I wanted to write up a brief article about this to point people at when they inevitably parrot the uninformed ‘attack’ they heard from someone else on the Internet: “Cryptos are just ponzi schemes”. In my earlier article I tackled the silly notion that “only criminals use crypto”, so I wanted to specifically address the ponzi scheme angle.
Let’s start with the basics, or we have no basis for having a useful discussion. What is a ponzi scheme? According to Investopedia, a ponzi scheme is “a fraudulent investing scam promising high rates of return with little risk to investors. A Ponzi scheme is a fraudulent investing scam which generates returns for earlier investors with money taken from later investors. This is similar to a pyramid scheme in that both are based on using new investors’ funds to pay the earlier backers.”
I think this latter bit, i.e. “using new investors’ funds to pay the earlier backers”, is where people with less familiarity with assets like crypto and stocks are misled into thinking crypto fits into this definition. On the face of it, it sounds true – hey you have to sell your crypto to someone to make money from it, that sure sounds sketchy! While yes you have to sell your crypto if you want to make a profit from it, this means crypto is no different from the stock market. And it seems the FEC agrees with this idea, since in the US crypto gains are basically being regulated the same as stocks now. We’ll address the rest of the ponzi definition in a bit, but I really want to hit on this part because otherwise intelligent people seem to so easily fall for this by the FUDers online.
How buying and selling crypto actually works
As someone who has actually bought and sold crypto (gasp!) how the process works is there are markets (called cryptocurrency exchanges) where you can buy and sell crypto. Two of the most common ones in the US are called Coinbase and Kraken. Anyone can sign up to buy or sell crypto, but you have to identify yourself, just like if you wanted to start buying stocks or bonds. There is an active market price for nearly all cryptos so you know before you make any decisions what the cost will be, and most importantly there is liquidity in the market, which means a large supply of the cryptocurrencies (provided by sellers) and dollars (provided by buyers).
Because of this liquidity, anyone who wants to buy or sell a reasonable amount of a given crypto (under say a few million bucks worth) can easily do so. It’s really important to understand here that (at least with any reputable crypto) you don’t need to know anyone to be able to get in or out of the market, the process of buying and selling does not require you to know who you’re buying from or selling to.\
How ponzis and pyramid schemes work
Ponzi schemes are completely different. In something that’s a stock-based ponzi, it is usually set up by lying to regulators about what the asset actually represents. This usually ultimately means a lot of jail time for the people who set them up. For most ponzi schemes (stock and not stock-based), you have to usually know someone in order to buy some of whatever the asset is. Sometimes, they will still even call it a stock even though you can’t buy it from a stock exchange – this should be a big red flag. Also once you’ve bought into whatever the ponzi is about, the onus is now on you to find more suckers to buy from you in order to make sure you get your return – this is the Multi Level Marketing aspect which many ponzis use.
We have a bit more to discuss, but I want to make sure I’m crystal clear about what a ponzi or pyramid scheme is, and how to identify one. As you can see, for most cryptos, this is just an unfair label pushed by people who are either ignorant and hate any new technolgy which is still young and needs more time to become useful to regular people – remember how great the Internet was in the early 90s? Probably not, if you actually had to live through AOL dial up and email forward chains. Crypto is still finding its place, give it time. Don’t invest if you don’t want, just don’t listen to people who spread falsehoods about what it is and isn’t.
Even worse these folks often have an ulterior motive of trying to sell you something (sometimes even a different crypto!) Be on the lookout for this when someone wants to sell you something right after they tell you that “ALL crypto is a scam”.
“So you’re saying all crypto is legit? I don’t believe you”
First, I want to be clear: not all cryptos are legit. Many of them are, but it may not be easy to tell the legit ones from the scams. If you are not the kind of person who really likes to research the people behind the assets you invest in, and take time to read the whitepapers for the product (some cryptos do not even have a whitepaper, much less a website) and understand what value a crypto is bringing to the market, then it is still very easy to get tricked into buying something that’s actually worthless.
If this sounds like you, then if you do want to invest, please just stick to buying very big cryptocurrencies like BTC or ETH. If a coin’s promise is to “make people rich”, then it’s safest for you to assume that you are not one of the people getting rich, you’re one of the people giving up your money to make those few at the top of the pyramid rich. Legitimate coins have a specific goal which actually advance either the computing landscape or the financial industry. Anything else feel free to consider a scam, be my guest.
General newbie crypto advice you didn’t ask for
A little more advice: Please for the love of God, do not go onto Youtube, and dive into the rabbit hole of obscure crypto investor videos showing 2000% APY if you buy this really obscure crypto that no one has heard of. That literally is a pyramid or ponzi scheme, for two reasons. One, you may be able to buy in initially, but once the price starts to crash, and it will, you will suddenly find there are no buyers for your super obscure crypto, because it’s obscure! Also, remember the definition from earlier: a ponzi is “a fraudulent investing scam promising high rates of return with little risk to investors”. There is always risk in crypto just like in stocks, Treasury Notes, what have you. If you do not understand what the risk is then you should not be investing at all, end of story.
Also, if someone says “send crypto to this address and you’ll get 2x (or 3x or whatever) back”, it is indeed always a scam! People don’t give out money in the internet for free, for any reason! If you don’t answer Nigerian email scams, do not send crypto to people you don’t know, regardless of who they claim to be. If you do answer Nigerian email scams, then stop doing that!
Other parting advice for the new investor
Finally, you should not buy another crypto that sounds like a big name one but is much cheaper – can you guess why it’s so much cheaper? I can talk your ear off about why Bitcoin Cash (BCH) is an acceptable coin to buy but that you should never invest in Ethereum Max, but you won’t know any of this if getting into the details of a technology is not super interesting to you. Again, stick to the main coins if you want to invest in this new and exciting field of computing and finance.
Also understand that it’s very, very difficult to get your funds back if you do get scammed. My advice to anyone who wants to invest in crypto is the same as it has been for years: get a Coinbase account, buy a little crypto of your choice on a regular basis (even just $10 a month), and forget it’s there. Use dollar cost averaging to slowly build up something that will be worth a lot down the road. If once you educate yourself about crypto you find yourself enjoying it, then welcome to the future! You can always buy in more as you get your confidence (and most importantly knowledge about who you can trust) up over time. Start slow.
Anyway this went on a bit long but I wanted to get this out there. Best of luck, do your own research, and have a great weekend.