Is Bitcoin a Ponzi Scheme?

Even before digital currency landed on the public's radar in 2013, people have been asking, "Is Bitcoin a Ponzi scheme?"

Many of Bitcoin's critics are convinced the answer is yes. Look at the comments section of almost any online story about Bitcoin and you'll see at least one self-appointed expert declaring Bitcoin a Ponzi scheme.

Is Bitcoin a Ponzi scheme?They're not alone, though. A fair number of financial pundits and bona fide financial experts periodically denounce the digital currency as a Ponzi scheme. Even institutions have chimed in.

Back in 2012, none other than the European Central Bank put out a study that called Bitcoin a Ponzi scheme. Since then, the ECB has only backed off a little. Earlier this year, a new report said Bitcoin is "inherently unstable" and ripped cryptocurrencies in general as "scamcoins."

The collapse of the Mt. Gox Bitcoin exchange in February 2014 had many announcing that not only was Bitcoin a Ponzi scheme, but that it was finished.

One of the harshest critics at that time was Bruce Richards, CEO of Marathon Asset Management, in an appearance on Bloomberg Television's "Market Makers" program.

"I think it's a Ponzi scheme, I think it's a fraud," Richards said. "I believe that Bitcoin will not have a legitimate place in history as a currency."

But while Bitcoin survived the Mt. Gox debacle and has continued to draw Wall Street interest and venture capital at an increasing rate, many remain unconvinced.

Like Washington Post reporter Matt O'Brien, who has written not one but two articles this year denouncing Bitcoin as a Ponzi scheme.

Making matters worse is that some bad actors have used Bitcoin to perpetrate real Ponzi schemes. In particular, Bitcoin cloud mining is overrun with fraudulent operators.

But there have been more conventional cases as well, such as New York-based Bitcoin Savings & Trust. In November, BS&T operator Tendon Shavers was arrested and charged with fraud for allegedly taking thousands of investors' bitcoins for himself, as well as paying off early investors with bitcoins from later investors.

And yet such activity is no different than Ponzi schemes and fraud committed using U.S. dollars. In other words, while Bitcoin can be used in a Ponzi scheme, the digital currency itself is not a Ponzi scheme.

To get a clearer answer to the question "Is Bitcoin a Ponzi scheme?" consider how a Ponzi scheme is defined...

Is Bitcoin a Ponzi Scheme? Why It's Not

Calling Bitcoin a Ponzi scheme misunderstands both.

First, let's look at what a Ponzi scheme really is. Basically, a single operator organizes an investment system in which existing investors get returns paid with money from new investors. Of course, the operator takes most of the money for himself.

The best known recent example is the case of Bernie Madoff. He launched his Ponzi scheme in the 1990s from his existing investment firm, which he had founded in 1960. He promised - and delivered - high returns for years by using newer clients' money. He covered his tracks with false trading reports.

Bitcoin has none of the attributes of such a scam. For one thing, it isn't controlled by any one person or institution. In fact, Bitcoin is completely decentralized.

A central operator skimming money from clueless investors is a key requirement for something to be a Ponzi scheme - and Bitcoin clearly does not have one.

Another key requirement for a Ponzi scheme is a lack of transparency, essential to keep those being fleeced in the dark.

Bitcoin Is Open and Transparent - the Opposite of a Ponzi Scheme

But Bitcoin is one of the most transparent financial systems ever devised. Every transaction is recorded in the public blockchain, the common digital ledger that's shared over the Internet. Anyone can look up any transaction on the blockchain, even months or years after they took place.

[epom key="ddec3ef33420ef7c9964a4695c349764" redirect="" sourceid="" imported="false"]

Also, in a Ponzi scheme, investors are promised regularly paid high returns. There are no such guarantees with Bitcoin. Anyone who buys Bitcoin takes a risk as they would with any other investment, be it stocks, bonds, or commodities.

And if you buy Bitcoin, your money is not used to pay off existing Bitcoin owners. You can buy Bitcoin and spend it, hold it, or sell it any time. There's no backroom pipeline connecting investors' accounts as there is in a Ponzi scheme.

Finally, Ponzi schemes that collapse do not resurrect themselves. Once it's over, it's over. That's what happened in the Madoff case.

Back in 2014, Bitcoin's critics viewed the failure of Mt. Gox and the steep drop in the price of Bitcoin as the demise of a Ponzi scheme. If that were true, Bitcoin would have ceased to exist in 2014.

But nearly 18 months later, Bitcoin is still here and gaining traction every day. After hitting a low of $177.28 in January, the Bitcoin price is up 62% to about $287. That's not how Ponzi schemes work.

Meanwhile, venture capitalists have invested $397 million in Bitcoin-based startups so far in 2015, already exceeding 2014's full-year total of $361.5 million. Again, spent Ponzi schemes don't attract accelerating interest from sophisticated investors like venture capitalists.

But don't expect critics to stop calling Bitcoin a Ponzi scheme.

The Bottom Line: People keep asking "Is Bitcoin a Ponzi scheme?" even as the digital currency continues to thrive and attract attention from Wall Street and venture capitalists. That's because a vocal group of critics keep leveling the Ponzi scheme accusation at Bitcoin, even though it's completely unfounded. When you break it down, Bitcoin has none of the characteristics of a Ponzi scheme.

Follow me on Twitter @DavidGZeiler.

Is Bitcoin a Bubble? Not all of Bitcoin's critics think it's a Ponzi scheme. Some call it a bubble and liken it to the Dutch Tulip Bulb Mania of 1634-1637. But not all bubbles are created equal. Some bubbles blow up and disappear, but others simply correct an overheated market. Here's why Bitcoin falls into the latter category...

About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

Read full bio