Playing A Ponzi
- Ryan Bunn
- Dec 2, 2024
- 5 min read
Is a Ponzi scheme a bad investment if participants are aware it is a Ponzi scheme?—How I earned a 24 billion percent IRR in the 2021 crypto craze—How I intend to keep the proceeds, forever.
“If you’re going to panic, panic first.” Nassim Taleb
PLAYING A PONZI
Ponzi schemes are not good investments. The most widely known operators of these schemes, including Bernie Madoff and Charles Ponzi himself, were swindlers. Notably, their investors did not know in advance they were participating in a Ponzi scheme.
But what if an investor did know?[1] The structure of these schemes does offer early investors the potential for profit. Any Bernie Madoff investor that knew in advance about the scheme could have withdrawn their funds at a profit (provided a sufficient number of earlier investors hadn’t beaten them to the cash).
Introduction to Crypto
In 2014, with Bitcoin trading at $800, a coworker insightfully asked me, “why wouldn’t you put 1% of your investment portfolio into Bitcoin?” I read the white paper by “Satoshi Nakamoto” and immediately found reasons not to invest: I didn’t understand it (too hard pile), returns were based exclusively on selling at a higher price (greater fool investing), and, most importantly, I had no idea how to invest in Bitcoin at this time (what was a cold storage wallet?!).
Bitcoin crashed to $400, the S&P marched onward, and all was well, until Bitcoin’s astonishing and massive resurgence. My coworker is now, certainly, more financially secure than I.
Since 2014, crypto has become mainstream, its technological use case more clear, and Bitcoin’s role in a portfolio, even if misguided, is being debated openly by institutional investors. By 2021, fully recognizing I was late to the party, I decided to dive in.
Becoming A Miner
I pursued three investment avenues. First, and most educationally, I built an Etherium mining rig in my home office. This investment was primarily in computer hardware trading at ridiculous prices.
With my limited GPU power I earned dollars a day, not enough to keep up with the electricity bill, particularly over the summer when my office reached an uninhabitable 105° with the A/C running. Giving a full allocation of my mortgage for the now unusable real estate, I never had a hope of generating positive cash flow.
Diamond Hands
Avenue number two was the direct purchase of Etherium enabled by a recently IPO’d exchange and newly developed wallet technology that didn’t require a USB key and pages of hex codes to access. I promptly moved my “coin” to a secure wallet, further exploring the plumbing of the crypto markets, and connected my wallet to my mining rig so my percentage of basis point mining rewards could compound in my preferred coin, Etherium.[2]
At this point I was nearly overwhelmed by excitement, wondering how much profit I could take off the table while still promoting myself as a laser-eyed, diamond-handed crypto ape. Bitcoin was on its way to $500,000 per coin, and given Etherium’s equally compelling (or dubious?) investment case, I was sure it would be right behind.[3]
Bleeding Edge
Finally, I purchased a non-fungible token (“NFT”), technology built upon the blockchain representing ownership, in this case, of a work of art. This was the market where I saw the most frenzied activity. If there was any Ponzi in which I would be early, the NFT market was it.
For my NFT, I chose a .JPG I found pleasing enough to print and frame in my office.[4] If nothing else, this framed physical representation of ownership of a virtual asset would cover a bare wall and ideally spark some conversation with guests.
After enjoying the idea of digital asset ownership for a few weeks I listed my NFT on a digital-asset specific auction site and waited for the bids to roll in.
An Investor Amid Speculators?
What are the keys to winning a Ponzi scheme? First and foremost, exit before the scheme is up. Incorporate prudent diversification in case the chosen scheme fails. Limit the total investment only to what can be lost. Never double down and pursue a path to ruin. Basically, follow the disclaimer provided by DraftKings to all new gamblers, if one cannot simply sit on the sidelines.
I viewed the endeavor as a learning experience - about crypto, frothy markets, Ponzi schemes, and my personal investing fortitude. I never believed I was making a prudent investment.
As Benjamin Graham warned, “when the investor employs the same medium as the speculator, the line of demarcation between one approach and the other is one of mental attitude only, and hence is relatively insecure. It is not likely to keep him immune from speculative contagion, especially when this is rampant in the very issues in which he has made his investment.”[5]
With crypto as my medium I officially joined the herd.
“I think the people who are professional traders that go into trading cryptocurrencies, its just disgusting...its like somebody else is trading turds and you decide, 'I can't be left out.'" Charlie Munger
Crypto Winner
Six weeks after purchasing my NFT I received a bid from HAL-NFT.[6] HAL kindly offered me 25x my initial investment, a tidy IRR of over 24 billion percent. Speculative contagion achieved!
As a true value investor, I immediately set to convert my proceeds to real cash. This process took four hours and nearly 8% of my sale proceeds, a first-hand glimpse into the issues cryptocurrency faces as a payment mechanism. This lengthy and stressful process only added to my daily fear of losing the rest of my crypto-related investments.
My other schemes ultimately broke even, resulting in a ~4x return on my overall crypto strategy.[7]
STAYING A WINNER
A key to being a speculative contagion winner is getting out—and never getting in again. My track record in crypto, as it stands today, is meaningless. Part of Charlie Munger’s wrath against crypto stemmed from its early success. Winning initially can be a curse if, in the long-run, the odds are against you. My gains are only gains if I do not lose them all by participating in the next round of speculative contagion. This is the, often unseen, downside of pure speculation.
Fortunately, I felt uncomfortable with my capital being deployed into cryptocurrency. The possibility of losing my savings was more painful than the excitement of windfall profits. Via this experience I’ve confirmed my status as a boring value investor who appreciates cash flow, real assets, and other fundamentals underpinning the valuations of my holdings.
[1] The saga of Herbalife, aka the “Battle of the Billionaires”, put the question of the legality of multi-level marketing schemes to the courts. It seems the structure is legal if the terms are out in the open.
[2] All of my research (mostly blog posts, reddit threads, and YouTube interviews with the various coin founders) suggested Etherium would be the technological protocol underlying the blockchain revolution.
[4] This NFT was created by English artist Damien Hirst specifically to “explore the boundaries of art and currency—when art changes and becomes a currency, and when a currency becomes art.” Learn More
[5] Security Analysis (1934)
[7] I sold my Etherium the day Putin invaded Ukraine and scrapped my rig prior to summer 2022 so my office would remain habitable.
“Yes, sometimes the wildest idea, which looks like the most impossible idea, becomes so firmly entrenched in your head that in the end you take it to be something realizable...Moreover, if the idea is combined with a strong, passionate desire, then perhaps sometimes you take it in the end to be something fated, necessary, predestined, something that cannot but exist and come to be! Perhaps there’s some reason here as well, some sort of combination of presentiments, some unusual force of will, that is becoming poisoned by your own fantasy or something else...”
The Gambler, Dostoyevsky
