Our New Economic Engine March 31st, 2022.
The global economy is, if you think about it, a pretty incredible human achievement. We made up this thing called "money" and started using it to track and transfer value between people. Today, thousands of years later, billions of people have exchanged value between each other, building a nearly unbroken streak of increasing economic prosperity worldwide.
Despite the massive scale of our modern economy, the engine that powers it is small and simple: the positive-sum trade–any transaction where each person involved ends up better off than they started.
Wonky terminology aside, positive-sum trades are so commonplace that it's easy to overlook how magical they are. Conservation of mass says that the total amount of matter in a closed system is fixed, no matter what. Adding something to one pile means taking it away from another. Yet we buy, sell and trade goods and services every day in a way that increases our individual well-being and increases the well-being of others at the same time. Your neighborhood baker is more than happy to exchange a loaf of bread for a few dollars from your wallet because the money is worth more to her, and the bread is worth more to you.
Our experience makes it hard to imagine an alternative system driven by negative-sum trades, where one party is left worse off than before. When you leave with something of mine and I leave without compensation, that's theft, and theft is no way to build an economic system that can sustain for generations. Nobody would willingly enter into a negative-sum trade, right?
Adele Spitzeder's innovation
Well, there's always deception. People are susceptible to myriad cognitive biases, and those biases can be weaponized to malicious ends by clever and charismatic individuals. A successful con job leaves the victim feeling like they've made a positive-sum trade, only to later realize that the trade was negative-sum, with them on the losing side.
The typical con works on one victim at a time, and in general cons are not scalable for a few reasons. First, it's difficult to subcontract the work of running a con, due to the rare combination of skills required to pull it off. Second, cons rely on individual misjudgment and would fall apart if victims could consult with others before making a bad decision. Finally, there's a limit to how many people can be made victim of a particular scheme before community knowledge neuters its effectiveness. Consequently, these things come and go, and only a few people are taken in by any given scam.
Enter Adele Spitzeder. She was a Bavarian actress who fell onto hard times but in the late 1800s found a path to economic recovery via a new, scalable confidence trick.
Her innovation was as simple as it was clever. She borrowed from moneylenders, promising to repay the debt along with generous interest. Then she proceeded to pay said interest not by going out and earning a return, but instead by taking on more debt from other moneylenders and using those "proceeds" to pay earlier lenders.
Unlike the typical swindle which is limited in scale, this one requires drawing in more and more people over time. No shrinking violet, Spitzeder took out ads in her local paper to tout the opportunity, and was happy to let news of the opportunity spread naturally via word-of-mouth as well.
Also unlike the typical swindle, not every participant would end up losing money on Spitzeder's deal. The ultimate victims of such a scheme are the last ones in, who have no investors following behind to pay them back. Meanwhile, the earliest participants will have profited immensely, having been paid out of the newcomer's investments.
This remarkable scheme was a genuine triumph. Aside from making enough money to live like a baroness, Spitzeder uncovered true economic alchemy: a trade that isn't negative-sum nor positive-sum, but instead an uncertain alloy of the two.
Though Spitzeder executed the first recorded instance of the concept, we now know this sort of thing as a Ponzi scheme, named after Charles Ponzi, an Italian immigrant who brought the concept to America after learning about it at his banking job in Canada. And we also know, due to his infamous downfall, that all such schemes are eventually doomed to flame out and fail.
While schemes of this form can't stand the test of time, they point the way to a new economic engine that might.
The Nakamoto Scheme
In the first few decades after Ponzi's time, small tweaks to the model gave us pyramid schemes and Multi-level Marketing companies, which were meaningful (if somewhat uninteresting) evolutions of the concept. Today, however, we have an exciting new technology that can be applied to address and improve upon two weaknesses of the classic model in order to create something revolutionary.
The largest weak point of a classic Ponzi is the fact that someone well-known is running it. This person may attract curiosity, skepticism, or even law enforcement, and with enough of the wrong kind of attention, the whole enterprise is shot. Instead, it's preferable to run the Ponzi scheme without any operator at all. In addition to avoiding any single-points-of-failure, there's the added benefit that no person is ultimately responsible for any benefit or harm. Those on the losing end of the scheme won't know who ripped them off, and those profiting won't know who they ripped off, either.
The second major weak point is that paying regular dividends to investors is an expensive and cash-flow intensive operation. If the recruitment of new members is not swift enough, the sudden disappearance of the dividend is the beginning of the end for a classic Ponzi. Instead, it's better to replace the promise of a dividend with the promise of equity and then convince investors that they will be able to reap similar or larger rewards by cashing out their ownership share at a later date. So long as the number of investors wishing to cash out simultaneously is kept to a minimum, any liquidity problems are eliminated by a shared confidence in the scheme.
What is this miracle technology that can address these weaknesses? I know you've already guessed it: cryptocurrency.
The difference in potential outcomes between a Ponzi run by an actual person paying dividends and one run autonomously, monetized by equity has been convincingly argued by Preston Byrne to be a difference in kind rather than in degree, and @DontPanicBurns coined a new term for it: the Nakamoto Scheme, after Satoshi Nakamoto, the pseudonymous creator of its first real-world implementation.
What can we do with it?
The simplest and easiest thing to do with this new technology is to tell everybody about it, convince everybody to eventually "invest" in it, then sit back and let the windfalls roll in.
But that's boring. These Nakamoto schemes reliably spin off excess economic value that doesn't have to sit there waiting for a use. If the aggregated equity holders are willing, a portion of the upside could instead be directed outside the scheme, towards something more interesting.
For example, we could use the proceeds to purchase art, or precious legal documents. Or we could let the proceeds serve as the capital base for membership clubs and sports venues. We could pay people out of the proceeds to bootstrap social networks and distributed wireless networks. We could even fund our cities with the proceeds rather than raising taxes. Although some things are not, money is fungible, so the possibilities are nearly endless.
Take a step back and appreciate what's happened here: We've created a globally scalable Ponzi scheme, run by no one, for the benefit of anyone, and we can use this new economic engine however we like!
Unless it eventually implodes.