David M. Webb, Hong Kong’s most influential market gadfly, has dismissed crypto-currencies, which have roiled markets with their phenomenal rise in value over the past few weeks, as “the world’s first decentralized Ponzi scheme.”
In the Dec.14 edition of his blog, Webb-site.com, Webb argues that “so long as we have governments with the power to tax and spend in their own currencies, digital pseudo-currencies will never gain traction. Bitcoin and its imitators are a zero-sum game in which the sum of all fiat currency paid for it is the sum of all fiat currency received for it, excluding mining costs.”
Webb is a retired investment banker and an active investor in Hong Kong stocks. He is the deputy chairman of the Hong Kong Securities and Futures Commission’s Takeover and Mergers Panel. Earlier Bitcoin participants, he wrote, are “now cashing out the billions that newcomers are putting into this distributed Ponzi scheme. Play it for entertainment value if you want, but remember that you are purely betting on the greater stupidity of others.”
Bitcoin and other “digital pseudo-currencies,” as Webb calls them, will fail because “no single operator is running it, and everyone has a chance to participate in it, but its value is determined purely by the weight of money coming into it and the willingness of holders to sell it. Like any Ponzi scheme, earlier participants came in at lower cost, and are now receiving much of the billions of dollars (yes, really) that newcomers are putting in.”
Webb’s argument is running counter to thousands of enthusiastic participants in cryptocurrencies, who say they are a democratic mechanism that removes banks and governments from the intermediation process, allowing “leadership [to] thrive with free-form creativity, ambitious innovation, and a national culture in which such aspirations can be pursued.”
However, there is the troubling fiasco over Mt. Gox, a Tokyo-based Bitcoin exchange that by the start of 2014 was handling 70 percent of all bitcoin transactions in the world. A month later it closed and began liquidation. The operators announced that some 850,000 bitcoins belonging to customers and the company were missing and likely stolen, an amount valued at more than $450 million at the time.
The crypto-cuurency’s advocates say that can’t happen again. But, Webb writes, most of the larger participants will privately admit, “if only to themselves, that Bitcoin is a bubble, but they also believe that they can get out before it crashes, or don’t much care because they have already cashed out far more than they put in. But just remember this: Bitcoin is essentially a zero-sum game. At any point in time, the cumulative sum of all net cash put in by losers will equal the cumulative sum of all net cash taken out by winners (excluding mining costs).”
Millions of smaller participants, perhaps holding the not-unjustified view that the world’s banking systems and governments have failed them, think that Bitcoin or other crypto-tokens are the future of money, according to Webb, a utopian ‘end of fiat currency’ scenario in which money trading will be in units of “crypto-currencies” that allow the people to control their financial lives instead of banks and governments.
“We’re here to tell you, for reasons explained below, that as long as the world has governments with the power to tax and spend, that isn’t going to happen, “Webb writes. “Citizens should instead pressure their governments to stop the insane amount of interference in the banking system which has kept it so difficult and expensive for honest people to wire money, open accounts and do business, particularly when they are running small businesses. Banks should not be expected to act as policemen, particularly now that governments are getting more access to their customers’ data.”
Bitcoin is not a currency, according to Webb’s report. “To be viable as a currency, something must be both a medium of exchange and a store of value. These are mutually independent criteria: one cannot be satisfied from the other. If a currency doesn’t have some intrinsic value relative to real-world assets or liabilities, then even if you can wire it around the world in minutes, its value will fluctuate based on the willingness of others to take it off your hands and nothing else. It won’t be a reliable store of value, so it will be tossed around like a hot potato. Any merchant who accepts it will immediately convert it into a fiat currency to avoid the risk of holding it.
We will let Webb explain in his own words why he is a skeptic:
“Governments no longer guarantee the exchangeability of their currencies for gold, silver or other rare atomic elements. They instead issue “fiat” currencies, basically IOUs, the value of which (measured in other currencies, or the goods and services it can buy) can also crash if they print too much – as Zimbabwe did. A fiat currency is only as good as the country which issues it.
“However, a government levies taxes in the same currency (creating liabilities for taxpayers), and spends that money to pay civil servants and provide citizens with basic goods and services, such as education, healthcare or public roads, or just hands it out as welfare that its poorer citizens can spend. A government also measures business profits and salaries in the same currency – giving currency its third major function, as a unit of account. You won’t see companies or people filling out their tax returns in Bitcoins.
“So a government (particuarly an elected one) has an inherent incentive not to dramatically devalue its currency, destabilizing its economy with hyperinflation and reducing the real value of both its tax collections and its expenditures. Situations like Zimbabwe are the exceptions that prove the rule, and almost always result in the overthrow of the government involved.
“Governments therefore aim to manage the quantity of money so that there is just a modest incentive to spend it or lend it; many central banks have declared targets of 2 percent inflation and some (notably the US Federal Reserve) have a dual mandate of maximizing employment.
“By comparison, Bitcoin isn’t issued by any government or any single entity. Nobody stands behind it, and its rate of creation is determined not by inflation targets but by a simplistic formula which halves the rate of production every 4 years. Indeed, because supply does not expand to meet demand, Bitcoin has been going through hyper-deflation – the price of everything measured in Bitcoin has been plummeting, making it irrational to spend Bitcoin unless you expect it to decline in value. So perversely, anyone who has the confidence that this is the future of currency is unlikely to spend it.
“Incidentally, that formula for the mining rate, like every other aspect of a distributed system, is only set by consensus; it is perhaps only a matter of time before the consensus, out of rational self-interest, decides to abandon the software-imposed cap of 21 million Bitcoins and increase the reward for “mining” it, once the majority of operators have cashed out enough from the Ponzi scheme to make that attractive. What makes you think that a global collective of miners, without a country or an economy to run or an election to win, will not at some point begin to debase their “currency”?
“Some Bitcoin proponents say that its value is derived from its utility as a medium of exchange – but that just takes you round in an infinite loop, because to be able to exchange value for goods and services, a currency must have a widely-accepted, stable value on its own. And even if that utility were there, the fees for transactions have begun rising, make Bitcoin unviable for small transactions.
“This has also prompted a split within the mining community (known as a “hard fork”), with a new variation in the software to allow more transaction capcity in every 10-minute settlement run. The result is that each old Bitcoin token on 1-Aug-2017 split into a current Bitcoin token and a “Bitcoin Cash” token, and there is no reason why that can’t happen again.
“The combination of price volatility and transaction fees has also resulted in some early adopters such as Valve Corp (operator of the Steam gaming platform) dropping it as a means of payment.”