neither are directly redeemable into underlying USDC, Tether, or bank dollars. But this doesn't prevent Rai and Dai from staying close to their targets (in Rai's case $3-ish and in Dai's case $1.) In the absence of direct redeemability, the main force pushing these tokens towards target is the requirement that vault owners (i.e. debtors) repurchase Rai and Dai to repay their Rai- and Dai-denominated debts to the system. This is the same force that stabilized the Bank of Aneroid's $10 fiat note in my story. Recall that Frank's $10 note was valuable because Selma needed it to close her debt to the Bank of Aneroid.

Adding an on-demand redemption feature to the Bank of Aneroid's notes only makes this stabilization more direct and immediate, much like Maker's addition of a direct redemption mechanism, the PSM, resulted in a more direct fusion of Dai to its $1 target. (The PSM means that Dai has become non-fiat money.)

Another force keeping Rai and pre-PSM Dai anchored to their respective targets are the threat of Rai's "global settlement" or Maker's "emergency shutdown." Basically, in extreme scenarios both systems can be completely unwound. When this happens all the collateral held in the system gets distributed back to its respective stakeholders, including the owners of Rai and Dai. The knowledge that this could happen helps nudge the price of Rai and Dai closer to their targets.

The Bank of Aneroid's notes are also subject to their own version of emergency shutdown. At any point in time the owners of the Bank of Aneroid can wind up the bank. By collecting on all of their debts, selling those debts to others, or seizing collateral, the Bank can buy back all of the notes they have issued at par. The possibility that this could happen helps pull the Bank of Aneroid's fiat notes towards a stable terminal value.

Sure, there are stablecoins that depend on an underlying ponzi process to stay pegged to $1. But Rai and Dai do not fall into that category of stablecoins. Rai and Dai use non-ponzi mechanisms to create a stable version of the dollar. The Bank of Aneroid's fiat notes are not ponzi-ish for the same reasons that Rai and Dai are not ponzi-ish. And the same goes for Federal Reserve dollars, Bank of Canada dollars, and Bank of England pounds, which operate on the same principles as the Bank of Aneroid's fiat notes.

There are two kinds of people who label bitcoin a ponzi

There are two kinds of people who label bitcoin a ponzi. The first group is made up of salty nocoiners who launch the word ponzi as an insult. These people disliked bitcoin and/or bitcoiners pretty much from the get-go. They criticize it at every chance they get.

The second group uses the word ponzi in a neutral, or analytic sense. They aren't describing bitcoin as a ponzi in order to insult bitcoin, but in the same way that a biologist would describe a certain mosquito as belonging to the family Culiseta longiareolata rather than Culiseta minnesotae.

In philosophy, this distinction is captured by the contrast between descriptive and normative statements. A descriptive claim is one that describes a situation. "Brutus killed Caesar." A normative one is that makes some sort of value judgement about how things ought to be. "Killing is wrong."

Likewise, economists distinguish between positive and normative economics. (The economic distinction is the same as the philosophical distinction, so I won't rehash it, but here is a good article.)

So returning to our two kinds of people who label bitcoin a ponzi, the first is hurling normative statements about bitcoin. "Ponzis are frauds, which makes them bad. And bitcoin is a ponzi, so it too is a fraud." The second group is making descriptive or positive statements about what sort of thing bitcoin is in the universe of financial things.

Now, bitcoiners tend to bristle at all bitcoin is a ponzi statements. And that's because they perceive them to be attacks on their tribe. And the normative statements are, for the most part, designed to be attacks. And so bitcoiners raise their defences and engage in blustery counterattacks. These counterattacks are also composed of value-laden normative statements.

I find these flareups of normative versus normative statements to be unhelpful.

The positive/descriptive claim that bitcoin is a ponzi isn't an attack. And it can't be countered with ideological bluster. It deserves a much more nuanced critique.

And to clarify, the word ponzi is not an entirely accurate description of what bitcoin is. Back in 2017 Preston Byrne provided a more precise description of Bitcoin as a Nakamoto scheme. Give it a read. It's quite well-written. For my part I've been using the Bitcoin as a chain letter descriptor since 2018 and more recently here.

Byrne's and mine are essentially the same idea, that bitcoin is a ponzi. Except not quite. Bitcoin is a decentralized ponzi scheme, one without a schemer. I describe it as an honest chain letter. Byrne uses the word automated.

I will add, "Nakamoto Scheme" is a descriptive label rather than a normative onehttps://t.co/yXtYfELVSk

— Preston Byrne (@prestonjbyrne) February 23, 2021

After all these years, I still haven't seen a convincing explanation for why bitcoin is neither a Nakamoto scheme nor an honest chain letter. That is, I haven't seen a good positive/descriptive response to the positive/descriptive statement that bitcoin is a decentralized ponzi. One of the best alternative theories, bitcoin-is-money, broke down long ago in the face of empirical evidence. And the bitcoin-is-gold description isn't panning out too well.

Bitcoiners haven't turned the perceived slight into a virtue. If someone is calling you names, then proudly adopt the slur. If the descriptive statement bitcoin is a ponzi is accurate and popular, then adopt it and make it your own. "Yep, of course bitcoin is a chain letter/Nakamoto scheme. And that's a good thing."

I mean, there are many ways to go about making bullish normative statements about bitcoin being a ponzi. For instance, a chain letter is managed in a decentralized manner. That make it almost impossible for authorities to suppress them. A creative bitcoin meme artist could rejig this descriptive statement into a celebration of bitcoin being impregnable.

Put differently, up till now all normative statements invoking bitcoin's ponzi nature have been used by critics to attack bitcoin. Where are the normative statements that embrace bitcoin's ponzi nature in order to defend bitcoin?

---

P.S. After publishing this post, someone sent me a perfect example of a meme that puts a positive slant on bitcoin's ponzi nature.

In my post I said that we need bullish bitcoin-as-ponzi memes. Here's a nice one. https://t.co/qrDSI6BVlM

— John Paul Koning (@jp_koning) June 28, 2021

Ponzis and bitcoin as a response to a bad economy: the case of Nigeria

Usually when I think about gambling and speculative excess, I've always associated it with giddy prosperity. When an economy is doing well, productivity is improving, new technology is being introduced, and unemployment is low, people have extra income that they can throw away at the casino. Or they put it into their brokerage account and, with the help of margin, generate speculative bubbles.

But lately I've been rethinking this view. Speculative bubbles and over-gambling are just as likely to be driven by sick and decaying economies as they are by prosperous ones. And Nigeria is a prime example of this.

Nigeria, one of Africa's largest major oil producer, plunged into recession in 2015 as oil prices collapsed. It saw only anemic growth from 2017 to 2019 before COVID-19 pushed it back into a much deeper recession.

Over that period Nigeria has seen an explosion of ponzi schemes. It started with MMM in 2016. Since then Ultimate Cycler, Icharity Club Nigeria, Get Help World Wide, Givers Forum, Twinkas, Crowd Rising, and Loom have all ripped through the country. Jack & Ibekwe (2018) provide a full list below, although it misses a large chunk of ponzis since it doesn't go past 2018.

Jack & Ibekwe (2018)

Jack & Ibekwe's paper is just one in a burgeoning Nigerian academic literature on ponzi schemes. This body of work provide us with plenty of useful information about what sorts of Nigerians are participating in ponzis and why.

How many Nigerians participate in ponzis? In a survey of 287 Port Harcourt business students, Bupo & Abam-Smith (2017) found that an astonishing 72% of students were involved in various ponzi schemes. Onoh's (2018) survey of 230 Nigerians found a participation rate of 78%.

The high participation rates that Bupo & Abam-Smith and Onoh pinpoint are confirmed in a 2016 poll run by NOIPolls, an established Nigerian polling agency. After querying 1000 Nigerians, NOIPolls found that 68% of survey participants had either participated in a ponzi, or knew someone who did. I would find a 5-10% national ponzi participation rate to be mindbogglingly high. But if the above data is correct, Nigeria far exceeds this. Given a population of over 200 million, tens of millions of Nigerians have participated in ponzis.

Who are the Nigerians that are playing? In their survey of 135 ponzi investors, Jack & Ibekwe found that young Nigerians aged 20-29 were most likely to be involved in ponzi schemes. Participants tended to be students and had post-secondary education. In a 2018 survey of 190 ponzi investors in the city of Calabar, Agba et al (2018) reported similar results. Most investors were unemployed, held a Bachelor of Science degree, and had a low income.

Another fact that blew my mind away is that many of the Nigerians who are involved in ponzis are self-conscious ponzi investors. That is, these aren't dupes. They know the nature of the game they're playing.

For instance, 66% the university students that Bupo & Adam Smith surveyed were aware that they were participating in a scam, one that would soon crash, but they played anyways, presumably because they believed they were skilled enough to get out before the end. Onoh found somewhat less ponzi self-consciousness in his survey of 230 Nigerians, with 34% realizing at the outset that the scheme made high returns by re-cycling contributions. But that's still a lot of savvy players.

-----

Let's back up a bit and define the term ponzi scheme. A ponzi is a type of zero-sum game, much like a lottery or a casino game such as roulette. By zero-sum, I mean that nothing of value is created. For each person who makes a profit, there is necessarily someone who loses. Put differently, ponzis and lotteries don't generate funds, they redistribute funds.

All zero-sum games have an algorithm, or sorting method, for figuring out who will lose and who will win. A lottery, for instance, redistributes funds from all losing ticket numbers to the winning ticket. A poker game redistributes the pot from bad card hands to good hands. A ponzi scheme's unique algorithm is to pay early entrants at the expense of late entrants.

What attracts people to zero-sum betting games is the allure of massive returns. Buy the right lottery ticket and your life will change. Choose the right number on the roulette table and you earn an immediate 3400% return on your investment. Get in early on the right ponzi, and you'll be vaulted into a totally different socioeconomic class. Of course, on net these schemes don't generate any wealth.

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Back to Nigeria. What the Nigerian ponzi scheme literature suggests is that ponzi schemes were self-consciously used by Nigerians as a coping mechanism for economic malaise.

For instance, in their survey of ponzi investors Jack & Ibekwe found that 60.3% cited harsh economic conditions as their reason for joining ponzi schemes. In a survey of 384 ponzi investors, Obamuyi et al (2018) found that one of the most popular reasons for participating in ponzis was the "current economic situation." And in Bupo & Abam-Smith's analysis of 287 Port Harcourt business students, 231 agreed that the scheme helped reduce the impact of the present recession.

So let me paint a picture. Nigeria has always been a highly unequal country. The poor are very poor, the rich are very rich. There is plenty of poverty (although this is improving) and not much of a government-run social security net. Nigeria also suffers from endemic corruption, and this impedes the ability of regular folks to improve their lot.

The yearning and frustration that this creates gives rise to a constant demand for quick financial escapes, or zero-sum games. But what sorts of zero sum games? Nigerian authorities take a relatively paternalistic approach to gambling. Depending on the game, Nigerian law either prohibits it outright or limits it. For instance, Nigeria has only three land-based casino for 200 million people. Non-skill based card games are illegal. Apart from sports betting, online casinos are prohibited, and many foreign websites don't accept Nigerians. 

So a big part of the demand to play life-changing betting games gets channeled into whatever the underground market can provide, like ponzi schemes.

If you start with a large population of unhappy young people who want to play life-changing zero-sum games, combine that with limitations on legal gambling, and add in a massive economic collapse which only makes their lives worse, you're going to get a big wave of illegal ponzi schemes cropping up.

Canada and the US also have problems with inequality and poverty, albeit not as extreme as Nigeria. Our economies have also been hit by the biggest shock in decades.

But unlike Nigeria, Canada and the US have well-developed capital markets. So when desperate Canadians and Americans look for long shot life-changing bets, they needn't limit themselves to traditional gambles like lotteries, casinos, or online poker. Online brokerages like Robin Hood and Wealthsimple make it easy for us to make hundred-to-one bets in options markets or leverage up on Tesla or GameStop stock.

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In addition to embracing ponzi schemes, Nigerians have also become the world's most prolific owners of cryptocurrencies, as the chart below illustrates. This data comes from Global Web Index via this article.

[Source]

I've been tracking bitcoin usage in Nigeria for a while now. We know that bitcoin is being used in combination with gift cards by Nigerian-based business email compromise and romance scammers as a convenient way to repatriate extorted funds:

"Paxful portrays itself as bringing financial services to the world’s unbanked, and perhaps they are, but the US-based company has become a bazaar for West African scam artists selling stolen gift cards."

How Nigerian BEC gangs launder money via Paxful: https://t.co/5XGRuwNJ6w pic.twitter.com/SsFK1eVNbz

— John Paul Koning (@jp_koning) October 15, 2020

We also know that Nigerians living in the US are making remittances to their Nigerian friends and family using this same combination of gift cards and bitcoins. Buying gift cards and exchanging them for bitcoin and then Nigerian naira may sound like a circuitous way to make remittances. But it is economical because families get the superior black market exchange rate rather than the official rate.

Great article by @MattAhlborg. He documents an exotic remittance corridor that has sprung up between US and Nigeria to avoid exchange controls:

US cash → Gift cards (iTunes, Amazon, etc) → Bitcoin → Nigerian naira deposits. Quite the crazy journey.https://t.co/2yQ5Urwemg

— John Paul Koning (@jp_koning) December 5, 2019

Nigerians who shop at foreign online stores face monthly card limits, some as low as US$100. Again, this is because Nigeria's central bank rations access to foreign exchange. Cryptocurrencies may be a hack around this. Also, Nigerian importers have been using cryptocurrency as a trade currency for Chinese imports. Rather than having to rely on acquiring carefully-rationed foreign exchange from the Central Bank of Nigeria, they can offer a Chinese exporter some bitcoins and the goods will be shipped.

So cryptocurrency is certainly being used as an alternative form of doing payments. But this can't explain why 20% of Nigerians (around 40 million people) hold some of the stuff. After all, unofficial imports, scams, and remittances are a small part of economic activity.

------

I'd suggest that Nigeria's cryptocurrency adoption is a natural extension of its earlier ponzi scheme addiction. 

Like a poker game or roulette or the lottery, cryptocurrencies such as Bitcoin or Litecoin are zero-sum betting games. They redistribute a fixed pot among participating players. Of all types of zero-sum games, cryptocurrencies are most similar to ponzi schemes. Both use an "early bird" redistribution algorithm: late entrants' funds are paid out to early birds. But cryptocurrencies are not quite ponzi schemes. Whereas ponzis such as MMM or Ultimate Cycler are centrally managed by a coordinator, a cryptocurrency is spontaneous and decentralized.

In the same way that young Nigerians turned to ponzi schemes as an economic drug for coping with the 2015 collapse and ensuing lack of opportunity, they may be doing the same with cryptocurrencies. COVID-19 has pushed Nigerian unemployment to its highest level in a decade, the young being hurt the most. And so once again desperate Nigerian students are on the hunt for life-changing zero-sum bets. This time they've settled on cryptocurrency, the decentralized nature of which renders them almost impossible for authorities to stop.

My "ponzi" interpretation of Nigerian cryptocurrency adoption runs counter to the crypto-optimist view.

Cryptocurrency advocates see adoption of cryptocurrencies in developing nations like Nigeria as a vindication of cryptocurrency-as-monetary technology. Their thesis is that legacy payments systems and central banks in developing countries are failing at their task, and so cryptocurrencies like bitcoin are being adopted because the offer a better monetary alternative.

The crypto-optimist view overestimates the usefulness of cryptocurrency-as-currency. There are certainly some cases where Nigerians are using cryptocurrencies for payments, and I presented them above. But the main reason that cryptocurrencies are popular is why any zero-sum game is popular: they intoxicate players with the promise of huge price gains.

Viewed in this light, Nigerian adoption of cryptocurrencies isn't a bitcoin fixes this moment. Rather, it's a repeat of Nigeria's earlier adoption of MMM and Ultimate Cycler. That these games keep sweeping through Nigeria is a symptom of underlying economic misery. Desperate to escape their plight, young Nigerians are once again making last-ditch bets on zero-sum betting games.

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There is a silver lining.

Traditional ponzi schemes are often run by scammers rather than honest game managers. In an honest ponzi, 100% of the invested funds are paid out by the manager before the game closes down. But in a ponzi scam, the game manager absconds with the pot. And so ponzis often collapse before coming to their inevitable, natural end.   
 
Cryptocurrencies aren't run by a central game manager. As long as players custody their own coins, there is no one who can abscond with players' funds. So a desperate Nigerian student who wants to make a potentially life-changing zero-sum bet may do a bit better buying ₦10,000 of bitcoins than putting ₦10,000 into the next version of Ultimate Cycler, since bitcoin is more secure. (See this post for more).

But let's not kid ourselves. A nation of desperate gamblers, ponzi players, and cryptocurrency punters is a sad development. It is a symptom of a sick economy, one in which unemployed young people are flocking to make zero-sum bets because that is the only way they see their lot in life improving.