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Bitcoin, a ponzi Scheme?
Why is this article relevant for IBPS / SBI Bank PO, RRB and Other Bank Exam Aspirants?
Almost all exams including IBPS PO, IBPS RRB, SBI PO evaluate students on their knowledge of Banking General Knowledge and Current Affairs. This section is not only high scoring but also has high cut-offs. To ensure that you do well in this section, you need to ensure that you are regularly in touch with the latest news in the banking world and the economy.
Finance Ministry opines that Virtual Currencies are Ponzi Schemes:
The recent weeks have witnessed a spurt in the prices of Bitcoin and other cryptocurrencies. The Finance Ministry of India has expressed concern and likening them to Ponzi schemes. Noting the “phenomenal increase” in the price of virtual currencies (VCs), including Bitcoin, in India and globally, a statement from the Finance Ministry said: VCs don’t have any intrinsic value and are not backed by any kind of assets. The price of bitcoin and other VCs... is entirely a matter of... speculation resulting in spurt and volatility in their prices. Consumers need to be extremely cautious so as to avoid getting trapped in such Ponzi schemes, the statement added.
The Ministry said VCs are not reliable as they are stored in digital/electronic format, making them vulnerable to hacking and malware attack. Meanwhile, the Finance Ministry’s position regarding taxation of gains on cryptocurrency trade is still unclear. The Income Tax Department conducted surveys on nine VC exchanges in Bengaluru, Hyderabad, Mumbai, Delhi and Kochi to ascertain the source of funds.
What is a Ponzi Scheme?
A Ponzi scheme is a fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns for older investors by acquiring new investors. This is similar to a pyramid scheme in that both are based on using new investors' funds to pay the earlier backers. For both Ponzi schemes and pyramid schemes, eventually there isn't enough money to go around, and the schemes unravel.
A Ponzi scheme is an investment fraud where clients are promised a large profit at little to no risk. Companies that engage in a Ponzi scheme focus all of their energy into attracting new clients to make investments. This new income is used to pay original investors their returns, marked as a profit from a legitimate transaction. Ponzi schemes rely on a constant flow of new investments to continue to provide returns to older investors. When this flow runs out, the scheme falls apart.
Why the name Ponzi?
The first notorious Ponzi scheme was orchestrated by a man named Charles Ponzi in 1919. The postal service, at that time, had developed international reply coupons that allowed a sender to pre-purchase postage and include it in their correspondence. The receiver would take the coupon to a local post office and exchange it for the priority airmail postage stamps needed to send a reply.
With the constant fluctuation of postage prices, it was common for stamps to be more expensive in one country than another. Ponzi hired agents to purchase cheap international reply coupons in other countries and send them to him. He would then exchange those coupons for stamps that were more expensive than the coupon was originally purchased for. The stamps were then sold as a profit.
This type of exchange is known as an arbitrage, which is not an illegal practice. Ponzi became greedy and expanded his efforts. Under the heading of his company, Securities Exchange Company, he promised returns of 50% in 45 days or 100% in 90 days. Due to his success in the postage stamp scheme, investors were immediately attracted. Instead of actually investing the money, Ponzi just redistributed it and told the investors they made a profit. The scheme lasted until 1920, when an investigation into the Securities Exchange Company was conducted.
Modern instances of Ponzi Scheme:
As technology changed, so did the Ponzi scheme. In 2008, Bernard Madoff was convicted of running a Ponzi scheme that falsified trading reports to show a client was earning a profit.
Characteristics of a Ponzi Scheme:
Regardless of the technology used in the Ponzi scheme, most share similar characteristics:
- A guaranteed promise of high returns with little risk
- Consistent flow of returns regardless of market conditions
- Investments that have not been registered with the Securities and Exchange Commission (SEC)
- Investment strategies that are a secret or described as too complex
- Clients not allowed to view official paperwork for their investment
- Clients facing difficulties removing their money
Why is the Bitcoin likened to a Ponzi Scheme?
The price of Bitcoin may even quadruple — because its price is based on pure speculation, and these stories are feeding such speculation. But Bitcoin’s market price is almost certain at some point to crash and burn, just as the dot-coms did, and for the same reason: because it is all hype. And there will be no one to turn to when it does, because no government or bank is backing it up.
Bitcoin’s price is not a reflection of its growing usage as currency; it reflects merely a demand for the mirage of its speculative value. Its price is rising only because people all over the world are hearing stories of how others doubled or tripled their money in a short period — and they don’t want to miss out.
Also Read Bitcoin - Will it kill the Rupee?