Why Bitcoin is not a ponzi scheme

Some time ago, the Washington Post posted an article rehashing a recurring claim against bitcoin: that it is a ponzi scheme with no inherent value (you can read the full article here). Unfortunately, as has been proven time and time again, this idea is patently wrong.

Matt O’Brien, the article’s author, begins by asserting that bitcoin has no inherent value, because,  “despite companies trying to get free PR by saying they’ll accept it, almost nobody uses it to buy anything other than drugs.” The numbers seem to tell a different story. For instance, overstock.com, an online retail store and staunch supporter of blockchain technology, has recently announced taking in $3 million worth of sales from customers paying in bitcoin.

bitcoin Ponzi Scheme
Why Bitcoin is not a ponzi scheme?

TigerDirect, an online computer-product retailer, also began accepting bitcoin as payment in January of 2014. As early as this March, it announced that it had taken in an excess of $1 million in sales from bitcoin purchases.

Obviously bitcoin is not being used just to buy drugs; far from it. In fact, over the past few years, bitcoin has been continuously attracting larger and larger businesses. This past year, Zynga began accepting bitcoin for in-app purchases. Microsoft has recently begun accepting it for Xbox games and mobile content.  Many more bitcoin sales have undoubtedly been done using gift cards from gyft.com, purchased with BTC.

Next, after a few paragraphs of things Mr. O’Brien finds distasteful about bitcoin, but has nothing to do with whether or not it is either a ponzi or a “real” currency, he gives his argument to back the claim that bitcoin is somehow a ponzi scheme. He begins by  explaining how miners secure the ledger of transactions, the “blockchain”  to prevent double spends of the same bitcoin.  In return, they are rewarded by receiving newly-minted bitcoins every time they are the first to prove that a “block” of transactions does not include a double spend. As more miners enter this game, the difficulty of securing a block increases.

So far, Mr. O’Brien has everything correct; this is how blockchain technology works. Hethen makes an error, though, in claiming that poor financial management by some miners is actually a sort of ponzi scheme built directly into the blockchain technology. He claims that, since many miners went into debt trying to buy the newest “supercomputer” for mining and now some of them cannot afford to pay back their debts as the bitcoin price declines, the technology itself is flawed. He never actually finishes his argument explaining how the above situation is akin to a ponzi scheme, though. So. I will have to take some liberties in assuming that he means to imply this:

  • Miners take out a loan in order to buy the newest “supercomputer.”
  • Unable to pay back the loan due to price declines, miners either go into default or continue to go deeper and deeper into debt to buy newer equipment.
  • The cycle continues until these overleveraged miners are forced into default, lining the pockets of the companies that made the mining equipment while destroying the finances of the debt-riddled miners.

While it may be true that some miners did do this, it  has nothing to do with how bitcoin works. It is not a flaw in the system, but the inevitable consequence of horrible money management that sinks these miners; as every investor know, you should never risk more than you are willing to lose. It is not the fault of blockchain technology that some miners may have gotten in over their heads. That happens in every financial market. It is the responsibility of nobody but oneself if you decide to risk the consequences of over leveraging your capital.

Why Bitcoin is Not a Ponzi Scheme?

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