Don’t Get Tricked, Bro: How to Recognize a Ponzi Scheme

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Before I began writing for Medium, my focus was on writing for a crypto-compensated blogging platform like Steemit. Though plenty of sites like Youtube handsomely reward successful content creators, there’s been confusion surrounding Steemit because of the inclusion of crypto currency. Myself? I’m not concerned. Let me explain why.

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A Ponzi scheme is a type of investment scam. Unique among every other scam I have detailed so far in that you can actually make money at it. It’s wildly unethical to do so, since the returns you will see come out of the pockets of people who bought in later than you (who may never see a cent back). But it is indeed possible to make a lot of money investing in one of these.

Ponzi schemes start with someone claiming to have a risk free, high return investment opportunity. They won’t say exactly what it is, or will give some bullshit answer to that question. If you invest, they can use that wealth to convince others to invest. Then they use the investment money from the second round of investors to pay off the first.

Since the first round of investors has received the high return they were promised, they will vouch for the truth of your claims, which attracts many more investors. Which is necessary, since you’ll need to keep attracting a larger and larger number of investors each round, in order to both pay off the previous round of investors and also skim off some for yourself. This becomes unsustainable very quickly.

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For those who haven’t heard it, there’s an old Arab tale about an inventor who, when offered compensation for his brilliant work, asks that it come in the form of wheat. The Sultan laughs at the meager request. Only, the inventor stipulates that it be measured using a chess board.

A single grain placed on the first square. Then two on the next, four on the next and so on, a doubling every time. Of course by the end, the amount of grain called for exceeded by many times the Sultan’s wealth.

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We are all like the Sultan, in that exponential math is not intuitive for us. For the human brain, really. That is the weakness a Ponzi scheme leverages. For in fact, the number of investors necessary to keep a Ponzi scheme going exceeds the entire population of Earth after a dozen or less rounds of new investors.

If the guy who started it isn’t an idiot, he is long gone before it reaches that point. So what’s the problem, if people make money? It’s hard to visualize without a much wider, more “squat” pyramid but the number who lose all their investment money and never see a dime of it back is much, much, much larger than the number which profit. Exponentially larger.

What are the odds you’ll be one of the few who see a return? Whoever tries to talk you into investing, if they know it’s a Ponzi scheme, and you make it clear you also know, is likely to misrepresent how old it is.

If you cannot find trustworthy information about when it began and how many rounds of investors there have already been, your odds of making any money are incredibly poor for simple statistical reasons.

The other factor to consider is that, much like a pyramid scheme, there is a built-in incentive for investors to go out and talk others into investing. If they are totally naive they might just think it’s a great opportunity that really works (as they got the return they were promised.) However if they realized after investing that it’s a Ponzi scheme, the only way to get their money back is to help attract enough people for the next round of investors.

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The end result is massive redistribution of wealth from a large number of people to a much smaller number, usually the buddies of the guy who started it, as they’re the ones he would be most likely to clue into the fact that it’s a Ponzi scheme, and that they can get rich by being in the first few levels. Bernie Madoff is one of the most famous examples of this in recent years.

So, what about crypto currencies? A Ponzi scheme? Only if people stop using it, and the few people with the most of it stored up cash it all out and leave. Such accusations were leveled at Bitcoin years ago, but it’s still around and valued much higher than it’s first peak, despite the recent collapse of the crypto market.

Why? Because it has real value, because it’s useful for untraceable transactions. The fact that people use a currency and believe in its long term value is what keeps it afloat.

The value of crypto in general as currency also comes from public confidence. Any given altcoin is exactly as precarious as Bitcoin, but also exactly as potentially viable in the long term if people keep using it. Unless those at the top decide to derail the gravy train for everybody else by cashing out all their coins at once and going into hiding, crypto isn’t a Ponzi scheme. Instead, it is at least potentially sustainable, so long as crypto continues to be used as a currency and people keep valuing it.

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