In my opinion, one of the strongest arguments against cryptocurrency in general is the ponzi objection. This is prominently advanced by Professor Stolfi and Chris DeRose. I will present here my own formulation of it in a simplified form and why I think the objection does not necessarily hold in general, although I believe it can in some circumstances.

Ponzi Argument

Consider a hypothetical cryptocurrency, “Coin”, which can only be exchanged for another store of value (but not goods with inherent value) and has no other utility. For simplicity, let us say that Coin is only traded against USD. By definition, it then has only speculative value. Let us declare that it thus has no real value.

Then it is easy to observe that with no friction Coin is a zero-sum game: every dollar gained by selling a Coin is a dollar lost to someone who now has a Coin instead. With friction (costs to maintain, exchange fees, etc), Coin is a negative-sum game among its buyers and sellers, and in total, will lose them money.

Because all payouts come from future investors, going to earlier adopters, Coin easily fits the model of a Ponzi.

Value Creation Counterargument

Here’s why I believe that Coin need not be a Ponzi, and instead, could be a “pure store of value”. First I’ll need to talk about my view of what the history of money, or more generally, stores of value can teach us.

Throughout history, many different things have been used as money: stones, shells, beads, salt, gold, sticks, paper, and more. While some of these have had intrinsic value, others have not. All of them when used as currency were exchanged at rates above what their practical utility alone would have justified. This can be termed “speculative value” as distinct from “intrinsic value”, although the lines can rarely be perfectly drawn. Although there are certain characteristics common to these, like being hard to counterfeit and of somewhat limited supply, none of these characteristics alone suffice to guarantee value.

What makes a potential store of value into a current store of value is the belief of people with economic power. If beads can buy Manhattan, they are being valued as more than their intrinsic value alone would justify. When this additional speculative value is sustained over a significant period of time and with sufficient economic power, it makes sense to recognize a store of value.

Now, because stores of value that are recognized as such are long-lived, it is rare to see the creation of a new store of value. Before cryptocurrency, a notable example would be the creation of the Euro. When a new store of value is created, new value is created.

So if Coin were to have market demand, and if this were to last for an extended period of time, then in my view it has become a new store of value and created value in the process.

Tulips, Pogs, Beanie Babies, Enron, Madoff, and other bad arguments

Now there are two major branches of counter-argument to this I have seen. One is the bubble objection: tulips, pogs, and beanie babies all had high speculative value for a short period of time but no longer do. Therefore, cryptocurrency must be a scam. There are a couple major flaws I see in this argument. First, all of them inherently had unbounded supplies, and the latter two had companies with incentive to keep selling more which tended to make the higher prices unsustainable. Second, while it’s true that they were short-lived, and by their very nature were unlikely to be otherwise, this objection must necessarily fall then if Coin survives for an arbitrary length of time.

The second objection is the fraud objection: Enron and Madoff’s fund had high prices for an extended period of time, but ultimately crashed when their fraud was revealed. Therefore, cryptocurrency must be a scam. While I do believe there is hype in cryptocurrency that can rise to the level of fraud, in general objections are made to cryptocurrency regardless of its parameters being fully disclosed and whether or not such misrepresentations are present. It’s true that “the market” can be inefficient and especially so when there is misinformation (even when skeptics are attempting to raise an alarm about it). Prices are not infallible. Yet, mispricing in the presence of fraud is not an argument for dismissing economic activity in the absence of fraud.

A related objection I’ve seen is the ignorance argument: anyone who chooses to buy into cryptocurrency in the absence of such fraud must then be simply ignorant or irrational. While it’s always tempting to dismiss those who disagree with oneself as fools, this seems like a cop-out. There’s certainly plenty of evidence that people in general are not the “rational actors” of basic game theory, but still I think that a voluntary willingness to pay for something in the absence of fraud is prima facie evidence of value, and not to be so easily dismissed merely because of a lack of inherent utility.

In my view, cryptocurrency is a novel economic experiment because it represents a “pure” store of value being created without a government or central banking mandate. There is no inherent utility, so arguments about value being necessarily being based on such are tested by it. It is essentially pure speculation. If it can continue to attract interest and, more to the point, economic power over an extended period of time (decades and centuries), then I believe it will have in fact created value based on a collective belief that it has value.

It is counter-intuitive and subtle, and it’s easy to understand why it is often dismissed as a scam. This makes it all the more important to clearly disclose risks, acknowledge the speculative nature, and steer well clear of those who want to build hype.

I leave it as outside the scope of this work how such value can be built, but in short I believe that it is through honest work with a long-term perspective.