Cash vs crypto: Who does Ponzi scheme better? [Video]

Robert McCauley, an academic from Boston College and Oxford, stated that Bitcoin (BTC-USD) is worse than a Ponzi scheme since the eventual use case for the cryptocurrency remains unknown, while its high energy demand renders it a "negative-sum game."

McCauley wrote in the Financial Times that the roughly $20 billion invested in mining thus far "is gone."

According to him, the underlying structure of Bitcoin trading is very similar to a Ponzi scheme, in that early investors are paid off by latecomers, and there is no economic value created in between.

A second non-resident senior scholar at the Global Development Policy Center at Boston University claimed that the Bitcoin (BTC-USD) system would kill society in the long run because of the costs associated with sustaining it, particularly in terms of electricity use.

“Every day, investors send money to miners. And the majority of it is flushed down the toilet on a daily basis. Most of it has been consumed by fire "he stated. "And that's just the cost to the community as a whole. All of that is a failure."

A professor at Oxford University, McCauley discovered that some Ponzi schemes were able to recuperate part of their losses even after their failure. Bernie Madoff's swindle, which has repaid around 70 cents on the dollar at this point, was used as an example to prove this point

According to him, there would be no assets left to divide among the surviving investors if Bitcoin went out of business.

On the topic of McCauley's view on Bitcoin (BTC-USD), he said that he's still waiting for it to establish its usefulness before he changes his mind.

We've been waiting for the use case for quite some time, he admitted. "We're going to have to wait and see what the future holds, but new ideas are on the horizon. However, we're still a bit on the fence."

Banks use fractional reserve banking rather than mining.

Only a small percentage of bank deposits are backed by cash in this arrangement.

It's the system that led to the financial collapse of 2008.

We can borrow money to buy homes, start businesses, and keep the globe moving because of this same system.

At once, it's like having Dr. Jekyll and Mr. Hyde looking after your finances.

In fact, many individuals are enraged by the whole situation, which is understandable.

Fractional reserve banking is one of Professor Murray N. Rothbard’s favorite topics, and he doesn't hold back when it comes to his thoughts on the subject.

As he puts it:

Ponzi scheme; shell game, or fraud in which false warehouse receipts are issued and circulated as if they were cash.

His complaint is that banks enrich themselves at our expense, in other words.

In Rothbard's view, our banking system is a Ponzi scheme since it offers a high rate of return with no risk.

This is how it all works.

We borrow money from the bank and pay a fee for the privilege of doing so. When a banker pushes a button on a computer, the results are instantaneous! - commercial money is created by the bank.

The bank, on the other hand, lacks the monetary resources to back up the loan it just issued.

Rothbard's world is here too. The bank serves as a repository for money. The 'fake warehouse receipt' is a computer-created commercial money transaction. The banking system around the world uses this commercial money, but it can't be backed by money the bank didn't have to begin with.

Rothbard isn't the only one who sees a problem.

Mervyn King, the former governor of the Bank of England, had some thoughts on the issue of banks owing individuals money during the financial crisis. He quotes Winston Churchill in his book, The End of Alchemy:

For the first time, "...never in the area of financial endeavor had so much been owed by so few — and with so little fundamental reform"

So, banks made loans that borrowers could not afford to repay. Not much has changed. Unpayable loans may still be made by banks.

Since fractional reserve banking has been proven to be a Ponzi scheme, why aren't we doing something about it?

It would be better if they had to keep 100% of the deposits they get in cash and called these “reserves”.

"100 percent reserve banking," sometimes known as "full reserve banking," was proposed before as part of The Chicago Plan in 1933. This idea was first floated in the wake of the Great Depression when banks were once again in the news.

Full reserve banking is what comes to mind for many individuals when they think about banks. Having a large bank account like this is like having a safe deposit box.

When you deposit your funds with the bank, they are securely locked away. You can take it out of the bank whenever you choose. Because the bank does not lend it out, you never have to worry about not being able to access it when you need it.

By depositing your money in a bank, you are removing it from the general economy. As a result, the amount of money in circulation decreases, while demand deposits at the bank rise, resulting in an unaltered amount of money in circulation. The bank cannot take any risks with your money if this mechanism is in place.

No reason exists for your money to be depleted by the bank. It doesn't mean that you won't have access to your funds if a run on the bank occurs, which is when a large number of people withdraw all of their money at once.

Forcibly increasing the bank's reserves to 100%, would avoid a bank run. Those bogus warehouse receipts also prevent the bank from making loans. It also prevents bankers from creating dangerous investments with other people's money and then peddling them as low-risk options to their customers. (Remember the crisis around subprime mortgages...?)

But…

Our small business loans, mortgages, and other investments like real estate and stocks are all denied because the bank engages in dangerous operations like these

There is no doubt that fractional reserve banking is the system that takes on the risk of funding new investments, no matter what those investments are. Our economy depends on it.

As long as people don't all withdraw their funds at the same time, our fractional reserve banking system will work - although it's a never-ending balancing act to keep track of deposits and withdrawals.

Bank deposits don't lie around doing nothing; they're put to work finding homes and businesses and supporting other expenses (such as hazardous enterprises by bankers "looking for yield").

With a bank account of £100, the bank may lend out £50 and deposit it in the account of someone who needs it for a small business loan. However, you're still owed £100 by the bank.

As a result, the borrower has £50 and the bank owes you £100. £150.00 in total is the final sum. When it comes to genuine money, only £100 exists because the bank has invented £50 for profit.

At any given time, only a fraction of the bank's deposits, or reserves, are guaranteed by cash and can be withdrawn.

Or, to paraphrase Rothbard, the bank issues warehouse receipts, which are then exchanged for the purportedly identical amount of cash. Fractional reserve banking, in this light, appears to be a Ponzi scam.

So, what happens if people all want to get their money out of the bank at once?

If a bank does not have enough cash on hand to pay everyone, a run on the bank is possible.

When Michael requests his money back from the bank, he doesn't get it, and the bank closes for the day as mayhem prevails, do you remember that scene?

That's a lot like what happened in the 2008 Financial Crash, only considerably worse.

It was difficult for banks to tolerate losses on speculative 'investments' during the financial crisis. People and institutions were anxious to get their money back in case of a bank run, which increased the likelihood of a stampede.

A liquidity crisis is when banks can't get their hands on the money quickly enough to settle all the debts they've accrued.

Rothbard's term "false warehouse receipts" refers to this.

As "money warehouses," banks lend money that isn't guaranteed by actual cash deposits.

If this happened to your business, you'd go out of business and your creditors would come knocking on your door.

As a result, when a bank fails, the Central Bank (the Federal Reserve) acts as a lender of last resort and bails it out when the Government tells it to. Rules allow for the generation of money and the printing of currency in order to do this.

People consider the Central Bank bailing out bad banks as unjust — a risky move that could have unintended consequences. If the banks lose, the taxpayer picks up the tab for them.

It's not just the Central Bank that creates money, but also the Federal Reserve.

When private banks create these loans, they do the same. Because debts must be returned at some time, some economists disagree. However, this is based on the assumption that they are, which isn't always true.

During the financial crisis, can you picture being in control of a bank?

Debt reduction is necessary since you've loaned out too much money, but more money is needed as people and institutions withdraw their finances.

As a result, you must increase your debt in order to obtain the funds you will need. There is a direct correlation between the creation of money and debt!

An intriguing point is made here: banks create money, but not wealth.

To put it another way, taking out a loan means that you have more money at your disposal. You have more money at your disposal to buy whatever you need.

This money is still owed to the bank. It hasn't made you any more money. In addition, you must reimburse the bank for the privilege of borrowing from them. As a result, you're actually poorer because you owe more money today than you did before you got into this mess.

It's possible to develop your own riches by investing the difference between what you've borrowed and what you've earned.

No matter how much money you have, it has no intrinsic value. It's just a way to facilitate a transaction. Even more importantly, banks are simply speeding up this process.

This is all right. Moreover, "producing money" does not imply a Ponzi scheme on its own.

It's possible that the procedure turns into a Ponzi scam as the chance of not getting paid back increases. In other words, it's a no-brainer to lend money if the bank has high confidence in being repaid with interest.

The bank, on the other hand, requires a higher rate of return – more money – to grant a loan when the danger of not being paid increases. And that's when things start to go wrong.

 

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