By Gary North
I hereby make a prediction: Bitcoins will go down in history as the most spectacular private Ponzi scheme in history. It will dwarf anything dreamed of by Bernard Madoff. (It will never rival Social Security, however.)
To explain my position, I must do two things. First, I will describe the economics of every Ponzi scheme. Second, I will explain the Austrian school of economics' theory of the origin of money. My analysis is strictly economic. As far as I know, it is a legal scheme -- and should be.
PONZI ECONOMICS
First, someone who no one has ever heard of before announces that he has discovered a way to make money. In the case of Bitcoins, the claim claim is literal. The creator literally made what he says is money, or will be money. He made this money out of digits. He made it out of nothing. Think "Federal Reserve wanna-be."
Second, the individual claims that a particular market provides unexploited arbitrage opportunities. Something is selling too low. If you buy into the program now, the person running the scheme will be able to sell it high on your behalf. So, you will take advantage of the arbitrage opportunity.
Today, with high-speed trading, arbitrage opportunities last only for a few milliseconds seconds in widely traded markets. Arbitrage opportunities in the commodity futures market last for very short periods. But in the most leveraged and sophisticated of all the futures markets, namely, the currency futures markets, arbitrage opportunities last for so brief a period of time that only high-speed computer programs can take advantage of them.
The individual who sells the Ponzi scheme makes money by siphoning off a large share of the money coming in. In other words, he does not make the investment. But Bitcoins are unique. The money was siphoned off from the beginning. Somebody owned a good percentage of the original digits. Then, by telling his story, this individual created demand for all of the digits. The dollar-value of his share of the Bitcoins appreciates with the other digits.
This strategy was described a generation ago by George Goodman, who wrote under the pseudonym of Adam Smith. You can find it in his book, Supermoney. This is done with financial corporations when individuals create a new business, retain a large share of the shares, and then sell the stock to the public. In this sense, Bitcoins is not a Ponzi scheme. It is simply a supermoney scheme.
The Ponzi aspect of it comes when we look at the justification for Bitcoins. They were sold on the basis that Bitcoins will be an alternative currency. In other words, this will be the money of the future.
The coins will never be the money of the future. This is my main argument.
THE AUSTRIAN SCHOOL'S THEORY OF MONEY'S ORIGINS
The best definition of money was first offered by Austrian economist Carl Menger in 1892. He said that money is the most marketable commodity. This definition was picked up by his disciple, Ludwig von Mises, who presented it in his book, The Theory of Money and Credit, published in 1912.
In that book, Mises argued, as Menger had before him, that money arises out of market transactions. That which did not function as money before, now functions as money. Something that was valuable for its own sake, most likely gold or silver, becomes valuable for another purpose, namely, the facilitation of exchange. People move from barter to a monetary economy. This increases the division of labor. As more and more people use the money commodity in order to facilitate exchanges, the division of labor extends, and as a result, people's productivity increases. They can specialize. This specialization produces increased output per person, and therefore increased income per person.
In this scenario, something that had independent value becomes the focus of traders, who find that their ability to buy and sell increases as a result of the use of this commodity. Money develops out of market exchanges. Money was not used for its own sake initially, but it becomes widely used as money as a result of innumerable transactions within the economy. (I discuss this in my chapter in Theory of Money and Fiduciary Media, published by the Mises Institute in 2012.)
Here is the central fact of money. Money is the product of the market process. It arises out of anunplanned, decentralized process. This takes time. It takes a lot of time. It spreads slowly, as new people discover it as a tool of production, because it increases the size of the market for all goods and services. No one says, "I think I'll invent a new form of money."
Note: any time you see a proposal of a new form of money, hold on to your old form of money.
The central benefit of money is its predictable purchasing power. A monetary commodity is not easy to produce. The cost of mining is high. Money is slowly adopted by a large number of participants. These participants use money as a means of exchange. Why? Because it was valuable the day before. They therefore expect it to be valuable the next day. Money has continuity of value. This is not intrinsic value. It is historic value. So, a person can buy money by the sale of goods or services, set this money aside, and re-enter the markets in a different location or in a different time, in the confidence that he will probably be able to buy a similar quantity of goods and services.
Money is not accumulated for its own sake. It is accumulated to buy future goods and services. It is useful in the facilitation of exchange precisely because its market value varies little over time. It is the predictability of money's market exchange rate that makes it money.
BITCOINS ARE NOT MONEY
Now let us look at bitcoins. The market value of one bitcoin has gone from about $2 to $1,000 in a year. This is not money. This commodity is not being bought for its services as money. It is unpredictable to a fault.
Admittedly, those who got in early on this Ponzi scheme are doing very well. They will probably continue to do well for a time. As more people hear about this investment, which is justified in terms of its future potential as money, more people will buy it. Late-comers are not buying it because they understand its potential as future money, any more than the late investors in Charles Ponzi's scheme thought they were buying into the arbitrage potential of foreign postage stamps. They are buying Bitcoins because we are in the midst of a Ponzi scheme mania. They will continue to buy because they think this time it's different.
What's cool about North's analysis is that it conveniently comes pre-refuted.
ReplyDeletehttp://consultingbyrpm.com/blog/2013/10/why-misesians-need-to-tread-cautiously-when-disparaging-bitcoin.html
"So my point is, the certain group of Misesians who keep deriding Bitcoin and saying it will eventually collapse, it’s a passing fad, it will never take off beyond internet geeks, etc. etc., because of Mises’ regression theorem, aren’t making any sense. Mises’ regression theorem wasn’t making an empirical prediction about a medium of exchange never attaining the status of money, unless it started out as a regular commodity. No, Mises is saying we can’t conceive of even a medium of exchange (which is a weaker condition than money) that didn’t start out as a regular commodity. Bitcoin is clearly, unequivocally a medium of exchange right now. There are websites where people trade Bitcoins directly for “real” goods. There are people who will sell a “real” good for Bitcoin, intending only to trade away the Bitcoin in the future for something else “real.” Thus Bitcoin is right now a medium of exchange, no doubt about it. "
You are missing North's point. He is saying that Bitcoin is not being used as a medium of exchange. Thus, Murphy's critique deosn't apply.
DeleteWhat you are saying is disconnected from reality. Bitcoin *is* being used as a medium of exchange, which is exactly what Murphy is pointing out. Nothing that North is saying is original or insightful; like Wenzel and Schiff, he was caught completely flat-footed by Bitcoin, and now he presumes to lecture us about why Bitcoin and all crypto-currencies are all going away and never coming back.
DeleteI just bought lunch with them today, gold with them yesterday, and clothes with them last week. What do you mean they are not being used as a medium of exchange?
Delete"What do you mean they are not being used as a medium of exchange?"
DeleteWe are not talking about an individual using them, we are talking about the group as a whole. Look at the velocity of your average bitcoin, ie: How often is it being exchanged? The answer is "not much at all". The vast majority of BitCoins are being hoarded and not spent to buy goods and services.
Money is whatever people decide it is. You would think libertarians would be in favor of a free market in money. Let the people decide what they want to use as money.
ReplyDeleteWhere do you get the idea that Gary North says that you shouldn't have a free market in money? In his article, he says at least a half dozen times that Bitcoin should not be made illegal. He just thinks it is dumb and will result in a lot losing money.
DeleteOf course he says it shouldn't be made illegal. North would completely destroy any credentials he has as a libertarian if he would say the opposite.
DeleteThere is still anonymous' question (i'm paraphrasing) how exactly this "free market in money" is supposed to look if anything other than precious metals that surfaces as a currency is instantaneously ridiculed and bashed by libertarians (and yes i am talking about ridicule, not merely objective argument). Doesn't seem like being open to a free market in money to me. Sounds like certain personal interests being protected.
A free market in money would look just like this. People are free to ridicule/bash and offer whatever arguments they want, right or wrong, about any given money/currency. No one's coercing anybody, so I don't see how "certain interests" are "being protected" in some improper way, as you implied.
DeleteHowever, many libertarians would prefer gold and silver because the two medals have thousands of years of history and wealth preservation to back them up. They're proven, and they're rarely a bad investment in the long run. Bitcoin is barely out of the womb, by comparison. I'm sure all the "Misesian Bitcoin Hater Gang" appreciates what Bitcoin could mean in terms of currency competition, they just don't believe it's a very strong competitor compared to other options like gold and silver. BC's wild price fluctuations and the amount of speculation in the market only add to that skepticism.
It sounds like more of a pump and dump than a Ponzi scheme. Regardless, I wish I'd bought at $2.
ReplyDeleteSame here. I don't care what you call it, if I had bought at $2 (don't have any) I'd sell now and never look back.
DeleteUSG thinks BTC is money. If you exchange currency for any other product of computer not a money exchange, and if you simultaneously exchange the product of computer work for currency it is not a money service. If you exchange the product of computer work mining BTC for currency and visa versa, it is a money exchange subject to regulation.
ReplyDeleteWhat if "the most marketable commodity"; the most wanted thing in the world was freedom from the government? How dare Bitcoin try and provide this?
ReplyDeleteAnd yet another Austrian Economist that will be eating crow for years to come.
ReplyDeleteHe doesn't understand what how a ponzi scheme works. In a ponzi scheme, people pay money to Ponzi, Ponzi puts it in his pocket and claims the money is invested. If someone demands their money back, Ponzi takes money from a new investor and gives it to the old investor. Social security is not a ponzi scheme. Bitcoins are not a ponzi scheme. You are however cordially invited to a stoning.
ReplyDeleteWhy, you stoned again?
DeleteSocial security is a Ponzi scheme by your own definition.
DeleteYes SS is a textbook Ponzi scheme. The US treasury is Ponzi and he just keeps putting IOUs in the pot.
Delete"In a [Social Security] scheme, people pay money to [the government], [the government pretends to put] it in [its coffers] and claims the money is invested. [When retirees] demand their money back, [the government] takes money from [current workers] and gives it to the [retirees]. Social security is a ponzi scheme."
DeleteThere, fixed that for ya, Wolfgang.
"Ponzi takes money from a new investor and gives it to the old investor."
ReplyDeleteWolf! That IS social security. Lord knows we love you, but you are either as dumb as a box of rocks, or you get your jollies baiting the bear. Either way it's getting tiresome...
Jerry, bitcoin, like SS, will end up as a ponzi scheme. New "investors" will be paying the old ones until no one wants to buy from the new investors and the system crashes. Bitcoin's "problem" is you don't have buyers who buy simply because they have more than enough of everything else(think central banks or the worlds super producers like oil states) especially dollars or another medium of exchange. Bitcoin is filled with people who bought yesterday in order to sell tomorrow to increase their dollar holdings.
ReplyDeleteNow think of gold and who ultimately owns it. It is the anti-bitcoin(or litecoin or peercoin or zerocoin or novacoin or primecoin or feathercoin or terracoin or worldcoin or tagcoin or fastcoin.....).
North argues that bitcoins is a Ponzi scheme, but he actually backs off of that claim as his argument proceeds and he ends up stating that in reality, his main problem is that bitcoins will never be money.
ReplyDeleteBitcoins may be in a bubble, but they are not a Ponzi scheme. A Ponzi scheme is where the promotor does not invest the money paid to him as promised, but instead uses money inflows from subsequent customers to pay out earlier customers, thus creating the illusion that the phony investment was actually made and is yielding a high return. North says that in bitcoin's case, the creator is promising that if you buy bitcoins now, he can sell them for you at a higher price later on. But the bitcoin creators have made no such claim, nor have they kept your bitcoins for future sale. They take your money and give you your bitcoins. There is no fraud involved. They gave you the promised bitcoins and have made no promises of future value. It is a speculation, not a Ponzi scheme.
North's discussion of whether bitcoin will ever be money is much better. He nails the difference between "intrinsic value" and "historical value." Schiff used incorrect terminology when he argued that bitcoins have no intrinsic value. I am not even sure what "intrinsic value" means. Value is a subjective determination made by each individual as to where a certain number of bitcoins fall on his list of things he wants to have. Right now, many people have ranked their desire to own one bitcoin higher than their desirse to own $1,000 US paper dollars. Bitcoins are real in that they represent a unique set of computer code and they are scarce in that they cannot be easily multiplied. Thus they do constitute a "good" and qualify as "property" because of their scarcity. But there is nothing "intrinsically" valuable about any good.
The real distinction, as highlighed by North quoting Menger, is that bitcoin has never been valued for a purpose other than money. But I don't know if this is a valid distinction as applied to bitcoin, because the argument can be made that bitcoin right now IS being valued for a purpose other than money. It is being valued right now for its potential to become FUTURE money. I don't know if Menger would say that money can only arise out of a good that was valued for a purpose other than either current money or future money. That is the question. But I also agree with North that as of right now, bitcoin might be being valued not just as potential future money, but mainly because it has gone up in price and is expected to continue to do so. In this sense, yes, it is in a speculative bubble, but it is not a Ponzi scheme, and because it is scarce and real, it does not have to fall to zero.
I also agree with North, however, that if bitcoin is ever to achieve the purpose for which it is currently being valued highly, namely as future money, it will take a long, long time and that its current price is probably more of a speculative bubble caused by the excess of paper money and peoples' urgent desire to unload that paper money in anything they can, like bitcoin, real estate, art, etc. As to what its ultimate exchange value will be against other goods, and paper money, is anyone's guess. I don't see why it has to fall to zero against other real goods, and especially not as against paper money, which also stands a good chance of falling to zero as against real goods.
So my bottom line conclusion is that I sure wish I had bought bitcoin earlier and I might still buy it, hoping to profit off of people's continuing desire that it someday becomes money, but I rather doubt it will become so. In my view, a better form of digital currency would simply be gold-backed digits that would be unique representations of actual physical gold. The transfer of those digits in exchange transactions would represent the transfer of title to the underlying gold without the need to ship the actual gold from buyer to seller.
The idea that it will never be money means it can only be a ponzi scheme. To say he backs off his claim is wrong.
DeleteWrong to say that North backs off the claim that its a Ponzi scheme? To quote North's article: "In this sense, Bitcoins is not a Ponzi scheme."
DeleteAlso, how does it follow that if bitcoin will never be money, that it can ONLY be a ponzi scheme?? If it turns out the gold will never again be money, does that make the promotion of gold sales a Ponzi scheme?
Focus on "In this sense.."
DeleteThat argument could be made for anything. Gold has evidence of being money or store of value for 1000s of years. Today CBs hold it and the super producers of the world want it. BTC has none of that. If I started selling fig seeds to people who then sold them to others(and so on) at a higher price on the idea that they would become the new money of the world, this would not be sustainable because unless someone who can sustain the high price(central bank or a super producer) agrees to do so, the users of the fig seeds will have to sell out to get what they need.