By Subhash Jangala
On 14th April 2021, Bernie Madoff, the mastermind behind the largest ponzi scheme in the history of human civilization passed away at the age of 82 in a United States federal prison while serving his 2009 sentence of 150 years in jail. He was accused of “not just a bloodless crime that takes place on paper, but one instead that takes a staggering toll”, in the words of the US District Judge who awarded him the maximum jail-time that federal prosecutors had requested.
Quite remarkably, at the same time, in a different part of the same continent, a bizarre bull-run kicked off for Dogecoin, a meme-based digital currency surprising financial experts and commentators across the globe.
A brief background however on Madoff’s ponzi scheme merits attention. “One big lie” was how Madoff himself described the asset management arm of the firm a day before he was arrested by Federal prosecutors. Pretending to be trading in securities, using his “unique” strategy of picking winning bets, Madoff promised his investors a steady return on their investments. Investors did receive a steady return for a surprisingly long amount of time. However, the returns were not earned. They were fictitious. Older investors were paid off from the investments made by newer investors. As it is obvious, this arrangement would continue only until new investors grow at a substantial rate to cover for the increasing revenue expenditure. The genius in Madoff was his ability to manufacture counterfeit returns all through the recession in the 1990s, the 1998 financial crisis and the September 2001 attacks. The 2008 financial crisis was however, too sharp for Madoff to “manage”. Older investors pulled out, new ones dried up and banks stopped lending. Eventually the scheme unraveled revealing losses amounting to USD 65 Billion.
So what links Madoff and cryptocurrencies?
Cryptocurrencies are essentially digital currencies that are not issued by any central authority and depend on the users of the currency for their validation. The validation is recorded on the Blockchain which is there for everyone to see. Since the currency is decentralized, there is no geopolitics involved. Since the transactions are publicly available, implementing counterfeit transactions is extremely difficult. Since the entire system is encrypted using cryptographic protocols, the transactions are secure. Most importantly, they are easily convertible into USD at the moment. Most “serious” cryptocurrencies, like Bitcoin, are limited in number protecting against inflation. Cryptocurrencies have been the darling of fin-tech observers since 2013 and we are presently in the midst of a cryptocurrency bubble with prices of every kind of cryptocurrency shooting through the roof.
One such cryptocurrency taking birth in 2013 was Dogecoin featuring the unassuming face of a Japanese Shiba Inu dog which was a viral meme in the same year. Developed by two software engineers as a fun experiment, Dogecoin reached a market capitalization of 85 Bn USD in the first week of May 2021. That is about as large as India’s e-commerce market. And what is the market capitalization founded on? Nothing more than a few barks.
On three accounts, the rapid growth in cryptocurrency is comparable to a ponzi scheme. People invest into these because they expect good returns. There is no identified source of generating revenue on the investment. The good returns that early investors earn are on account of the new investors who expect further growth. While cryptocurrency is touted as the future of banking and decentralized finance (DeFi), none of that has materialized yet and even if it does, holders of crypto currency would not be able to generate any income from these investments. Bitcoin apologists however make claims about the inherent value of cryptocurrencies through the amount of work it takes to mine a bitcoin. While contesting that claim is an entire article in itself, let’s look how Dogecoin fares vis-à-vis other cryptocurrencies.
Dogecoin is a currency, significant quantities of which are held by a small number of wallets. The top 10-11 wallets hold close to 50% of Dogecoin. That makes it a considerably risky and volatile market. Even within the already highly risky cryptocurrency business. The whim of one holder one fine day could bring the value of Dogecoin back to the ground. In addition, the issuance of Dogecoin is not limited like Bitcoin which is capped at 21 Million coins. You just can theoretically mine as many Dogecoins as you may like, making the very foundational reason for bitcoin’s demand absent in the case of Dogecoin. Dogecoin also has very small mining pools which make it even more vulnerable to fraud. Large and well spread-out mining pools make it impossible for scamsters to attempt making fraudulent entries to the chain of blocks being verified simultaneously across the globe. Some critics also claim Dogecoin is mutable. Immutability is one of the founding principles of cryptocurrencies which makes the Blockchain secure from arbitrary changes. Immutability offers stability to a coin since rules are set and are not changeable. Dogecoin, if immutable, is vulnerable to wild fluctuations if a majority decides to alter the nature of the coin.
The dog on Dogecoin was a joke. Unless major economies decide to adopt cryptocurrencies in a big way into mainstream fiscal and/or monetary policies, the joke will continue to play on in the wallets of the millions of the investors looking for a quick return. While the early investors feed on the newer ones, it may not be unreasonable to expect an “another big lie” revelation in the future.
(Subhash Jangala is Joint Director (OSD), Publicity Division, Directorate General of Administration and Taxpayer Services, CBDT. The views expressed are the author’s own, and do not represent those of the Government of India or Financial Express Online.)
The suggestions/recommendations around cryptocurrencies in this story are by the respective commentator. Financial Express Online does not bear any responsibility for their advice. Please consult your financial advisor before dealing/investing in cryptocurrencies.