On Wednesday, we ended class on the assertion that Bitcoin is in fact a Ponzi Scheme. Some of us have heard of the famous Bernie Madoff case, or have some other background knowledge on schemes, but what is a Ponzi Scheme, really? How does it operate? In this blog, we dive into Ponzi Schemes, explain how Bitcoin is effectively a scheme in and of itself, but question other institutions in our country, such as Social Security, and explore elements within them that make them similar to Ponzi Schemes themselves.
In short, a Ponzi Scheme is investment fraud. A man, such as Bernie Madoff, or a company will lure in investors with the promises of major payoff down the road. The schemer will then attract more investors and pay back the initial investors with the newer investors money, boasting of their success in the market relative to their “competitors” who are actually investing the money. From then on, the cycle repeats, and the scheme grows, with each wave of new investors paying off the “investments” of those who came before them. Not a single real investment is made--the whole thing is fraud--the schemer gets rich, the newest investors get scammed, and the whole scheme unravels and collapses when it runs out of new investors to supply cash for its previous investors.
Bitcoin is a complicated and confusing new form of “digital currency” that operates on the dark web. In theory, it brings down the cost of buying goods online. People purchase Bitcoins because they believe their worth will eventually skyrocket as it becomes more common. The first people who went in on bitcoin tend to hoard their own bitcoin for this reason, waiting for this skyrocket in value and popularity. They recruit new investors in bitcoin and encourage them to spend all their bitcoin in order to facilitate this. In short, past investors are waiting to cash in on newer investors spending for their own financial gain--sound familiar? For this reason, many economists come to the conclusion that Bitcoin has become nothing more than a Ponzi Scheme. While it may have been intended to be a shining beacon in the growing trend of digital currency, Bitcoin has faltered, has suffered extreme volatility and recent depreciation in value, and could turn out to be a giant scheme, leaving countless losing significant amounts of their own money.
Thinking now of some elements Ponzi Schemes in terms of other things we have learned about this past semester, why isn’t Social Security considered to be a Ponzi Scheme? Retired people, people who used to be in the labor force, are profiting off of tax revenue from people currently in the labor force. The government literally takes your tax money with the promise of payoff up to 45 or 50 years down the road. We have even discussed how Social Security is going to run into trouble as the workforce shrinks down and the system runs low on taxpayers to support the system. This sounds dangerously close to a Ponzi Scheme. But why is it not a Ponzi Scheme? Certainly every taxpayer in America hasn’t been duped by a mere scheme since before the Second World War, right? Right.
Before we explain why social security is not a Ponzi scheme, let’s delve a bit deeper into the political elements of social security that make it appear to be a Ponzi scheme. Essentially, political gain made it expedient for politicians to promote the social security early in its development. It provided big payouts to retirees when the workforce was still large enough to bear the burden of the newly retired. As John C. Goodman says in his Forbes article titled “Why Was Social Security Designed like a Ponzi Scheme?”, “This [early year revenues that are much higher than the required payout] means that (like a chain letter), politicians can give retirees in the early years more than what was promised. They can also spend the extra revenue on other programs that confer benefits on their constituencies.” To put it in short, at the beginning of social security politicians gain valuable political capital by going above and beyond promises made at the onset of social security. However, political gain does not dictate a shift in policy until the well begins to run dry - a shift we’re beginning to see now. While political expediency did make social security into a perhaps inefficient system, it did not make a Ponzi scheme - as the next paragraph explains.
Social Security is not a Ponzi Scheme. In real Ponzi Schemes, such as Madoff’s, everything on the books is fraud, and no real investments of any kind occur. The Social Security Administration describes Social Security as follows: “It would be most accurate to describe Social Security as a transfer payment--transferring income from the generation of workers to the generation of retirees--with the promise that when current workers retire, there will be another generation of workers behind them who will be the source of their Social Security retirement payments.” Ponzi Schemes, the investors’ money isn’t being invested in anything at all, but for Social Security, there are extremely detailed financial reports put out annually about the system, ensuring that no fraud occurs. So in conclusion, while Social Security may look somewhat like a Ponzi Scheme on the surface, this could not be further than the truth. When the government takes your money for Social Security, it is really investing it and putting it towards the cause it says it is going to. It is not fraud; it is not a Ponzi Scheme.
- What makes a Ponzi Scheme a Ponzi Scheme? How does it operate
- Research the Bernie Madoff case of 2008, how is this case exemplary of why such schemes eventually are doomed to collapse?
- Taking this information about Bitcoin into account, why should you be weary of just buying into Bitcoin today?
- Senator Rick Perry called Social Security a Ponzi Scheme during the GOP debates, why is he incorrect? What about the makeup of Social Security would lead people to believe him?
- Can you think of any other systems that may appear in some ways to be a scheme, while not being a scheme in actuality?
- WaPo on Social Securty (1) and (2)
- Business Insider on Bitcoin
- CNN on Bitcoin
- CNBC on Bitcoin
- WaPo on Bitcoin as Pyramid Scheme
- Forbes on Social Security (1) and 2)