[Cryptocurrency is not merely a bad investment or speculative
bubble. It’s worse than that: it’s a full-on fraud.]
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CRYPTOCURRENCY IS A GIANT PONZI SCHEME  
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Sohale Andrus Mortazavi
January 21, 2022
Jacobin
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_ Cryptocurrency is not merely a bad investment or speculative
bubble. It’s worse than that: it’s a full-on fraud. _

Tether prices listed on the Kraken website., Tiffany Hagler-Geard /
Bloomberg via Getty Images

 

Cryptocurrency is a scam.

All of it, full stop — not just the latest pump-and-dump
[[link removed]]
“shitcoin” schemes, in which fraudsters hype a little-known
cryptocurrency before dumping it in unison, or “rug pulls
[[link removed]],”
in which a new cryptocurrency’s developers abandon the project and
run off with investor funds. All cryptocurrency and the industry as a
whole are built atop market manipulation without which they could not
exist at scale.

This should surprise no one who understands how cryptocurrency works.
Blockchains are, at their core, simply append-only spreadsheets
maintained across decentralized “peer-to-peer” networks, not
unlike those used for torrenting pirated files. Just as torrents allow
users to share files directly, cryptocurrency blockchains allow users
to maintain a shared ledger of financial transactions without the need
of a central server or managing authority. Users are thus able to make
direct online transactions with one another as if they were trading
cash.

This, we are told, is _revolutionary_. But making unmediated online
transactions securely in a trustless environment in this way is not
without costs. Cryptocurrency blockchains generally don’t allow
previously verified transactions to be deleted or altered. The data is
immutable. Updates are added by chaining a new “block” of
transaction data to the chain of existing blocks.

But to ensure the integrity of the blockchain, the network needs a way
to trust that new blocks are accurate. Popular cryptocurrencies like
Bitcoin, Ethereum, and Dogecoin all employ a “proof of work”
consensus method for verifying updates to the blockchain. Without
getting overly technical, this mechanism allows blockchain users —
known as “miners” in this context — to compete for the right to
verify and add the next block by being the first to solve an
incredibly complex math puzzle.

The point of this process is to make adding new blocks so difficult
that meddling with the blockchain is prohibitively expensive. Though
the correct answer to these puzzles can be easily verified by anyone
on the network, actually being the first to find the answer requires
an enormous amount of processing power — and thus electricity —
and outcompeting the rest of the network is impractical.

For their troubles, miners collect a reward for being the first to
verify the next block. The Bitcoin blockchain adds a new block every
ten minutes, and the block reward is currently 6.25 newly minted
bitcoins, worth nearly a half million dollars at Bitcoin’s last
all-time high. Competition for block rewards has led to a computing
power arms race as prices have risen. Mining bitcoins on a personal
computer is no longer feasible. The majority of cryptocurrency mining
is now conducted in commercial mining farms, essentially huge
warehouses running thousands of high-powered computer processors day
and night. The electricity expended mining Bitcoin and other
cryptocurrencies is rapidly approaching 1 percent of global usage,
which is famously greater
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than the total electricity consumption of many smaller developed
nations.

Given that cryptocurrencies don’t produce anything of material
value, this enormous waste of resources renders the whole enterprise a
negative-sum game. Investors can only cash out by selling their coins
to other investors — but only after the miners and various
cryptocurrency service providers take the house’s rake. In other
words, investors cannot — in the aggregate — cash out for even
what they put in, as cryptocurrencies are inefficient by design.

This makes them a poor and costly form of currency and absolutely
ludicrous as a long-term investment. We could dismiss them as a doomed
experiment in the “greater fool” theory of investing, in which
investors attempt to profit on overvalued or even worthless assets by
selling them on to the next “greater fool” — think of it as
gambling on a high-stakes game of musical chairs — if the rising
price of Bitcoin and other cryptocurrencies were simply a function of
demand.

This isn’t the case. Price manipulation plays as much or more of a
role than demand in driving prices higher.

The Central Bank of Crypto

This isn’t some big secret. In a widely circulated 2017 paper
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researchers attributed over half of the then-recent rise in
Bitcoin’s price to purchases made by a single entity on Bitfinex, a
cryptocurrency exchange headquartered in Hong Kong and registered in
the Virgin Islands. These purchases were timed to buoy the price of
Bitcoin during market downturns in a way that so strongly indicated
market manipulation, the authors found it inconceivable that such
trading patterns could occur by happenstance.

Critically, these purchases were not made with dollars, but with
Tether, another type of cryptocurrency known as a “stablecoin”
because its price is pegged to the dollar so that one tether is always
worth one dollar. Many offshore cryptocurrency exchanges lack access
to traditional banking, presumably because banks deem doing business
with them too risky
[[link removed]].
Bitfinex, which shares a parent company and executive team with Tether
Ltd (the issuer of its namesake cryptocurrency), struggled to find US
banking partners after Wells Fargo abruptly stopped processing wire
transfers between the exchange’s Taiwanese banks and their American
customers in 2017 without giving reason.

This was a problem. Without traditional banking relationships for
issuing wire transfers, exchanges cannot easily facilitate trades
between buyers and sellers on their platforms — someone has to pass
cash between buyers and sellers. Stablecoins solve this problem by
standing in for actual real dollars. They allow cryptocurrency markets
to maintain ample liquidity — the ease with which assets can be
converted into cash — without actually having to have cash on hand.

Tether has become integral to the functioning of global crypto
markets. The majority
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of Bitcoin trades are now conducted in Tether, 70 percent by volume.
By comparison, only 8 percent of trade volume is conducted in real
dollars, with the remainder being other crypto-to-crypto pairs. Many
industry skeptics, and even proponents, see this as a systemic risk
and ticking time bomb. The whole system relies on traders actually
being able to exchange tethers for real cash or — far more commonly
in practice — other traditional cryptocurrencies that can be sold
for cash on banked exchanges like Coinbase or Gemini, both
headquartered in the United States.

Should faith in Tether falter, we could see its peg to the dollar
collapse in a flash. This would be a doomsday scenario for crypto
markets, with investors holding or trading crypto assets on unbanked
exchanges unable to “cash” out, since there was never any cash
there to begin with, only stablecoins. This would almost certainly
cause a liquidity crisis on banked exchanges as well, as investors
rush to cash out their crypto anywhere possible amid cratering prices,
and banked exchanges processing far less volume would almost certainly
not be able to pick up the slack.

There is no reason to have any faith in Tether. Tether’s peg to the
dollar was initially predicated on the claim that the digital currency
was fully backed by actual cash reserves — a dollar held in reserve
for every tether issued — though this was later shown to be a lie
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The company has since continuously revised down claims about how much
cash they keep in reserve. Their latest public attestation
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on the matter, from March of last year, claimed to be holding only 3
percent of their reserves in cash. The rest was held in “cash
equivalents,” mostly commercial paper — essentially IOUs from
corporations that may or may not exist, given that reputable actors
trading in commercial paper don’t appear to be doing any business
with Tether
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While even these modest claims about their reserves may be a lie, as
Tether has never undergone an external audit, none of this really
matters, since Tether’s own terms of service
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the redemption of their digital tokens for cash. Should the market
suddenly lose faith in Tether and exchanges become unable or unwilling
to exchange them one for one with dollars or the respective amount of
cryptocurrency, Tether accepts no obligation to use whatever reserves
they may or may not have to buy back tethers.
And in practice, Tether rarely buys back or “burns
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their tokens (sending the tokens to a receive-only wallet so as to
remove them from circulation and decrease the supply, in an attempt to
raise the price), as one would expect if the purpose was simply to
provide market liquidity as claimed. If that were the case, we would
expect the overall supply of Tether to closely track daily crypto
trading volumes. Exchanges would only keep enough Tether on hand to
cover trading volume and presumably sell off or redeem excess Tethers
for cash when fewer people are actively trading crypto.

Instead, the Tether supply has been growing exponentially for years,
exploding during crypto market bull runs and continuing straight
through years-long downturns. There are now over 78 billion tethers in
circulation and rising, about 95 percent of which was issued since the
latest cryptocurrency bull market started in early 2020.

There is no conceivable universe in which cryptocurrency exchanges
should need an exponentially expanding supply of stablecoins to
facilitate daily trading. The explosion in stablecoins and the
suspicious timing of market buys outlined in the 2017 paper suggest
— as a 2019 class-action lawsuit
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alleges — that iFinex, the parent company of Tether and Bitfinex, is
printing tethers from thin air and using them to buy up Bitcoin and
other cryptocurrencies in order to create artificial scarcity and
drive prices higher.

Tether has effectively become the central bank of crypto. Like central
banks, they ensure liquidity in the market and even engage in
quantitative easing — the practice of central banks buying up
financial assets in order to stimulate the economy and stabilize
financial markets. The difference is that central banks, at least in
theory, operate in the public good and try to maintain healthy levels
of inflation that encourage capital investment. By comparison, private
companies issuing stablecoins are indiscriminately inflating
cryptocurrency prices so that they can be dumped on unsuspecting
investors.

This renders cryptocurrency not merely a bad investment or speculative
bubble but something more akin to a decentralized Ponzi scheme. New
investors are being lured in under the pretense that speculation is
driving prices when market manipulation is doing the heavy lifting.

This can’t go on forever. Unbacked stablecoins can and are being
used to inflate the “spot price” — the latest trading price —
of cryptocurrencies to levels totally disconnected from reality. But
the electricity costs of running and securing blockchains is very
real. If cryptocurrency markets cannot keep luring in enough new money
to cover the growing costs of mining, the scheme will become
unworkable and financially insolvent.

No one knows exactly how this would shake out, but we know that
investors will never be able to realize the gains they have made on
paper. The cryptocurrency market’s oft-touted $2 trillion market
cap, calculated by multiplying existing coins by the latest spot
price, is a meaningless figure. Nowhere near that much has actually
been invested into cryptocurrencies, and nowhere near that much will
ever come out of them.

In fact, investors won’t — on average — be able to cash out for
even as much as they put in. Much of that money went to cryptocurrency
mining. Recent analysis
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shows that around $25 billion and growing has already gone to Bitcoin
miners, who, by best estimates, are now spending $1 billion just on
electricity every month, possibly more.

That money is gone forever, having been converted to carbon and
released into the atmosphere — making cryptocurrencies even worse
than traditional Ponzi schemes. Most of the money lost in Bernie
Madoff’s infamous Ponzi was eventually clawed back and returned to
investors. Much of the money put into cryptocurrency, even if courts
could trace back tangled webs of semi-anonymous cryptocurrency
transactions, can never be recuperated.

Regulatory Failure

Ponzi schemes of this scale typically target other financial firms,
banks, elite institutions, and other wealthy investors.
Cryptocurrency, by comparison, is the people’s Ponzi. Cryptocurrency
exchanges with user-friendly interfaces, as well as financial services
companies like Square and PayPal, allow retail investors with few
assets and little financial literacy to buy cryptocurrency on their
smartphones.

The minimum purchase on Coinbase is only $2. On Robinhood, it’s a
buck. A recent Pew survey
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found that one in three adults under thirty have bought or used
cryptocurrency. It is everyday working people who will suffer most
when their savings inevitably evaporate overnight.

Regulators and policymakers have been slow to protect the public.
Ponzi schemes can remain solvent for years while flying under the
radar of law enforcement and regulators. Madoff ran his hedge fund as
a Ponzi for at least seventeen years. While the Securities and
Exchange Commission (SEC) failed to heed multiple warnings from an
industry whistleblower for seven years, regulators acted quickly once
Madoff was turned in by his own children. He was, after all,
defrauding the wealthy, bankers, celebrities, and elites.

The cryptocurrency Ponzi scheme has its own whistleblowers, but
they’re hardly necessary. Tether is built atop and hosted on other
public blockchains, predominantly Ethereum and Tron at the moment.
Every time Tether prints another round of stablecoins, now by the
hundreds of millions or billions at a time (always in suspiciously
round numbers), sometimes several times a week, literally anyone can
see. There are Twitter bots [[link removed]]
analyzing cryptocurrency blockchains and posting large or suspicious
transfers of new stablecoins that make this as easy as clicking
follow. Tether is cooking the books right out in the open. Skeptics
have been pointing this out for years, but regulators and policymakers
did virtually nothing until cryptocurrency went mainstream and wildly
overvalued cryptocurrency companies began posing a risk to traditional
financial markets.

Their response is a case of too little too late. The SEC and US
Commodity Futures Trading Commission subpoenaed
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Tether and Bitfinex in 2017. In 2018, the Justice Department launched
a broad probe
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into cryptocurrency price manipulation and quickly homed in on Tether.
Tether was ultimately fined
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$41 million for lying about their reserves, among other wrongdoings,
and also settled
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a suit with the New York attorney general for $18.5 million for the
same reason. But these actions are a slap on the wrist given the level
of fraud and have not slowed down Tether’s money printer in the
least.
Meanwhile, regulators haven’t even tried to stop cryptocurrency from
infecting broader financial markets. The SEC let Coinbase go public in
April, and several other US-based cryptocurrency exchanges, including
Kraken and Gemini, are planning
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to do the same. The first cryptocurrency futures ETFs have debuted
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in recent months, giving traditional investors indirect exposure to
cryptocurrency by investing in a range of cryptocurrency companies.
Fidelity Investments also launched
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cryptocurrency ETF in Canada that would actually hold
cryptocurrencies, which would allow investors to make direct
investments in cryptocurrency on the same platform where they manage
retirement savings; Fidelity is seeking
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the green light from US regulators to allow Americans the same direct
access.

While a few listed companies, most notably Tesla and MicroStrategy,
have taken multibillion-dollar gambles on cryptocurrency with company
money, most of these companies are simply offering custodial or
transactional services rather than investing into cryptocurrencies
themselves. They are operating parasitically, profiting off
investments into the crypto Ponzi while rushing toward IPOs before the
whole thing collapses.

These companies hold precious little cryptocurrency themselves and
thus little risk. Even MicroStrategy, though initially spending $250
million in company money on Bitcoin in August 2020 while the CEO
shilled crypto on Twitter, proceeded to raise billions more in
repeated rounds of fundraising.

Policymakers have done little to curb any of this. Even those paying
attention to problems with unregulated stablecoins seem hell-bent on
trying to preserve the wider cryptocurrency industry. A recent report
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from the Biden administration assesses the risk of stablecoins without
investigating their primary role in market manipulation. SEC chair
Gary Gensler wants
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to regulate stablecoins as either securities or money market mutual
funds accounts. The STABLE Act
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a bill languishing in Congress since last year, would require
stablecoins be fully backed and regulate issuers and anyone offering
related services.

These efforts are as insufficient as they are misguided. Governments
won’t be able to keep unregulated stablecoins from being traded on
exchanges operating outside their jurisdiction. Tether is not the only
stablecoin game in town. Tether has printed more than $8 billion in
stablecoins since November. Meanwhile, South Korean crypto firm
Terraform Labs, which few people have even heard of, minted another $8
billion of their own stablecoin (TerraUSD). There are others behaving
similarly. Shut these operations down and there’s nothing to stop
them or a copycat from setting up shop elsewhere.

The problem extends beyond unregulated exchanges and issuers. Coinbase
also has its own stablecoin pegged to the dollar, USDC, managed by
partner company Circle, which is also looking to go public with an
SPAC deal
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that would exempt it from the scrutiny of a traditional IPO. There are
now 45 billion USDC stablecoins in circulation, most of them issued
since 2020, just like with Tether. Coinbase and Circle also lied
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about their stablecoin being fully backed by cash when in fact
reserves are mostly composed of yet more mysterious commercial paper,
which is less liquid and far riskier. As Amy Castor, who has long
reported on cryptocurrencies, put it
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“Despite efforts to distance itself from Tether, Circle is starting
to look more and more like a similar scheme, only with a different
critter on the wildcat banknotes.”

Ban Them All

Going after fly-by-night stablecoin issuers will devolve into a
hopeless game of whack-a-mole. The only real solution is to ban the
trade of private cryptocurrencies entirely. We cannot stop foreign
actors from issuing unbacked stablecoins and manipulating crypto
prices on unregulated exchanges. But we can make it illegal to sell
cryptocurrencies on banked exchanges, such as Coinbase, operating
entirely legally while they cash people out of the Ponzi scheme.

This would, of course, kill off cryptocurrency almost entirely,
relegating it back to an oddity of the tech enthusiast. No one should
shed a tear. Cryptocurrencies have virtually no legal use case.
They’re great for facilitating ransomware, laundering money,
distributing narcotics and child porn
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running Ponzi schemes, and… not much else. They fail as currencies
due to high transaction costs. They fail as “digital gold” or a
“store of value” because they consume ludicrous amounts of energy
to run what is essentially a glorified spreadsheet.

China already banned [[link removed]]
cryptocurrencies entirely, and India
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and Pakistan
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are poised to do the same. Other countries have also made moves to
prohibit or constrain cryptocurrencies, but Western liberal
democracies are notably permissive. This is in no small part due to
aggressive industry lobbying [[link removed]], which
includes hiring former financial regulators and compliance officers
into the industry to influence policymakers.

Among their ranks is Brian Brooks, who was the chief legal officer at
Coinbase before serving as acting Comptroller of the Currency in the
Trump administration. Now CEO of blockchain mining company Bitfury,
which is also purportedly looking
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to go public, Brooks joined other crypto CEOs to testify before the
House in December. Predictably, they oppose meaningful stablecoin
regulation, as they understand that it would kill the industry and
render their companies worthless.

These people and everyone else in the cryptocurrency industry are
complicit in the Ponzi scheme and actively misleading the public. They
understand that fraud is the engine driving their industry and fueling
their profits — and that is perhaps the most damning indictment of
private cryptocurrencies and the industry surrounding them.

The 2008 financial crisis made clear why the financial sector must be
brought under public control. Cryptocurrency and “decentralized
finance” aren’t special — they’re just more of the same
privatization and deregulation masquerading as high-tech
“solutions” we’ve seen in other industries. Unregulated,
privatized financial markets pose the same risks to the public whether
or not they are “on the blockchain.”

In the case of cryptocurrency, regulation is an existential risk
precisely because regulatory loopholes and fraud are the only reason
the industry appears profitable despite being wholly unproductive and
a waste of energy resources. The same applies to private
cryptocurrencies as a whole. The longer governments take to ban them,
the worse normal people will be hurt.

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Sohale Andrus Mortazavi [[link removed]] is a
writer based in Chicago.

 

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