Bitcoin: A bubble waiting to burst likes Ponzi schemes

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FILES-SINGAPORE-INTERNET-BITCOINExactly in Bollywood style when cops reach at the end of a brawl,at last the government has woken up to press the alarm bell against bitcoins or cryptocurrency. Countries like South Korea, Bolivia, Ecuador, Kyrgyzstan and Bangladesh have already banned cryptocurrencies. J.P.Morgan, the financial wizard, calls Bitcoin a “fraud” and the largest Ponzi scheme ever in humanity.  The Finance Ministry has now come out with an action plan against bitcoin and cryptocurrencies.

For our readers, I would like to explain that the claim that bitcoin holds huge fundamental value as a medium of exchange is yet to be seen. Bitcoin was invented by an unknown person or group to be a digital currency. It allows money to be transferred directly between individuals using cryptography. Bitcoins are reportedly created at pre-determined and gradually decreasing rates, with a total limit of 21 million issuable coins. Buyers sit on their coins while they wait for their price to rise further. What is wrong with bitcoin is that its supply is constrained and increasingly falling short of demand. As such instead of functioning as a currency, bitcoin remains a speculative empty asset.

The so-called block chain technology is showing increasing interest in it as many people are out to make a quick buck. Bitcoin or any other cryptocurrency may have intrinsic value because of the kind of money early birds are making out of it. However, it is nowhere close to widespread use as a medium that helps in the exchange of goods and services like the ethical currency which is a legal tender. A Morgan Stanley research note recently concluded that bitcoin’s acceptance “is virtually zero”. What then explains Bitcoin’s huge and phenomenal price rise? How can a top film star reportedly raise his investment of a few lakhs into crores of rupees? The lure of extraordinary gains and greed associated with it, of profits in very short periods of time in the case of bitcoin, has attracted people from all walks of life including some celebrities into this shady currency. Indeed, this is typical of bubbles that are driven by emotion rather than value as has been happening in case of Ponzi schemes or ‘chit fund scams’. Then there is an inherent danger because anyone who has access to a bitcoin password has the authority to spend the bitcoins it unlocks; loss of the password means loss of all of the associated bitcoins, with no recourse. Second, linear growth in the chain of blocks that make up bitcoin is resulting in exponential growth in the computation necessary to process and verify transactions.

Now our finance ministry has publicly accepted that there is a “phenomenal increase” in the prices of virtual currencies, including bitcoins, which are like “Ponzi schemes”. Ponzi schemes drive their name from Charles Ponzi, the notorious financial trickster who duped investors of about USD 20 million way back in the 1920s. The US regulator defines a Ponzi scheme as an “investment fraud” that pays existing investors with funds collected from new investors. Eventually, the scheme caves in when it fails to lure new investors or a large number of existing investors decide to cash out. Recently some top notch non-banking finance companies (NBFCs) of our country gained notoriety by launching Ponzi schemes and garnered huge sums of money.

Why gullible people are fascinated by bitcoins is that for example just one lakh rupees invested in bitcoin in 2010 would be worth a few hundred crore rupees today. That is the kind of extraordinary returns the bitcoin cryptocurrency has given to investors as its price has witnessed a meteoric rise, from just a few cents in 2010 to hit a lifetime high of over USD 11,000 last week. In 2017 alone, bitcoin price has increased by over 1000 per cent. In fact, the time it took for the currency to reach $11,000 after breaching the $10,000 mark was a single day. True to its nature, however, soon after hitting $11,000, bitcoin witnessed a sharp drop of 20 per cent before recovering some of its losses to close the day almost flat.

The sudden rise and fall in bitcoin value depends on demand and supply. If there are more investors, it would rise in view of more funds pumped into the system. Little doubt that other cryptocurrencies like Ethereum witnessed equally impressive gains and falls. Like the stock markets, this sudden rise and fall promotes speculation and people wanting quick returns rush to invest.  Actually, we can’t compare bitcoin which has no real world usage to stocks or even real currency.

The stocks or shares have value because they belong to a company which may go into red or earn huge profits. However, in comparison, the bitcoin is a scheme having no intrinsic value. The price goes up phenomenally when people are buying it and when they stop purchasing or investing, it goes doing and its value is nothing more than a big zero. In view of this, bitcoin is the most unreliable and is not going to become a legal currency. The truth hurts and the bitter truth or the stark reality hurts most. The current bubble may pop anytime for the same reason a Ponzi scheme eventually fails because of lack of public interest. The sufferers would be gullible people who are investing in it too late. Many of us are tempted to make a quick buck by investing in cryptocurrencies, particularly bitcoins. These promise phenomenal returns. One bitcoin, which was available for USD 0.09 in 2010 had surged to almost USD 20,000 in just seven years. It, however, had a rollercoaster ride, where for every winner there were several losers.
The finance ministry has now admitted that “there is a real and heightened risk of investment bubble” and “sudden and prolonged crash” would expose retail consumers who would lose their hard-earned money.

The ministry is also apprehensive that the virtual currency could be used for subversive activities such as terror-funding, drug-trafficking or money-laundering. The RBI has been issuing similar cautionary notes since 2013. Despite cautions from the guardians of the economy, many bitcoin exchanges are working with impunity in the country. Many rich celebrities and powerful people are associated with this rage. The finance ministry will be failing in its institutional duty if it did not move proactively to protect gullible investors from a Ponzi-like scheme. No virtual currency, not even the popular bitcoin, has been accepted as legal tender by any country. It is time for the Finance Ministry to act fast. Long ago a similar bubble burst in West and people lost everything, leaving thousands of investors in despair about their futures. History is repeating itself now with bitcoin. The price of bitcoin may yet double or even quadruple because its price is based on pure speculation and hype but the bubble is waiting to burst any time. It is time for the gullible public to be aware of the trap that they are getting into and for the Finance Ministry to act swiftly and sternly!

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