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Feb 7, 2018

Is bitcoin a Ponzi scheme? The math suggests it might be

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Prices of cryptocurrencies such as bitcoin may never stabilize, and digital tokens risk simply ending up being the equivalent of Ponzi schemes.

Using mathematical modeling and experimental economics, two University of Pittsburgh researchers tried to determine bitcoin’s value, and concluded that it’s "an asset which has no value by traditional measures" and may be in a bubble. Its price is largely driven by the opinion of fringe buyers, often holding erroneous views. As these fringe buyers run for cover, worried that their investment is not as secure as they thought, the price plummets. It goes up when the fringe buyers feel safe enough to step back in, they wrote.

"The cryptocurrencies may simply be a mechanism for a transfer of wealth from the late-comers to the early entrants and nimble traders," the authors, Carey Caginalp and Gunduz Caginalp, said in the paper published Wednesday.

This is not the first time bitcoin has been likened to a Ponzi scheme. Unlike traditional currencies, bitcoin isn’t used to buy goods and services in much of the world. Most owners are holding it as an investment, hoping for price appreciation. The digital currency’s value increased 14-fold last year, before crashing by 44 per cent so far this year. Furthermore, bitcoin is owned by a few, who have a huge sway over the cryptocurrency’s price. About 1,000 people own 40 per cent of all Bitcoin.

Carey Caginalp, who is an instructor at Carnegie-Mellon University, is a visiting scholar at University of Pittsburgh. His father, Gunduz Caginalp is a professor at University of Pittsburgh.

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