A popular smear against Bitcoin is to label it a “Ponzi scheme”. Recently, someone on Reddit was asking how to counter this claim. We took a little time to offer a response, and thought it worth expanding upon here.
The claim usually goes something like this:
Bitcoin is like a Ponzi scheme because there are massive rewards for the first adopters.
The quickest way to deal with this critique is to point out that it applies to virtually every kind of investment: Every successful investment rewards early-adopters more than those late to the show.
This would apply to ‘conventional’ investments — like stocks and bonds — as well as investments in fiat currencies and precious metals. It would also apply to investments in real-estate, fine art, and private business.
Bitcoin vs. Traditional (Fiat) Currencies
However, Bitcoin does aim to be an alternative to government-issued currencies. Thus, someone might make an argument like the following:
Since people simply use traditional (fiat) currencies as a medium of exchange, no-one benefits by having been an early adopter.
This however is simply not true. Many people do “invest” in currencies (usually foreign ones).
Further, the same observation — that fiat currencies are used as a medium of exchange — holds true for Bitcoin as well. Many people do use BTC for its utility in exchange.
Someday, we should hope, Bitcoin will be used primarily for that purpose too — as a medium of exchange, a better medium of exchange than the national currencies prevalent today. But until then, it is to some degree a speculative “investment” (despite having many real-world use-cases already).
Late-Comers Win Too
Another point against the ‘Ponzi‘ claim is the fact that late-comers to Bitcoin can — and do — benefit from the system along with early adopters. And early adopters certainly aren't left with an empty bag, as they are with a Ponzi scheme.
Everyone that uses Bitcoin, whether they benefit from its price increases or not, can benefit from the advantages it offers over other monies and payment networks: quick, international payments; censorship-resistance; irreversible transactions; etc.
(Bitcoin detractors may also argue that those who buy in at a high price lose when the Bitcoin price goes down... It's true that some people lose money that way, but it's not a necessary outcome as it is in a Ponzi scheme. And those that are prudent and patient will not be substantially affected by this phenomenon.)
Early Adoption Makes Bitcoin Possible
In fact, Bitcoin could never work without this “early-adopter reward“. Without the incentive, there would have been very little reason for people to mine or purchase bitcoins in the early days, or even to this day. Technological curiosity alone almost certainly would not have been sufficient to bootstrap the currency.
Speculators and early adopters are necessary to get startup companies off the ground. Bitcoin is like a startup currency. Speculators bring much-needed liquidity and market-share, both necessary if Bitcoin is ever to compete with “real” currencies.
Bitcoin Has Real Value
Although a bitcoin is useless by itself, the same is true of dollars, pounds, yen, and every widely-used currency. Interestingly, this phenomenon — the “nework effect” — is true even for many non-monetary goods.
Consider: Would you have any use for a telephone if nobody else had one? Was email useful in the 1980s, before its widespread adoption?
Like many technologies, Bitcoin becomes more and more useful as more people use it. And in that regard, crypto-currency has the potential to be at least as useful as widely-used fiat currencies prevelant today (setting aside the question of scaling the crypto-currency technology).
A Ponzi scheme, on the other hand, is a zero-sum game. Value is only transferred, not added.
Real, value-adding systems (or investments) are not zero-sum. The late-comers — even the last person to adopt — can benefit in addition to the early adopters (assuming they don't buy into a speculative frenzy/bubble and get burnt when the price corrects).
Compare this to the historical and ongoing situation with mobile phones, for example: the early adopters — and especially the early investors in the technology — have benefited the most. But that doesn't take away from the value that latecomers have received. Indeed, even the last person on Earth to receive a mobile phone will reap benefits.
Bitcoin has a number of features that make it attractive versus traditional currencies and payment networks. Unlike Ponzi or “pyramid” schemes, Bitcoin is a useful, value-adding technology — and nobody has to lose for others to gain (even though early adopters may, in the short run, benefit more).