Crypto Liquidity & The Lifecycle Of Ponzi Schemes

Authored by Tom Luongo via Gold, Goats, ‘n Guns blog,

With the Federal Reserve set to begin raising rates in a few weeks I thought it time to dive back into a discussion of crypto now that the ‘easy money’ era post-COVID is over.

I know many still don’t believe the Fed can stop QE, no less shrink its balance sheet, and because of that the refrain, “You can’t taper a Ponzi,” can be heard from every corner of financial media.

I tend to agree with that sentiment because, of course, all Ponzi schemes require new money to constantly come in to prop up the asset values of of the previous round of funding. This is the definition of a Ponzi scheme, after all.

But in a world of Ponzis built on top of Ponzis built on top of Ponzis the idea that the biggest one, on which all the others are built, can’t save itself for a time by popping all of the daughter Ponzis is a bit disingenuous, if not outright obtuse.

And it’s not because debt-based currency regimes aren’t inherently Ponzi schemes. They are. It’s because once the pile of currency is created it has the ability to move where it is treated best and away from those assets most vulnerable to liquidation.

So, the situation in the real world, as it unfolds in real time, is far more complicated than just “You can’t taper a Ponzi.” In the long run, yes, that is correct. But in the time frames where people actually make decisions on where to put their money to provide them a return, it is absolutely not true.

And this is the hardest thing I’ve tried to teach my readers and my patrons over the years. It’s one thing to accurately state what the end state of a particular system will be. In the case of the U.S. dollar reserve system, total and complete collapse is inevitable.

It’s quite another to put a time on when that will occur and in what order will the system collapse.

This is the fundamental problem I personally had to overcome during the early years of my financial writing career. When publishing a newsletter where you lay out an investment thesis and give people your best ideas it simply isn’t good enough in 2013 to say, “in ten to fifteen years all of these losing picks in gold or oil will be winners because the dollar is doomed.”

My approach had to become better, more nuanced and, frankly, more in tune with the ebbs and flows of markets while still maintaining my Austro-libertarian analytic framework.

I remember a particularly difficult moment back in January 2015 when I finally admitted that no matter how much I hated the U.S. dollar with respect to a hard asset like gold, my opinion didn’t matter and the market was still king.

The Fed and the other central banks still had plenty of caché with investors and therefore still had plenty of ammunition in their monetary artillery. Yeah, all they were doing was kicking the can down the road to create a bigger problem tomorrow, but that didn’t mean there wasn’t money to be made from it today.

That was the moment I had to face becoming better at this or getting out of the game completely. It meant truly humbling myself before the market and realizing you aren’t a ‘unique snowflake’ or any other such nonsense. You are treading a path others have before and you will again.

It meant going all in on what I do now, marrying the global macro picture with the political and social trends and place them in a context of seemingly unlimited corruption capable of sustaining hundreds of Ponzi schemes around the world simply because everyone wanted to believe in them.

For years, I’ve had a running discussion with Dexter White over the liquidity of the cryptocurrency market. He consistently points out that liquidity in cryptocurrencies is mostly a function of the capital flow into and out of bitcoin (BTC).

Everything else is a derivative of that and, in effect, if you control the flow into bitcoin you control what Ponzi schemes are sustainable within that market. That argument, in my opinion, was far truer in 2017/18, however, than it is today.

Since the high in April of 2021, Bitcoin and cryptocurrencies have been in a weird place. Bitcoin is clearly grinding through a counter-trend bear market while the rotation out of it and into other areas of the crypto-space have seen spectacular booms and equally spectacular busts.

Following that liquidity sloshing through various projects has made a lot of people a lot of money and cost a lot of people as well.

First with the Fed tightening dollar liquidity starting last June and now with the Bank of England getting ahead of the Fed in raising rates in the face of crippling inflation, we’re now looking at a much different milieu than we were this time last year when everything crypto was coming up roses.

It was that massive bull market through the first half of 2021, however, that saw tremendous liquidity flow into all sorts of new projects, new ideas for generating yield to attract capital. Whether they are or were Ponzi schemes is irrelevant.

Looking at the current DAO-pocalypse occurring in rebasing projects like OlympusDAO and it’s hard not to come to that conclusion. You pay out 7000+% for any amount of time without any reason to stay in the token other than ‘number go up’ and you are worse than any emerging market subject to ‘hot money flows.’ You are literally a time bomb with a short fuse waiting to blow up in everyone’s face.

From $800 to $35 and back to around $60 in two months, I think qualifies as an explosion, especially for a project less than a year old.

There wasn’t any real doubt about that. Just paying a yield in order to attract capital with no intention of doing anything with that capital other than holding it is playing a game of chicken with investors, waiting for the first guy to cash out and starting the avalanche of selling.

It doesn’t matter if you’re the Bank of Turkey or some guy with a few servers and a Github repository.

What we’re seeing in crypto is a massive acceleration of the lifecycle of these types of projects. Olympus has already spawned a ton of imitators simply because at its peak it attracted nearly $2 billion in capital in just a few months.

I’d say why something like that happened is equal parts stupid greed, the insane amount of price appreciation in crypto fueling it and the honest desire to build something new.

Projects like that only exist because the current system of capital formation is even more corrupt and less equitable than some bit of code with only minimal controls over the money flow.

Unfortunately, this is the way innovation occurs; a lot of painful trial and error and a lot of crippling losses. But without this environment there is no way off the current hamster wheel of Central Bank-backed Ponzi schemes.

For crypto to ‘grow up’ it has to build upon bitcoin’s foundation in a sustainable way, one where the replacements for the current upper layers of Exter’s Pyramid are self-contained such that the capital that flows into bitcoin at the bottom is treated well enough it has no desire to leave and go back to the fiat one.

It is rare that a new technology comes out the gate perfect the first time. So, I don’t look at Olympus as a failure because it’s pointing innovators into new and interesting directions trying to solve the Ponzi math and create that ever elusive sustainability which only comes from turning capital into real world assets.

They do this because the goal is laudable, end the systemic thievery of debt-based fiat money. In the case of one new crypto project I’ve found, even reverse the time risk of traditional lending in such a way that it frees the entrepreneur from the vultures of Wall St.

Bitcoin maximalists believe bitcoin achieved this perfection, and they have yet to be proven wrong. But neither have they been proven right. Only time will tell as imitators come and go. And I’m happy to remain both bullish on that prospect and skeptical of it simultaneously.

That said, bitcoin alone isn’t enough to contain the entirety of human activity or desired outcomes. This is where we are today and why things like the spectacular booms and busts of the various DeFi platforms are necessary growing pains.

We humans always do this. We go through every bad idea and iterate on them until something sustainable comes out of it, if ever. Even projects that have had their fundamentals challenged, like Olympus, and are still learning from their mistakes, have a future to help us understand what can be done to avoid the trap of the Ponzi structure.

One of the valid knocks against crypto is what’s the point if we can’t utilize these tokens, these magic beans which throw off yield, to procure real things in the real world? After all, isn’t that all money really is?

A place to temporarily park your savings on the way to getting some thing in the future you want/need. As the old system teeters and cracks and the ones who broke it try to shuck and jive us to throw good money after bad while their Ponzis collapse, it is this critical moment in time where new ideas flourish, good and bad.

Someone will crack that code, to turn the promise of math into real world wealth more efficiently, in the same way that someone will always try to manipulate it so that they don’t have to work for their dinner.

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