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World Bank Report: Bitcoin is a 'Naturally Occurring' Ponzi

| Published on July 17, 2014 at 11:02 BST

A recently published World Bank policy research working paper on Ponzi schemes mentions bitcoin as a “naturally occurring Ponzi”, clarifying that it has nothing to do with deliberate Ponzi schemes, as some bitcoin critics have claimed.

Kaushik Basu, World Bank economist and author of 'Ponzis: The Science and Mystique of a Class of Financial Frauds'  points out that most Ponzis today are not always as obvious as in the past, being far more sophisticated and more difficult to identify.

Market-driven bubbles

“The problem stems from the fact that we can have what Robert Shiller calls ‘naturally occurring Ponzis’, that is, financial bubbles that form without the manipulator’s baton but from finished natural market forces and with one person’s expectations feeding into another’s,” says Basu.

Basu goes on to present a hypothetical scenario: if people believe housing prices are bound to go up, they will “beg or borrow” to buy a house, thus creating more demand and contributing to prices spiralling out of control. When the bubble bursts, people who bought at the high end of the market take a hit.

Gold is another example, as it has witnessed numerous bubbles and crashes over the years. Basu notes that gold lost more value in two days of April 2014 than it did in thirty years, baffling both speculators and analysts.

The bitcoin bubble

Basu then cites bitcoin as an example of such a scenario:

“One of the most recent cases of bubbles occurred in the new ‘Bitcoin’ experiment. Bitcoin is a cryptocurrency; the main and original attraction of which is the low transactions cost associated with its use. One can buy bitcoin the way one can buy euros and trade freely with others having euros. Trouble started when people began speculating that the value of bitcoin would rise, thereby raising the demand for bitcoin and making the value-rise a self-fulfilling prophesy. In other words, what we witnessed recently in the bitcoin phenomenon fits the standard definition of a speculative bubble.”

In the past, notable bitcoin critics have claimed that the digital currency is a Ponzi scheme. Back in March, US economist Nouriel Roubini published a spate of heavily critical comments aimed at the cryptocurrency and its advocates via twitter.

In one post he said:

“So Bitcoin isn’t a currency. It is [by the way] a Ponzi game and a conduit for criminal/illegal activities. And it isn’t safe given hacking of it.”

Basu stresses, however, that bitcoin is not a deliberate Ponzi and that there is little to to gain by treating it as such. The bitcoin bubble of 2013 was the result of speculation rather than an organised scheme.

However, he says that bitcoin could have other things to teach economists and bankers:

“The main value of bitcoin may, in retrospect, turn out to be the lessons it offers to central banks on the prospects of electronic currency, and on how to enhance efficiency and cut transactions cost.”

The World Bank has remained relatively silent on the issue of digital currencies until now. Last year it organised a discussion on digital currencies, but its focus on the phenomenon is essentially academic.

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