When Is a Ponzi a Ponzi?

When Is a Ponzi a Ponzi?

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During last crypto bull market, I got into an argument with a few people I admire — the co-hosts of the “Crypto Critics Corner” podcast Bennet Thompson and Cas Piancey and pseudonymous crypto trader and renegade meme maker Poordart — about the nature of Ponzi schemes, and how they relate to blockchain protocols. In short, I tried to argue that “ponzinomics” were everywhere in finance, including crypto.

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The debate started after an ex-CoinDesker compared the then hot-crypto project Ohm to a Ponzi scheme in its novel attempt to bootstrap adoption. It was meant to ironically affirm Ohm’s financial incentives, which, if successful, could serve as a reserve currency across DeFi, in the way the U.S. dollar is for the world. My interlocutors took offense to the idea that the greenback is a Ponzi scheme. But, isn’t it — sorta?

Ponzinomics is not a real word, as far as I know, but it is a recognizable quality. You know it when you see it. A project is “Ponzi-like” when it incentivizes adoption through implicit or explicit promises of wealth, fraudulent or not. It is derived from the formally defined investment fraud named after Charles Ponzi, who lured investors with promises of high returns and “robbed Peter to pay Paul.”

The term ponzinomics was popularized by author Robert FitzPatrick in a book about multi-level marketing schemes, “Ponzinomics: The Untold Story of Multi-Level Marketing,” where he said companies like Nutrilite and Amway operate like financial pyramids because money primarily comes in via deceptive recruiting techniques and mostly flows to the top. MLMs, which are legal in the U.S. due to lobbying efforts, offer the guise of a legitimate business where products or services are sold.

Similar ponzinomic incentives are everywhere, if you keep an eye out. Economist Hyman Minsky uses the term “ponzi finance” to describe zombie corporations that are functionally dead, but continue to function and meet debt commitments by continuously gaining new sources of funding. Several other economists have theorized national debts can become “Ponzi games,” if governments continually pay off existing debt by issuing new bonds.

Ponzinomics may not even be a bad thing, necessarily, if capital is being put to productive use — but it does almost by definition increase the level of risk for later adopters, who may face the collapse of a financial system unless it is made sustainable or successfully wound down. This is part of the game theory behind bitcoin, afterall, often bought with hope it’ll become more valuable overtime either because it keeps its value relative to the dollar or is widely adopted.

The question is when does ponzinomics cross the line and become legitimately fraudulent? It’s not often the case that crypto scams are called Ponzi schemes when regulators are involved, like in the recent U.S. Securities and Exchange Commission (SEC) indictment of HyperVerse on Monday. After the scam imploded, and authorities got involved, they found Australian “blockchain entrepreneur” Sam Lee operated a scam that defrauded investors of $1.89 billion.

The HyperVerse story has been getting a lot of mainstream attention in part because of the “staggering” figures involved, as U.S. Attorney Erek L Barron put it, but also because of how weird it is. Apparently, Lee and his co-conspirators Brenda Chunga paid an actor to pretend to be a CEO and somehow, likely over Cameo, received endorsements from celebrities including Chuck Norris and Apple co-founder Steve Wozniak.

Court documents describe HyperVerse (also variously called HyperCapital, HyperFund and HyperNation) as a “pyramid and Ponzi scheme” that attracted investors with the allure of high returns from crypto mining and other false promises including a metaverse. “The only thing that HyperFund mined was its investors’ pockets,” SEC Enforcement Director Gurbir S. Grewal said in a statement.

Obviously, nothing was built with the money that was raked in from around the world. What’s interesting, when considering how Lee and Chunga reportedly spent the money, is that the alleged scheme does not even seem very profitable. Sure, they bought cars, property and designer clothing — but, considering the nominal figure raised, it seems like the HyperVerse Ponzi operated for so long because it paid out incoming revenue to existing users.

The scheme had an MLM component to it, which is how Chunga got involved when she was recruited in 2020 and invested $500. Recruits were promised passive income at a rate of 0.5%-1% per day, or an “accelerated” program. Chunga, one of only six “corporate” presenters, and the only one named besides Lee in the documents, received more than $3.7 million from the HyperFund platform and directly from recruiting investors in the U.S.

Things worked until it didn’t, and eventually unraveled when withdrawals were frozen in 2022. By the end, the promoters were attempting to bilk investments by selling users $10,000 NFTs and promising a “university-level blockchain education.” Very rarely can Ponzi schemes survive, eventually there is no one left to trick. Perhaps that’s another similarity with certain cryptos.

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