Dear Nouriel Roubini, Here's Why Bitcoin Is Not A Ponzi Scheme

NYU professor Nouriel Roubini, famous for his prediction of the 2008 financial crisis, tweeted today that bitcoin is, among other bad things, a "Ponzi game." Roubini is not the first and won't be the last person to make this accusation, so it may be worthwhile to briefly explain why this belief is mistaken.

Briefly put: Bitcoin looks like a Ponzi scheme in the same way that a whale looks like a fish. In reality, though, they are two entirely different animals.
  

Understanding Krugman on Bitcoin

In his column 'Bitcoin is evil' Paul Krugman writes:

I have had and am continuing to have a dialogue with smart technologists who are very high on BitCoin [sic] — but when I try to get them to explain to me why BitCoin [sic] is a reliable store of value, they always seem to come back with explanations about how it’s a terrific medium of exchange. Even if I buy this (which I don’t, entirely), it doesn’t solve my problem. And I haven’t been able to get my correspondents to recognize that these are different questions.

Krugman is entirely correct in that

1) the medium of exchange function and the store of value function are two distinct issues,

2) even if we were to assume for the sake of the argument that bitcoin was a successful medium of exchange this in and of itself need not thereby also make bitcoin a reliable store of value, and hence

3) we would need an additional argument to demonstrate that bitcoin could also succeed as a store of value.

None of these points seems particularly controversial, which makes it all the more surprising that Krugman writes that none of the smart technologists and bitcoin enthusiasts he's been in dialogue with even seem to recognize or acknowledge them.

Never one to shy away from speculating about what psychological and/or moral defects may cause the people who disagree with him to behave in such an apparently irrational and/or dishonest manner, Krugman devotes much of the rest of his column to suggesting that it is really an evil libertarian agenda rather than intellectual understanding and conviction that is what drives many bitcoin enthusiasts.[1]

The problem, however, may lie with Krugman rather than with the bitcoin enthusiasts.

Why Bitcoin Needs Neither 'Intrinsic Value' Nor Government Backing

One of the things that puzzles people most about Bitcoin, and what makes them most skeptical about its future, concerns the very nature of bitcoins and the source of their value. Put simply: Just what the hell are bitcoins exactly and why would anybody want them?

The most basic answers to these two questions are, respectively, that a bitcoin is a spot in a distributed ledger, and that what makes a bitcoin valuable is that it is a medium of exchange that at least some people are willing to accept as payment for other goods or services.

These answers, however, do little to take away the confusion and/or skepticism, because bitcoins are by nature so very different from other media of exchange that we are familiar with.

This becomes clear when we look at the different ways in which this type of confusion and/or skepticism is expressed by a wide variety of both experts and laypeople, including top economists like Paul Krugman, former central bankers like Alan Greenspan and Nout Wellink, Fed critics and hard money advocates like Peter Schiff, sympathetic Bitcoin observers like JP Koning, and many many more. Here are the most common points these critics make:

Why an end to Bitcoin's growth need not result in its collapse (unlike Ponzi schemes and bubbles)

Hardly a day goes by without somebody accusing Bitcoin of being a Ponzi scheme, or being like a Ponzi scheme.

At first sight this may seem like an odd charge: A Ponzi scheme is a fraudulent, secretive operation masquerading as an investment scheme while Bitcoin is an open-source currency and protocol.

Moreover, a Ponzi scheme is operated by one person or organization while Bitcoin is decentralized and not controlled or operated by any one person or organization.

Also, in a Ponzi scheme people are promised that their investment is low-risk while just about anybody in the world of Bitcoin will tell any prospective buyer that the risk is huge and that they should not invest more money than they can afford to lose.

Lastly, in a Ponzi scheme the (non-existent) returns are typically very steady while Bitcoin is notorious for its enormous volatility in price (and hence returns).

The same logic?
But while most critics would probably agree that Bitcoin is not a Ponzi scheme in these four respects, they would point to a more fundamental similarity, a basic logic that Bitcoin has in common not just with Ponzi schemes but also with manias and bubbles (e.g. here & here & here & here & here), a logic that goes a little something like this: