Having become totally bored of explaining why things like Bitcoin are a Ponzi, I thought for a change I would approach the issue from the opposite direction.
What then doesn’t constitute a Ponzi?
So here we go:
1) any enterprise that can take your money and invest it in an activity that generates earnings which can cover operational costs/taxes and leave an excess to be reinvested in the business or to be paid out to shareholders, (irrespective of new money coming in or not).
2) any enterprise that can take your money and invest it in an activity that generates earnings which can cover operational costs/taxes and leave an excess to be reinvested in the business or to be paid out to shareholders, and to be able to pay for any debt interest they owe, and/or be confident of being able to roll or repay debt, (irrespective of new money coming in or not).
3) any enterprise that can take your money and invest it in an activity that generates earnings which can cover operational costs/taxes and leave an excess to be reinvested in the business or to be paid out to shareholders, and to be able to pay for any debt interest they owe, (irrespective of new money coming in or not). AND … only be confident that the debt can be rolled in perpetuity rather than totally repaid. Though, of course, unless it’s a zombie company, it’s ability to roll debt will be based on investor judgment about its likelihood to repay in the future.
4) any enterprise that can take your money and invest it in an activity that generates earnings that can cover operational costs/taxes and leave an excess to be reinvested in the business or to be paid out to shareholders, and be able to pay for any debt interest they owe, and be able to raise money through new equity for the purpose of new growth-focused activity which derives its earnings either from doing more of the thing it’s already doing or doing something totally different, or in developing something different. (Something different is advisable if the old thing you are doing is becoming obsolete or over-saturated). All of this without failing to satisfy the pre-existing liabilities without the need for new money.
5) All of the above, except instead of a capital raising for growth, the company is able to raise money through a rights issue or extra debt to gain the money it needs to maintain current activity because it has generated an excess of earnings but a deficit. All this is usually seen as worrying for investors, but doesn’t indicate ponzi as much as dying business.
The one thing all non-ponzis, consequently, have in common is earnings.
A complete lack of earnings can, however, sometimes be forgiven in a young growth company that is clearly worth “something” but is yet to develop a marketing strategy. Earnings, nevertheless, are eventually expected.
Some enterprises that have a very low cost of capital due to overly enthusiastic public sentiment for their business can remain going concerns without generating all the earnings they need to satisfy all the above preconditions, but their shareholders must remain very forgiving of underperformance. What this means, effectively, is that in the most forgiving case shareholders are prepared to subsidise the company while it gets its act together or, at the least, to waive returns. Either way, the subsidy is assured through the overvaluation of the stock relative to earnings — the so-called earnings multiple —which buys (especially young technology companies) time to create the earnings they need to sustain their business. The higher the multiple the greater the shareholder support.
In those circumstances shareholders are agreeing to collectively absorb a portion of the costs that the company generates and which it can’t necessarily pay off with earnings alone. This is tolerated a lot in the technology sector because many companies need to forge brand new markets before they can deliver earnings. But these are considered very high risk investments.
If public enthusiasm in such companies wanes, any crash in the price of the equity can impact the concern’s ability to pay its debts and take company’s under. This is because the company can no longer depend on the implicit shareholder support which is provided by a high multiple. Namely, the ability to raise cash from equity investors who believe in the business at a rate that can cover their costs for x amount of time.
Yet even this type of company is not a Ponzi. It still has real earnings. Just, very often, not enough of them.
What is definitely a Ponzi then?
Any enterprise or scheme which has zero earnings from activities, never intended to have any, and survives only on the constant ability to pay out dividends to shareholders through the issuance of new equity or the entrance of new investors.
Why is bitcoin worse than a Ponzi?
Because on top of transferring wealth from latecomers to “early adopters” — at the cost of latecomers, who increasingly get a smaller percentage of the dividends relative to early adopters — it generates real world energy costs.
In other words, it uses up valuable energy — which could be preserved for much better purposes — for the sole purpose of transferring wealth from dumb money to “smart early adopters”.
Going around pretending you are a high-earning hedge fund when in fact you’re just a Ponzi is a much less heinous crime in comparison because at least your money grabbing efforts aren’t exhausting anyone else’s energy but your own.
Why is fiat currency not a Ponzi?
Because fiat currency is the equivalent of a stake in Sovereign Corp which generates real earnings. These earnings are reflected by the taxes that the sovereign corporation is able to collect.
The national concern is viable if the redistribution of those earnings — just like a well organised company — incentivise further growth, innovation and added value. If and when the national concern has to issue more and more equity in a way that dilutes all the collective shareholders (who are also the corp’s employees) in such a way that it diminishes the amount of added value they can claim you know its viability is being tested. But it’s still not a Ponzi. It’s just being badly managed.
Conversely, just like a company, it’s totally justifiable for the sovereign state to issue more stock if there is more than enough value to go around and not enough equity owners to share it with. Either way, in order to flourish, just like any company, the national concern should constantly be investing in new development (education), covering its costs (replace what it consumes), borrowing money when it can see potential for growth, looking after it’s employees (especially when they retire or get sick) and not be afraid to issue equity or debt for those purposes.
A badly managed national concern does none of the above, of course. Sometimes it issues equity for non-growth purposes. This is when unsustainable inflation happens.
But even a badly managed country that funds itself through constant equity issuance still has value. Furthermore, if there’s no inflation, it’s certainly not a Ponzi.
This is because the value of sovereign corp equity (national fiat) is the sum of a country’s natural resources, its collective intelligence, its ability and willingness to transform resources into added value products and services, its ability to maintain the goodwill of its employees to keep and most important of all its management.
But whilst bad management can seriously compromise a country’s potential and therefore the value of its national equity, it doesn’t change the fact that all those preceding values are still there to fall back on. Even a badly managed country has value and can be returned to growth through better management.
Which is why management, at both corporations and sovereign, must be held to account for bad decisions by vote-holding shareholders, who can force it out or force it to make better decisions that add value rather than detract from it.
Bitcoin derives no earnings from anything apart from inflows of value-backed dollars. Bitcoin has no central authority that can be held to account for mismanagement of the economy due to poor distribution of resources and claims. Most important of all, bitcoin does not replace the energy it uses.
The dollar, however, does derive earnings from the taxable surpluses of society. The dollar does have a central authority that can be held to account if mismanagement of the economy leads to poor distribution of those resources and claims on products produced. Most important of all, the US — which ultimately backs the dollar — does replace the energy it uses (albeit at a potentially unsustainable level, though this is a different issue).
Here is a diagram that tries to explain why either energy or information (innovation) have to be maintained or improved to keep a concern thriving.
Given the number of technology companies trading at crazy multiples due to a serious lack of earnings, it’s hardly surprising that silicon valley VCs have got so easily confused about what constitutes a Ponzi and what doesn’t
Anything that has zero earnings potential — and this also applies to tech firms –can only thrive through monopolisation, i.e. the constant capture and consolidation of competing businesses into its own enterprise. This is very much how any Ponzi works as well.
In these circumstances, the company (or Ponzi) must annihilate anything that threatens the value of its equity/scheme or risks the shareholder flock seeking better “early adopter” gains elsewhere.
Which, of course, is also the way that bitcoin works. And why it is that the more price goes up, the more tempting it is to support altcoins. In a world where bitcoin prices only go one way, bitcoin would have to gobble up every possible point of competition to keep its power. A tough job given a) how low the barriers to entry are in the altcoin world and b) the community’s inability to fund those acquisitions with new equity because eventually the new equity is capped.
Ponzi => anything that can’t exist without permanent inflows to cover its liabilities and costs.
Not a Ponzi => anything that has the potential to generate real earnings eventually.
Young earnings-less tech companies => providers of a service or utility that users won’t pay for directly but which shareholders are prepared to support nonetheless at their own cost. Potential ponzis or extremely bold bets.
The no earnings tax
Problem with the last type is that there’s usually only so long that private individuals are prepared to altruistically support services (at a cost to them) for the good of society. After a while the support becomes a type of self-imposed wealth tax or charity. These are the sort of services consequently that make much more sense being supported by government (if they are indeed truly useful and help the country at large run more efficiently).
But of course if millionaires have so much money that they’re happy to throw it away on unsustainable Ponzi ventures because they like them for ideological reasons, there’s probably no stopping them. But the venture becomes entirely dependent on their ongoing good will.
On which basis, the only compelling argument for Bitcoin not being a Ponzi is that it is a venture with genuine utility for some people but which can’t work unless investors are prepared to permanently cover its costs with their own capital. Also the fact that it doesn’t pretend to generate earnings.
Such a service however already exists. It’s called fiat money. The capital cost to support that system comes via the taxes we transfer into the national kitty.
Funny how billionaire tech giants are so happy to pay de facto taxes (i.e. Suffer capital losses) to support a scheme that concentrates wealth but so unhappy to pay taxes to a government that focuses on redistributing wealth for the sake of a better organised Sovereign Corp.