THE BLOG
01/27/2014 06:46 pm ET Updated Mar 29, 2014

The Bitcoin Is Victim of a Ponzi Scheme While Regulators Sleep

U.S. government agents have arrested Charlie Shrem, the CEO of Bitcoin exchange BitInstant, charging him with laundering money for customers of online drug bazaar Silk Road.

It started as a nice technology story. Through subtle algorithms, a complex system was based on the basis of a genius IT paper, written by Satoshi Nakamoto. Some geeks built up a sophisticated version of the good old barter system. History and the world have given us examples of such peer-to-peer systems. Who remembers that cigarettes were the currency in WWII prisoner camps? All form of barters developed over the years.

However, it is changing nature fast and carries huge risks. In a recent article on DealB%k of the New York Times, Mark T. Williams, a Boston University teacher and former commodity trader and Federal reserve examiner lists not less than five risks: Reputational, Trojan Horse, Asset Bubble, Consumer and Investment Protection and Regulatory.

In a few days the value of the Bitcoins increased by $10 billion and down intraday by $5 billion. Shouldn't this attract somebody's attention?

Bitcoin is not gold

The most famous barter system is gold. It was used for payments for centuries. Is Bitcoin like gold? Absolutely not. Gold has an intrinsic mineral and material value that is being used as well in the souks of the Arab world or by women in India. While gold investors have been investing in Bitcoins, they were fooled by the impression that it is one and the same thing.

There is no material or mineral value behind the Bitcoin.

Is Bitcoin a currency?

Libertarians love it because a public body does not issue it.

As classic economic books explain, money has three functions: instrument of exchange, unit of account and reserve instrument.

Bitcoin has been conceived as an instrument of exchange. Its value was defined by the relative value of the assets exchanged. So far so good.

However, over the past months, Bitcoins started to be actively traded on the market against real currencies. This means that Bitcoins could be exchanged against U.S. dollars. Until November 13, its value was not higher than ten dollars. So far so good.

How did it shoot up to $1,000 or more? The Bitcoin changed nature and became a reserve instrument. That was never the intention. But with 12 million Bitcoins in circulation, the temptation to keep them and maybe exchange for a higher value was high especially as its original value was close to nothing.

The Bitcoin market is manipulated through a Ponzi scheme

There is no doubt that some forces have decided to manipulate the recent value of the Bitcoin to an average of $1,000. That would create phantom value as long as buyers could be convinced to purchase Bitcoins at that price.

It is not difficult to manipulate a market where one can set the price with 1,000 Bitcoins. That manipulation can only work if buyers continue to be willing (with a little speculative push) that the Bitcoin has an intrinsic value.

This is the definition of a Ponzi scheme. As long as more money flows into the market, it might keep its value. Even then, intraday fluctuations of $500 show how fragile the scheme is.

One day, those who have accumulated millions of dollars will slowly but surely start selling their Bitcoins and the music will stop. There are no chairs in this musical game; all will fall down without any support.

That should remind us of the $50 billion Madoff Ponzi scheme. There were no assets or trades behind the scheme, and when trust disappeared, the whole amount was lost. Bernie Madoff is in jail for 150 years.

The Bitcoin has no intrinsic value

Contrary to a currency that founds its value in the economic performance of a country, foreign exchange reserves, balance of payment, and many other aspects, the Bitcoin only has a fiduciary value. In other words, the Bitcoin is only worth whatever a buyer is willing to pay. It is therefore essential for those who manipulate the market to keep the value at a certain level. This will allow the Bitcoin to go until it gets close to its maximum of 25 million units.

There is absolutely no economic, financial or social value to the Bitcoin.

Why do authorities refuse to act?

Regulatory authorities do not play any role here.

Imagine for a second that a stock would see its value go from $50 to $1,124. The Exchange would immediately interrupt trading, the SEC or the FTC would step in and an inquiry would be launched. We would know by now who are those who allegedly manipulated the market and what their intentions are. An orderly market would be restored after the inquiry and the value would go back to its historic value. But the Bitcoin is not a stock.

When the Federal Reserve Board pronounces that virtual "currencies like Bitcoin have legitimate uses and should not be banned," it commits two sins.

• By calling the Bitcoin a currency, it mischaracterizes it and gives it a currency legitimacy.
• By calling the Bitcoin a currency and not acting, the Federal Reserve effectively turns its back on its responsibility for currency circulation in the United States.

That might make the Federal Reserve an accomplice. When the market collapses, they will be made accountable.

The U.S. Senate and the IRS have not done their work.

The vacuum of regulator allows a potentially criminal scheme to flourish. In the absence of a regulator, the only resource is the Federal Bureau of Investigation: it could and should launch an inquiry for possible criminal manipulation.

Jack Lee, the U.S. Secretary of the Treasury, told in Davos that "we have to make sure it does not become an avenue to funding illegal activities".

Who is behind the Bitcoin?

There are forces acting behind the Bitcoin market. The "miners" of Bitcoins are certainly the primary suspect. However, recently, Wall Street stepped in. The Bitcoin Investment Trust started as an open-ended fund in 2013. Seminars are being organized on the management of virtual currencies.

They know how to manipulate markets, create a bubble, make money on it and leave investors in the cold after making billions of dollars. Since they are unregulated by any of the 22 US agencies that might have a reason to step in and feel encouraged by the Federal Reserve, why not speculate?

International reactions

China and Thailand are the only countries that banned the Bitcoin while India shut down Bitcoin exchanges. The Central bank of Finland washed its hands by declaring that the Bitcoin was a commodity not a currency.

Europe has not even taken a view on the Bitcoin and the European Central Bank.
Since the Bitcoin has a decentralized production, no country has truly considered itself to be competent.

Ultimately, the Bitcoin will be subjected to the same regulatory standards. As JP Morgan Chase Chairman and CEO, Jamie Dimon, told in Davos: "it will probably be the end of it." His vocal opposition to the Bitcoin is a refreshing voice in a chorus of sheep.

Investors are on their own

Since its creation in 2009, the Bitcoin has had a totally free ride. No authority will even try to go beyond the mechanism and those who created 12 million units. Investors should be aware that they are on their own and they will only have their eyes to cry if they are amongst those who bought and kept their Bitcoins in the last three months. No authority seems to be responsible for this $12 billion Ponzi scheme. Nobody will come to his or her rescue.

The Bitcoin operate in total non-legality. Soon enough, when the music stops, we will attend another version of the chorus that followed the sub-prime crisis: a denial of accountability. Pontius Pilatus is decisively still the model of regulators.

Bitcoin has arrived in Vegas and eBay allows it to be sold as a virtual currency. The casino is open for business.