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?

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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

Why did Dogecoin take off but Feathercoin didn't?

Dogecoin makes us all shake our heads. Introduced in December 2013 as a joke, Dogecoin is now worth over $50 billion, more than Ford Motor Co. Meanwhile Feathercoin, a more serious cryptocurrency that debuted in April 2013 (and initially worth more than Dogecoin), is currently valued at a tiny $10 million.

Here's the December 2013 list of top cryptocoins. After the first 3, all of them are pretty much dead/inactive except for the one that was started as a joke and is now worth $17 billion. 🤷https://t.co/ImBu5CUxpr pic.twitter.com/R0tPBWl35C

— John Paul Koning (@jp_koning) April 14, 2021

How are we supposed to understand the strange thing that is Dogecoin?

Let's start by exploring what these odd instruments are. While Dogecoin and Feathercoin seem like an entirely new phenomenon, I'd suggest that they're both really just an updated version of a fairly old financial instrument. You may remember those chain letters your parents used to get in the mail. "Send $5 to each person on the list, then copy it (adding your name to the bottom) and send to their friends," the letter would say. "Then wait for the money to flow in."

Old fashioned chain letters were simple ranked lists that propagated through the post. Propagation occurred in a decentralized manner. There was no "schemer" administering the whole thing. Each player was responsible for abiding by the letter's rules.

Dogecoin (along with Feathercoin) is an updated version of your parent's decentralized chain letter. To begin with, the deployment mechanism is different. Doge propagates over the internet, not the post. Secondly, Dogecoin software ensures honesty. By contrast, old fashioned chain letters – reliant as they were on pen, paper and photocopy machine – were dogged by cheaters who snuck their name to the top of the list.

Rather than have people manually append their names to the list, Dogecoin software creates all the entries in at the outset. And instead of being hierarchical, all spots in the Dogecoin list are equal, or fungible. (All of this goes for Feathercoin, too.)

But other than that, the core concept of a chain letter remains the same: those who already have a spot in the decentralized list are paid off by late-comers.

Sophisticated markets have sprung up to serve those who want to buy & sell these modern honest and fungible chain letters. PayPal, Robinhood, and newly-public Coinbase all let users buy Dogecoin. And so Dogecoin has been effectively fused into the regular financial system.

This degree of mass adoption never happened with your parent's chain letters. Prior to the emergence of cryptocurrencies, chain letter list entries weren't fungible. And so secondary markets never developed. Lacking any sort of integration into regular finance, the chain letters of the 1980s and 90s never went beyond being a sketchy underground phenomenon.

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Fans of honest & fungible chain letters (or HFCLs) like to explain them by adopting the complicated rhetoric of monetary economics. Feathercoin says it is for "feather lite payments." More famously, Bitcoin has been variously marketed as a "coin", a store of value, digital gold, or a form of electronic cash destined to "replace fiat currency." This has given the cryptocurrency sector a certain gravitas.

But as Joe Weisenthal points out, Dogecoin doesn't have any of these pretensions. It's just a fun token with a Shiba Inu dog as a mascot. And so all of the rhetoric that traditionally gets attached to cryptocurrency is conveniently stripped away. We get to see Dogecoin and Bitcoin for what they truly are, HFCLs.

Dogecoin's cuddly Shiba Inu has proven be a great tool for propagation, better even than bitcoin's marketing strategy of co-opting the stodgy lingo of monetary economists. In the chart below, I compare the market capitalization of the first 2,690 days of Dogecoin and Bitcoin respectively.

After 2,690 days, Dogecoin's market cap has hit $52 billion. This outranks bitcoin's market cap of $7 billion when it was 2,690 days old. Bitcoin didn't breach the $52 billion level until day 3137, more than a full year (447 days) after Dogecoin did. 

Think of market capitalization – the number of list entries multiplied by their current market value – as a measure of an HFCL's success. But take that number with a grain of salt. If all existing list entry owners actually did try to sell at once, an HFCL's value would fall to zero.

Nor is this the first time that Dogecoin has moved ahead of its older HFCL cousin. As the chart above shows, Doge's market capitalization outranked bitcoin through much of its early life. It also took the lead around days 1,300 and 1,600.

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Bitcoin fans aren't pleased. Dogecoin is a bit like your embarrassing younger sibling, the one that you want to hide in the closet because he/she reveals a little too much of the family's foibles. Cryptocurrency is supposed to be about monetary revolution, not fun dogs.

Bitcoiners have adopted various mental blocks to avoid being associated with coins like Dogecoin and Feathercoin. This involves publicly tarring any coin that isn't Bitcoin as a memecoin or a shitcoin. Not only are Dogecoin and Feathercoin categorically different from Bitcoin, they claim, but the category that they belong to is an inferior one.

I'll grant there are some differences, but none as deep as bitcoiners might prefer. Yes, Bitcoin is a bit older than Doge and Feathercoin. And they all have very different marketing techniques i.e. fun vs serious. And one of them, Dogecoin, has been (pound for pound) a bit more successful. But apart from that, they're all the same thing. They are all HFCLs.

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Whenever experts warn against chain letters, the point they always bring up is that chains cannot be sustained indefinitely. For everyone to make money, a chain letter must grow exponentially. But at some point the math stops working. There won't be enough people left on earth to feed the chain letter.

Does cryptocurrency have to end in tears? 

I'm not so sure. Yes, HFCLs require a constant stream of new players to buy in so that earlier players can exit at a profit. At some high enough market capitalization, there simply won't be enough buyers on earth to pay off ensuing waves of sellers. The HFCL collapses.

It doesn't have to collapse to zero, though. After a 90% or 95% fall the HFCL's price will start to stabilize. The peak-collapse-trough-mania-peak-collapse-trough-mania cycle begins anew.

Feathercoin offers a good template. Feathercoin and Dogecoin were both part of a huge influx of new HFCLs in 2012 and 2013. This crop included Peercoin, Terracoin, Novacoin, Litecoin, Sexcoin, Worldcoin, Ixcoin, and hundreds of others. You can see some of them on the list in the tweet at top of this post. Funny enough, I wrote about the 2012-13 cryptocurrency wave on my blog: see here and here. (Wow, hard to believe I've been doing this for so long.)

Below is a chart of Feathercoin's market capitalization over the last eight years. It has generally moved around between a trough of $100k-$1m and a peak of $10m-$100m. (Note that I am using a log scale axis.) Buy Feathercoin early and hold till its peak and you've effectively turned $100 into $10,000. It is this whiff of huge gains that tempts people into playing HFCLs. Buy too late, however, and your $100 becomes $1.

Of the 2012-13 crop of HFCLs, many of them look like Feathercoin. They haven't grown, but they still exist. Dogecoin is different (and so is Bitcoin). It shares the same general peak-to-trough pattern as Feathercoin. But its peaks and troughs have been steadily rising. 

What I think is happening here is that there is a huge pent up demand to play HFCLs. They are a fun way to potentially make huge amounts of money. But this demand eventually gets focused on a few lucky chains. After all, the market doesn't need 200 HFCLs when two or three large one will do. 

How does the market settle on two or three? I suspect it probably comes down to luck. Finicky things like mascots, logos, influencers, and catchy names probably play a role too. In Bitcoin's case, being first is a huge benefit. And so most HFCLs sort of putter around like Feathercoin. They don't die. But they don't expand either. 

I suspect that Dogecoin and Bitcoin will eventually follow the same pattern as Feathercoin. Growth will peter out. Peaks will start to roughly align with previous peaks. Troughs will form at the same level as previous troughs. And in-between these peaks and troughs, huge fortunes will continue to be made and lost.

From Circle-of-Gold to Mega$Nets to Bitcoin

We tend to dismiss chain letters as mere scams or frauds. In this post I want to get readers thinking about chain letters as a type of financial innovation, one that has been steadily updated over the decades.

Chain letters are lists. Players own a spot on that list. That list is governed by a rule: the first people on the list are to be paid by the latecomers. The chain letter stop working, or paying out, when no one else wants to join up.

The amount of money flowing to early-birds who joined the list is equal to the amount arriving from latecomers. No additional value gets created. That's why chain letters are zero-sum games.

The greatest technological strength of a chain letter is its decentralization. Each node, or participant, is independently responsible for receiving, copying, updating, distributing, and marketing the chain letter. Without a central schemer to indict, it's almost impossible for the authorities to stop the letter from propagating. Think of chain letters as the honey badgers of the financial world: tough, indestructible, and durable.

One of the most famous chain letters was the Circle of Gold letter. It reportedly started out in San Francisco and ripped through the rest of the U.S. in 1978. Here's how it worked:

In brief, I'd buy a copy of the Circle of Gold letter from you for $50 cash, and then mail $50 to the name at the top of the list, for a total outlay of $100. I'd then make two copies (removing the name at the top of the list an inserting my own at the bottom) and sell each for $50 to friends/family, for a total of $100, thus breaking even. The buyers in turn made copies and sold them on, the chain continuing. At some point my name would arrive at the top of the list and the money would begin to arrive in my mailbox.

Law enforcement declared the Circle of Gold letter to be illegal. But there was little they could actually do to stop it.

Chain letters like Circle of Gold may be difficult to eradicate, but they suffer from two big problems. I'll explain each of these problems, and also show how they were eventually fixed.

If decentralization is a chain letter's greatest strength, it is also the root cause of its main weakness. A buyer of a Circle of Gold letter had an incentive to break the rules by sneaking their name to the top of the list. Without a centralized administrator, there is no one who can prevent players from cheating.

This is the first weakness of chain letters. We'll call it the dishonesty problem. The dishonesty problem undermines a chain letter's credibility. If everyone knows that cheating will be rampant, they won't bother getting involved at all. Thus the odds of a letter widely propagating is going to be quite low.

To help make a chain letter more transmissible, what is needed is some sort of procedure that solves the dishonesty problem while preserving decentralization.

Enter Mega$Nets.

Mega$Nets was an ingenious 1990s-era chain letter that relied on software to prevent cheating. Here's how it worked:

• I buy a $20 Mega$Nets disk $20 from you
• After booting up the software I'd be asked to input my name and address, which was now locked into the program
• Before I could make copies of the disk, I had to mail $20 in cash to five others above me on the list. Once the $20 was received, these people would mail a code back to me.
• Only after I had entered the codes into the software could I duplicate the disk and sell it for $20. If the chain grew and my name worked up the list, I'd eventually start receiving a stream of $20 payments in the mail.

Mega$Nets software prevented names and addresses from being erased, thus preserving the list order. Importantly, it solved the dishonesty problem without compromising the decentralized nature of a chain letter. After all, Mega$Nets software ran independently on each individual machine, not from a central server.

Source: Donald Watrous's chain letter links

If Mega$Nets solved the dishonesty problem of chain letters, it didn't stay around very long. Eventually a programmer hacked Mega$Nets and figured out how to cheat the system. To undermine trust in the chain letter, he published his crack to the internet so that others could download it.

Now let's get to the second major weakness of traditional chain letters. Even if a chain letter manages to solve the dishonesty problem, it still suffers from another big weakness: lack of fungibility.

Fungibility is the idea that all members of a population are perfectly interchangeable with each other. Rice is fungible because one grain of rice is pretty much identical to another. My Tesla shares are fungible with yours. Dollar bills are fungible.

But positions in a chain letter like Mega$Nets are not fungible. A spot at the top of a chain is more valuable than a spot further down. And a spot on branch A of the Mega$Nets chain may have a different value than a spot at an equivalent height on branch B of Mega$Nets.

This lack of fungibility impinges on a players' ability to sell their spot in the chain letter to someone else. With every position in a chain letter being radically different, it's a huge chore for potential buyers to evaluate the market value of any single spot. And so a healthy resale market for chain letter spots can never develop.

Why would we want to be able to sell out of a chain letter? One of the big attractions of buying stocks, ETFs, bonds, gold, or currency is that we can resell these instruments, maybe two minutes later, maybe two decades later. If we are locked into an investment forever, we probably wouldn't want to invest very much in the first place. Likewise with chain letters. If a spot in a chain letter can be easily resold at a later time, then making an initial investment in the chain letter becomes a much more attractive proposition.

But is it possible to design a fungible chain letter? And if so, can we also solve the honesty problem while preserving decentralization? It sounds impossible.

Enter bitcoin, the world's first honest & fungible chain letter.

The novelty with bitcoin is that there is a fixed number of spots in the list.* New players can only join by purchasing a pre-existing position in the chain.** 

This approach is different from a more traditional chain letter like Mega$Nets or Circle of Gold. With Mega$Nets, the list is dynamic, not static. The number of spots in the list starts out small and expands organically as people join up, append their name, and generate a new spot in line. No need to buy someone's position out. Just add your own. New spots, however, are subservient to old spots

But Bitcoin software creates all spots on the list ahead of time, so no spot is superior or inferior to the others unlike . All bitcoin positions are fungible from the get-go.

As with every other chain letter, players "win" at Bitcoin by being early. The difference is that with bitcoin, winning is achieved by being one of the first to buy up a spot in a fixed non-hierarchical list. With a traditional chain letter like Mega$Nets, winning is achieved by creating one of the first entries in a hierarchical list that lengthens over time. Either way, the earlier one arrives, and the more latecomers who join up down the road, the richer one gets.

Because every single spot on the bitcoin list is fungible, buyers can easily appraise the worth of any single bitcoin (i.e. chain letter spot). And so a robust secondary market for bitcoins has developed where early bitcoin players fluidly auction off their positions to newer players. This marketability is one of the things that has turned bitcoin into such an incredibly contagious chain letter.

Bitcoin doesn't just solve the fungibility problem. It also fixes the dishonesty problem. Bitcoin software ensures that it is impossible for anyone to conjure up a new spot on the bitcoin list, or re-arrange the distribution of existing spots. (Some people describe this as solving the double-spending problem of electronic cash, but in this blog post it is the honesty problem of chain letters that is being fixed).

Finally, bitcoin achieves all this while being just as decentralized as its chain letter predecessors. 

Bitcoin is decentralized because individual participants can buy and sell bitcoin (i.e. spots in the list) in bilateral pairwise meetings. No need to rely on a central planner to distribute funds from late entrants to early birds. Secondly, much like Mega$Nets software, bitcoin software is deployed on thousands of computers all over the world. No central server. So like its traditional chain letter predecessors, bitcoin is very difficult for the authorities to attack.

In conclusion...

At first blush bitcoin seems like an entirely novel financial technology. But as I suggested in my post, it's just a meaner & badder version of chain letters like Circle of Gold and Mega$nets. 

What is revolutionary about bitcoin is how it has modified the chain letter model in order to solve the dishonesty and fungibility problems. Until bitcoin arrived in 2009, we had never seen the full capabilities of chain letters. Sure, chain letters regularly popped up, but they never lasted for more than a year or two. They were niche financial games played by odd people. Upstanding folks didn't touch them.

By solving the two problems of chain letters, bitcoin has radically dialed up the contagion factor for chain letter technology to a degree never experienced before. Bitcoin has become the first chain letter to go mainstream. It is the first chain letter to go global. Your sister is playing, your cousins are in, and so is your neighbour. Old-fashioned chain letters were for folks on the fringe. But playing bitcoin is something that regular people do. The abnormal ones are those who haven't yet secured a spot in line.

 

*Bitcoin has a 21 million cap. These 21 million coins were not created at inception. However, the protocol sets out the rules for their creation ahead of time.

** Players can also join by "mining" bitcoins. Mining is one of the processes that updates & secures the chain letter. Computers that engage in mining are rewarded with new bitcoins and/or a small fee out of the existing stock of bitcoins.

Bitcoin, 11-years in

Satoshi's first email [source]

Eleven years ago, Satoshi Nakamoto announced the bitcoin whitepaper to the world. Coinbase, a large cryptocurrency exchange, recently celebrated this milestone with a retrospective.

I'm going to remix Coinbase's narrative to tell a different account of bitcoin's last 11-years.

The thing that fooled us all for a while, myself included, is that we all thought bitcoin was solving a monetary or payments problem. It was labelled a coin, after all, and coins fall within the realm of monetary economics. To further complicate matters, Satoshi told his story using phrases like "electronic cash system" and "non-reversible transactions". Perhaps we deserve to be forgiven for not seeing bitcoin's underlying nature. After all, tearing down the existing monetary system and building a new one was a fresh and exciting narrative.

Anyways, Coinbase still believes this old tale. "As with other technologies, money has gone through many upgrades over the years," its marketing team writes. "Bitcoin is the latest breakthrough in a technology that’s millennia old."

What is now apparent is that bitcoin was never a monetary phenomenon. No, bitcoin is a new sort of financial betting game. It is a digital, global, highly-secure, and fairer version of the old-fashioned chain letter.

The premise behind bitcoin-the-game is that the current wave of buyers must guess when (or if) a subsequent wave of buyers will emerge, this second next wave's participation being contingent on when (or if) they believe a third wave of buyers to emerge. If they guess right, the early birds win at the expense of the late ones. And they can win a lot of money, as Coinbase points out in its post:

Source: Coinbase

Think of bitcoin as a pure mind game, a Keynesian beauty contest in which we "devote our intelligences to anticipating what average opinion expects the average opinion to be." Those old fashioned chain letters that you (or your parents) used to get in the mail were an early type of beauty contest. The price that Alice was willing to place on a chain letter was a function of whether she expected the next recipient, Bill, to play by the rules and send it on, Bill's expectation in turn depending on the odds that Jack would join the game.

But chain letters had a major flaw. The chain order could be easily compromised by a fraudster who miscopied the list and put their name at the front. Bitcoin fixes this by introducing robustness to chain letter-type games. Bitcoin's blockchain is an unbreakable public record of where in line game players stand. Altering this chain order would require tremendous amounts of computer power, as Coinbase illustrates in this chart:

Coinbase: Source

Bitcoin-the-game has been spectacularly successful. As Coinbase points out, it "went from an idea in 2008, and a first transaction in 2009, to over 27 million users in the US alone in 2019, or 9% of Americans." Below, Coinbase has charted the number of active bitcoin addresses that have been created over the years:

Source: Coinbase

Why did bitcoin-the-game succeed?

First, it's a fun and cutting-edge game. Many people dream of thrusting themselves out of financial obscurity into millionaire land. Bitcoin is a technologically-sophisticated way to get there. No one wants to play grandpa's lottery.

Secondly, the way that bitcoin is designed helps it spread. Most of the legacy financial games that bitcoin competes with (poker, lotteries, sports betting) are regulated by the government. Strict rules prevent game providers from reaching a wide audience. For instance, online casinos may be prevented from serving out-of-state players, problem gamblers may be banned, and those who are under 18 must be excluded. These financial games are usually centralized. This means they are hosted on a single website, or at a physical location like a casino, or by a government-run lottery corporation. Which makes it easy for regulators to shut down game providers who break the rules.

But bitcoin is different. Because it is a decentralized and digital financial game, it can't be regulated or shut down. And so it can serve the entire globe with impunity. Which it has done by spreading into every crack and cranny on earth. As is illustrated by another of Coinbase's charts:

Source: Coinbase

Based entirely on whisps and storms of psychology, the price of bitcoin is inherently volatile. Its core volatility has stayed pretty much constant over the last 11-years. Users should expect the same for the next 11 years. Even if more people join a Keynesian beauty contest, the average opinion of the average opinion will always be a fickle, inconsistent thing, and so price will always be jittery.

So what about bitcoin-as-money? Yes, people do use bitcoin for payments. But this gets dwarfed by its popularity as a financial game. The problem is this. Bitcoin payment functionality is implemented on top of a highly volatile chassis, a fun but fickle beauty contest. Which hobbles the effectiveness of the payments platform. Regular folks won't use the stuff to pay. They don't want the value of their spending stash to fall by 20% overnight. And game players don't want to waste their tokens on buying goods & services. That could mean potentially missing out on a life changing jackpot. That's why the promise of mainstream bitcoin payments has died a thousand deaths over the last 11 years.

That being said, the demand for bitcoin in economically volatile regions such as Venezuela has hit record highs. Coinbase suggests that thanks to inflation and capital controls, bitcoin is finally being used as the electronic cash for which it was originally designed.

Source: Coinbase

Coinbase could be right. In places like the U.S. with functioning monetary systems, bitcoin is just too awkward to serve as a payments alternative. But in places where monetary breakdowns have occurred, regular folks may be more willing to put up with the inherent pitfalls of transacting with bitcoin. And so we finally get to see bitcoin-as-money emerging.That's a good thing.

But bitcoin's popularity in Venezuela is also consistent with the bitcoin-as-game narrative. When people are desperate to improve their lives, they may have little other option but to roll the dice. In Run Lola Run, Lola needs to quickly make 100,000 Deutschmarks to save her boyfriend's life. She races to a casino and plays roulette. Likewise, in the face of societal collapse,  Venezuelans may simply be gambling on whatever potentially life-changing bet they can find. Bitcoin is one such a bet. Unwinding what portion of Venezuelan usage is due to bitcoin-as-game versus bitcoin-as-money is tricky.

Coinbase goes on to spout the typical cryptocurrency industry nonsense about legacy payments. It claims that "sending an international wire transfer by major US banks costs around $45, can take days to process, and can be done only during banking hours." And here is the chart it uses:

Source: Coinbase

That may be a good critique from ten years ago. But with SWIFT gpi having rolled out a few years back, multinationals can make near real-time cross border payments using the traditional correspondent banking system. For individuals and small businesses, fintech Transferwise offers instant remittances over fiat rails. These can settle on weekends in nations like the UK, which have real-time retail payments systems. I've touched on this before.

Continuing along with hyperbole, Coinbase makes the claim that bitcoin remittance fees are minimal compared to fiat. But this ignores the sizable foreign exchange fees that one must pay when converting fiat into bitcoin and back into fiat. I've gone into this calculus before.

What's next for Bitcoin? asks Coinbase in closing. Let me give it a shot. It's possible that bitcoin-as-game will stay popular for a very long time. And if it does, that could be a good thing. As I've suggested before, there is a demand as-such for financial games and bets, specifically early-bird bets. Compared to many of the fly-by-night games out there, bitcoin provides a fair and trustworthy option.

What about the original vision that got us all so excited, bitcoin-as-money? Crippled by bitcoin's game-based engine, bitcoin payments are probably never going to move beyond the niche role that they currently occupy. That's better than nothing. When those on the fringes are temporarily cut off from the conventional payments system, they'll always have an option for making transactions. It might not be a user-friendly option, but at least it's there.

A case for bitcoin

Mavrodi "biletov"

In this post I'm going to outline a case for bitcoin. I still think bitcoin is a bad medium of exchange and a rubbish store of value. It's just too volatile and unhinged, and it'll always be that way. But bitcoin still has an important role to play... just not the role that most people assume.

Sara Hess and Eugene Soltas recently published a fascinating article on the life of Russian ponzi-scheme architect Sergei Mavrodi, who passed away last month. I found it interesting that in the latter part of his career, Mavrodi openly advertised that his schemes were pyramids, yet people still bought in.

Ponzi-schemer Sergei Mavrodi clearly advertised MMM's risks and promised nothing in return, yet still people bought in. If he didn't trick people into joining, maybe society genuinely needed him to manage ponzis? https://t.co/5RAzDFvTgx pic.twitter.com/pUghQJQB00

— JP Koning (@jp_koning) April 26, 2018

This got me thinking. I've always sort of assumed that ponzi schemers were just con men who fooled innocent people into giving up there money. But even after Mavrodi lifted his skirt and told the truth, people still flocked to join his schemes. Maybe there is a constant demand on the part of willing and informed individuals for ponzis. Which would mean that folks like Mavrodi aren't just conmen. Rather, society genuinely needs them to manage ponzi games.

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We already knew that anyways, you might say. After all, Las Vegas exists, right?

The role that lottery and casinos operators play is certainly similar to that played by ponzi schemers. People take joy in gambling, and lottery operators and croupiers make sure these games run smoothly. Ponzis, lotteries, and poker are all versions of a zero sum game. If you win $10, it's only because someone else who was playing the game lost $10. Zero sum games are different from win-win games, say like stocks, bonds, and other liabilities including banknotes. Someone doesn't have to lose $10 on Google shares for you to be able to make $10 on Google. The underlying business generates income from its customer base and this provides each and every shareholder with a return.

What differentiates one type of zero-sum game from another is the rule used for redistributing money from losers to winners. Ponzis and pyramids are early-bird zero sum games: the jackpot goes to the earliest entrants and is funded by money provided by the latest entrants. A lottery, on the other hand, awards a randomly chosen participant with everyone else's money. Being the last buyer of a lottery ticket provides one with the same odds of winning the jackpot as the first buyer.

The coexistence of different types of zero sum games indicates that while the public has an ongoing demand for the chance to win jackpots, it also values the way those jackpots are rewarded. Perhaps a ponzi provide a different set of psychic returns than other zero sum games; getting in line early and looking back at all the late comers may offer a sense of satisfaction that a lottery can't provide.

Society has typically legalized lotteries while criminalizing ponzis and pyramids, although in Mavrodi's case there was some ambiguity since he cheekily advertised them as ponzis rather than trying to deceive the public. Luckily for authorities, ponzis and pyramids are easy targets. They have central points of failure. An administrator needs to collect money from new entrants and then pay it out to older entrants. So there is a physical entity with an address that can be sued by unhappy participants or pursued by the authorities.

Because they are illegal, ponzis have been driven underground. Unfortunately, the delegitimization of markets can have perverse effects. For instance, street drugs are often mixed with dangerous contaminants, say like how heroin is laced with carfentanil, an elephant tranquilizer. If the drug market were brought into the open, it could be that producers would be pressured by market forces to provide a purer product and fewer users would die from accidental overdoses.

The same argument applies to ponzis. Those who play them have to rely on fly-by-night operators who may abscond with the funds at any moment, the ponzi collapsing before reaching its natural end. If ponzis were legitimized, it would be much easier to have a transparent and well-run ponzi market.

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Like ponzis and pyramids, a chain letter is an early-bird game, a type of zero-sum game that use entrance order as its redistribution rule. And like ponzis and pyramids, they are illegal. The Circle of Gold chain letter that began in San Francisco in 1978 and spread to the rest of the U.S. through 1979 and 1980 is a good example of the genre.

In brief, I buy an existing copy of the letter from you for $50, and simultaneously mail $50 to the name at the top of the list, for a total outlay of $100. I then make two copies (removing the name at the top of the list an inserting my own at the bottom) and sell them for $50 each, for a total of $100, thus breaking even. By selling the letters directly rather than sending them via the mail, presumably I avoid mail fraud. The buyers in turn make copies and sell them on, the chain continuing. Once my name starts arriving at the top of the list the money will pour in. The letter exhorts recipients not to break the chain.

HODL is similar to the "DO NOT BREAK THE CHAIN" exhortations commonly found on chain letters. They're not wrong—if the chain holds, the money keeps flowing! https://t.co/Ha0qaJGWsC pic.twitter.com/xcgpW1OV25

— JP Koning (@jp_koning) December 22, 2017

Whereas a ponzi relies on a central node—or operator—for managing the game's flow of funds, a chain letter decentralizes the role of operating the system. Any participant who has bought a copy of the letter is delegated the job of faithfully modifying their version of the ledger (by removing the name at the top and inserting theirs at the bottom), sending the $50 by mail, and then passing the updated ledger on. Lacking attackable central nodes, chain letters are more difficult for the authorities to shut down than ponzis.

There are still a few key flaws with a chain letter. The first is that everyone who joins the chain letter needs to leave their physical address. And so it is possible for the authorities to target participants by getting a copy of the chain letter, visiting their home, and shutting it down that way. To avoid this risk, many would-be ponzi players will probably choose not to play.

The second flaw is that chain letters are not secure. Each participant has an incentive to mis-copy the list and put themselves at the top, thus cutting into the queue. This lack of credibility hurts the chain letter's ability to propagate.

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All of which gets me back to bitcoin.  Bitcoin is not a win-win game. It is a zero-sum game that uses entrance order as its redistribution rule, or an early bird game like a ponzi, pyramid, or chain letter. The only way to get ahead is if a subsequent participant buys one's bitcoins at a higher price.

But bitcoin brings a few unique features to the table. To begin with, Bitcoin is decentralized. Rather than a lone administrator like Sergei Mavrodi handling the scheme, the ledger is maintained by a disparate set of nodes. This makes bitcoin much harder to shut down than a ponzi.

Chain letters are also decentralized, but Bitcoin doesn't inherit the weaknesses of a chain letter. Although there are many different copies of the bitcoin ledger, these copies are constantly being checked against each other to ensure that they are all in sync. This means that—unlike a chain letter—there is no way to budge in line, say by re-writing the bitcoin ledger in one's favour. And this improves the durability of bitcoin.

Before I bring this all together and make my case for bitcoin, there is one other early bird game I haven't got into yet: the speculative bubble.

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Unlike chain letters, ponzis, and bitcoin, which are pure early bird games, bubbles occurs on the back of an already useful asset, say like a stock or commodity. During the late 1990s internet mania, for instance, the return on an internet stock could be decomposed into two components: a fundamental component and a zero-sum game that was being played on top of the stock's fundamental value. Those playing a zero sum game by purchasing internet stocks didn't give a damn whether the underlying internet business made sense. No, they were betting that a late-comer would arrive to take the stock off their hands at a much higher price.

To a fundamental investors (say like Warren Buffett), zero-sum game players are a nuisance. The zero sum game that they are playing adds a wasteful premium to stocks, pricing fundamental investors out of the market. At the same time, zero sum game players are probably just as annoyed by the fundamental component of the asset they are buying and selling. Its presence dampens the jackpot that they stand to win.

Prices provide useful signals to society. A zero-sum game that runs on top of an intrinsically valuable asset like a stock or a commodity distorts that signal. This can lead to wasted resources. Producers who decide to add capacity—say a new production plant—in response to a commodity's high price may only be reacting to the transitory mood changes of those playing that commodity's attached zero-sum game, and not a fundamental need for new supply.

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So having said all that, let me finally make my case for bitcoin. Bitcoin shouldn't be categorized along with monetary instruments like bank deposits, coins, and banknotes. Nor does it belong in the same category as win-win games like the stock and bond market. No, bitcoin should be grouped with other zero-sum games such ponzis, pyramids, speculative bubbles, and chain letters.

But this isn't necessarily a bad thing. It should be embraced.

City planners build bike lanes in order to prevent the dangerous mixing of cars and bikes. Likewise, if people who are playing zero-sum games on top of regular stocks and commodities can be diverted into bitcoin (and other pure early bird games like ponzis) instead, maybe that would make for a more ordered financial system. Early-bird games that are played on top of useful assets taint their price, and thus play havoc with the signal this price provides. But bitcoins, ponzis, and chain letters have no use as commodities, so there is no underlying real good that can be contaminated by the presence of zero-sum game players.

When criminalization drives ponzis underground, the supply of trustworthy ponzis shrinks and the supply of untrustworthy ones increases. Bitcoin has a role to play here. It is an open system. The set of rules that governs it are automatic and available for all to see, unlike the closed books of a ponzi administrator. There is no way for the system operator to abscond with everyone's funds. So bitcoin is a safer zero-sum game than an illegal ponzi. If people have a genuine need to play zero-sum games, shouldn't they at least be able to play a good one?

Is bitcoin expensive? Sure. Lots of electricity is required to ensure the integrity of bitcoin. But if bitcoin has managed to displace a bunch of poorly-run underground ponzis and pyramids, as well as reducing the signal-destroying participation of zero-sum game players in traditional financial markets, maybe the expense was worth it.

Dismantling a central bank

In a previous post, I made the point that banknotes aren't Samuelsonian bubble assets, say like a chain letter or a ponzi scheme or bitcoin. Upon the dismantling of a central bank, each note has a senior claim on a central bank's remaining assets. Rather than being mere "oblongs of paper", as Samuelson described them, banknotes occupy the very top of the capital structure hierarchy, above stock and bonds. This quality of being "well backed" might be sufficient for notes to trade at a positive value in the first place, and also help explain subsequent fluctuations in the purchasing power of those notes. In this post I revisit these ideas.

The process of dismantling a central bank would go like this. Imagine that the Reserve Bank of Fiji announces that it will wind up operations next week and recall all notes. Its assets consist entirely of Fijian dollar-denominated bonds. With the eminent end of Fijian dollars, the entire Fijian economy will have to quickly re-denominate existing debts and contracts into a new unit of account, say U.S. dollars. After this redenomination, the Reserve Bank of Fiji now finds itself holding a large quantity of U.S. dollar-denominated debt. It proceeds to sell these bonds, as well as its printing presses and premises, for dollars, and then uses dollars to cancel all Fijian notes. The Reserve Bank of Fiji is no more, and neither are Fijian dollars.

Because the central bank's hypothetical dissolution would result in noteholders ending up with some ultimate quantity of U.S. dollars in their pockets, Fijians can use this terminal value as a basis for computing the present value of Fijian banknotes. They would go about doing this computation in the same that they would with a stock and bond, both of which also have hypothetical terminal values, or liquidation values.

The inestimable Mike Freimuth, who blogs here, pointed out that there is a problem with this. How can Fijian noteholders actually quantify the amount of dollars to which they are entitled upon dissolution? This is easy if the Reserve Bank of Fiji is already on a dollar standard (say it redeems notes for US$1). Once all of the central bank's assets have been sold for U.S. dollars, each noteholder would get US$1 until all Fijian noteholders had been satisfied, upon which less senior stakeholders like bondholders and shareholders would get their portion of the central bank's remaining stash of U.S. dollars.

However, if Fiji is on a floating standard, the task of valuing noteholders' claims gets quite thorny. While fiat notes may have a senior claim on assets upon dissolution, it isn't evident how many actual dollars this entitles noteholders too. And if their quota of remaining assets, or terminal value, is not known at the outset, how can Fijians arrive at a value for notes in the first place?

One answer to Mike's criticism is that Fijian note owners come up with their best estimate of how much dollars the central bank (or a judge) would decide to award them upon a hypothetical dissolution. If the market's collective guess is that no assets would be forthcoming, then Fijian dollars would be worth nothing upon windup. If Fijians on average assume that the sale of bank assets would net $100m, and they think a judge would award them half of that, then each Fijian banknote will earn a prorated share of $50m. If they think that the all assets will be awarded to them, then they'll get a prorated share of $100m.

While these expectations about the terminal value of notes would probably be sufficient to jumpstart the positive value of Fijian dollars in the first place, this isn't a very satisfying explanation for subsequent variations in the price level. After all, the Fijian price level on any given day would be a function of Fijians' many and divergent expectations concerning their as-yet-unstated share of some future pie. As noteholders take potshots at guessing what this unknown size of this slice would be, the Fijian dollar would fluctuate wildly, sort of like a penny stock. Penny stocks owners have wildly fluctuating estimates concerning their ultimate, and unfixed, share of the corporate pie, which is only determined after debtors have had their pickings.

However, the behavior of currencies is not like penny stocks—the former tend to vary only a little in price from day-to-day. To explain price level fluctuations, it would seem that something other than the terminal value of the Reserve Bank of Fiji's assets must be at work.

Here I would like to reiterate my point from an earlier post that once a banknote has been jumpstarted into having a positive value, the dissolution-value of a central bank assets will only have a distant influence on those note's subsequent value. By far the more immediate effect that central bank assets have on the value of notes emerges via their ability to be mobilized in the maintenance of price stability. By selling assets for notes and retiring them (or threatening to do so), a central bank can prevent the value of their notes from flagging. Alternatively, the income earned by those assets provides the central bank with the resources to pay more interest (on reserves at least), a feature that will also ensure price stability.

So it seems to me that any impairment to a central bank's assets will affect the value of notes not so much because it lowers their value come future dissolution, but because it limits the central bank's ability to repurchase notes and pay interest in the present so as to maintain their price target. If a central bank didn't provide a target supported by a repurchase facility, then the value of notes would be dictated by something like their terminal value—and prices would be much more volatile then they are now.

When money ceases to be an IOU

Despite its odd denomination, the above is a genuine banknote. Ne Win, Burma's military dictator from 1962 to 1988 and the man pictured in the note, was convinced that his lucky number was nine. So he had notes issued in multiples of nine, including the forty-five and ninety kyat notes (which also each add up to nine 4+5=9, 0+9=9). But I'll get to this story later.

This is a continuation of a post I wrote earlier describing how central banknotes aren't mere bits of intrinsically useless paper. The standard view among economists is that banknotes are bubble assets. Because they are intrinsically valueless, the fact that paper notes earn a positive value can only be explained by the fact that the market expects them to have value in the future, much in the way that a ponzi scheme or chain letter is perpetuated. This view goes back to Paul Samuelson (pdf), who described how a "grand consensus" might be arrived at whereby society could contrive to have "oblongs of paper" pass at a positive value from generation to generation. The creation of such a bubble would allow for an efficient allocation of resources. As long as each generation could fool itself into thinking that the next would accept these worthless bits of paper, the scheme could continue indefinitely.

However, if real life banknotes were in fact pure Samuelsonian bubbles, then no one would bother participating in central bank redenominations. If a central bank were to announce a 10:1 redenomination, why take in your $1000 note to be redeemed for a $100 note? After all, your existing $1000 note will buy you more stuff than a prospective $100. That we do take part in redenominations is due to the fact that the central bank is threatening to do something to its legacy note issue—it is threatening to cease honouring them as its liability, or IOU, an act sufficient to drive that notes' value to zero. This quality of a banknote as a liability or IOU means that a note is not a Samuelsonian asset.

That central banks offer legacy note conversion at all  is another sign of the IOU-nature of bank notes. It explains why we don't see revolutions during redenominations and demonetizations. Those suddenly left holding old paper would riot on the streets upon the sudden displacement of their notes by a new currency. We don't see riots due to redenominations or demonetizations because banknotes aren't Samuelsonian—central bank paper carries an implicit IOU whereby the central banker will typically repurchase the legacy notes that they've issued at a fixed rate rather than letting those notes flap around in the wind.

For instance, when the European central banks ceased their issuance of domestic banknotes they didn't strand them. Rather, they offered a window in which individuals would convert legacy notes into euros. This window varied in size by country. In the case of the Banca d'Italia, for instance, lira could be converted into euros until February 2012, a ten-year window. De Nederlandsche Bank continues to offer to convert old Dutch guilders into euro, and will do so until 2032, while the Bundesbank, Banca D'Espana, and the National Bank of Belgium guarantee to perpetually redeem deutsche marks, pesetas, and francs respectively with euros. Here is a full list:

As a convertibility window narrows toward zero, a central bank's paper loses its IOU nature and approaches the ideal of Samuelsonian money. For instance, when Saddam Hussein decided to cancel the old "Swiss Dinar", he did so by offering note holders a tiny six-day exchange period, a mere crack compared to the massive windows left open by European central banks. Saddam narrowed this aperture even further by deviously shutting down the Iraqi border during the exchange period, preventing the large population of merchants in Jordan and elsewhere from crossing over into Iraq to swap their Swiss dinars for new dinars.

The Burmese kyat, pictured above, is another example of a note that approaches bubble money. In September 1987, Ne Win demonetized the largest denominations of kyat: the twenty-five, thirty-five, and seventy-five kyat notes, issuing in their place the aforementioned forty-five and ninety notes.

As dictator, Ne Win didn't seem to see any problem in burdening the Burmese population with these awkwardly-denominated notes. The legacy notes being replaced that September were already in odd denominations (25, 35, and 75), the hallmark of a redenomination in 1985 that replaced more conventional denominations of twenty, fifty, and one-hundred kyat notes. It seems that the seventy-five note was issued to mark Ne Win's 75th birthday, and the thirty-five replaced the fifty because it was, according to Ne Win's numerologist, the luckier of the two numbers.

To make matters worse, the legacy issue of kyat notes could not be converted into new forty-five and ninety kyat notes, effectively removing the IOU embedded in kyat notes and rendering a large part of the nation's stock of notes worthless. Here is an account of a Burmese individual at the time:

Then on September 5, without alerting even his cabinet, Ne Win passed a sealed envelope to the Information Minister. Inside were instructions to broadcast the enclosed announcement at 11:00 a.m.

I listened to the 1:00 p.m. news on the car radio outside the art exhibition. When the announcer said government employees would receive 450 kyats as emergency funding, I knew our kyat notes in denominations of 75, 35, and 25 had all been instantly devalued. At home that afternoon my family members gathered to pool our currency. Ko Gyi had received cash payment from a client on Thursday, all in 75-kyat notes, and I had not yet opened my two most recent pay envelopes, one containing my salary, the other my bonus, also dispensed in 75-kyat notes. My brother and I together had only 25 kyats in 10- and 5-kyat notes. Our other cash was useless.

Still hoping from compensation after the demonetization announcement in 1987, some people hoped to make a quick profit. Expecting a grace period, they started collecting 75 kyats by paying 50, then collecting 30 kyats for the same amount, then 20, until finally, when no follow up news came from the government, they realized they had lost everything. Two thirds of the total currency in circulation became useless paper, and ordinary citizens lost their entire savings. Even the beggars suffered.  - No Time for Dreams: Living in Burma Under Military Rule, by San San Tin

Ne Win had contrived to create Sameulsonian money.  Rather than greeting Ne Win's contrivance with open arms, popular uprisings began in 1988, eventually leading to Ne Win's resignation. Aung San Suu Kyi would emerge as an opposition leader in these uprisings.

North Korean won are a more recent example of notes devolving into mere "oblongs" of paper. In November 2009, the North Korean government announced a 100:1 redenomination. Nothing unusual here, except that North Koreans were given a seven-day window to convert existing Korean won into new notes. This window, already narrow, was further constricted by a ₩100,000 limit on the amount that could be converted. Given the then prevailing black market exchange rate of ₩3,000 to the dollar, the amount of legacy won that could be converted into new won was limited to around $30. Tragically, any North Korean who had won-denominated savings larger than that amount lost much of what they had.

Public anger forced the government to increase the limit to ₩150,000, but widespread uprisings as in the case of Burma never followed. The perception that future surprise redenominations might rob existing note holders has not promoted the stability of the won. Indeed, the inflation rate in North Korea is one of the highest in the world. Circulation of US dollars and Chinese yuan increased dramatically as a result of the redenomination, since no one fooled once wants to be fooled twice. (A shift to the use of the dollar also occurred in Burma as a result of Ne Win`s 1987 redenomination, as this interesting article points out.)

Though Samuelsonian money is an elegant idea, the reality is ugly. Only the most sinister dictators have tried to perpetuate it. The contrived currencies that have had Samuelsonian characteristics—Burmese kyat, North Korean won, and Saddam dinars—have been among the world's worst currencies. Widely accepted and long-lasting bank notes like dollars and euros are not bubble-like. Their issuers threat these as IOUs, much like a stock or a bond. If they fail to take these commitments seriously, say in the case of redenominations, their currencies will quickly be out-competed by currencies issued by banks that do.