Cryptocurrencies: Investment Opportunity or Ponzi Scheme? Part 2

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They were everywhere. Ads for BlockFi, Celsius, Gemini Earn, and the like, all promising high returns in exchange for lending your crypto. You could make anywhere from 8 to 10% or more, and though I admit the offers sounded tempting, it was never quite tempting enough for me.

Not because I have anything against putting my money to work, but because the whole thing just didn’t make sense. How were they generating these returns? Where was this yield coming from?

When a bank pays you interest on your savings account, it’s because they lend your money to someone else who pays an even higher interest to the bank to finance a new home, or business, or whatever. The bank makes sure the people they’re lending the money to are credit worthy and reliable, and they profit off the difference.

So with respect to these crypto lending platforms, was the idea that they would take my crypto and generate an even greater return somewhere else? But a 10% annual return is nothing to sneeze at. Good luck trying to generate that with any consistency over an extended period of time. So what were they thinking? Was it just a big scam? I don’t think so, but here’s what I think might have happened.

This is purely speculation, but based on everything that’s transpired over the last six months, I believe it all started with the GBTC premium. GBTC is the name of the financial product offered by Grayscale. For those uncomfortable buying Bitcoin using a crypto exchange like Coinbase, GBTC offered you a way to get crypto exposure using a traditional brokerage firm like Fidelity or Charles Schwab. The crypto bull market caused the price of GBTC to rise faster than the value of the underlying Bitcoin it was associated with as retail investors decided they would rather pay a premium than get left behind.

This provided a unique arbitrage opportunity for crypto hedge funds willing to borrow BTC to convert to GBTC and profit off the difference. My guess is they couldn’t help themselves, and they would then reinvest any gains and repeat the process. But what happens when the GBTC premium becomes a discount? It turns out there’s no way to redeem GBTC for actual Bitcoin. This is why Grayscale is trying to convert their product into an ETF as that would open an avenue to redeem shares for the underlying asset and presumably get rid of the discount once and for all. But we’ve been waiting for ETF approval for years. Who knows when or if it will ever get approved?

As a result, the discount keeps growing, and meanwhile Grayscale continues to collect their 2% fee on ~650K Bitcoins, or roughly $200M per year. They could of course dissolve the trust, but why would they want to give up that lucrative fee? And I’m not a lawyer, or a financial expert, but if dissolving the trust means they need to sell the BTC to pay back shareholders, what that would do to the cryptocurrency market is anyone’s guess. Maybe the SEC eventually approves the conversion to an ETF and those willing to buy GBTC today reap the benefits, but what if they never do? Will Grayscale just keep collecting their fees until they’ve bled the trust dry and end up owning all the BTC themselves? I honestly don’t know, but the point I’m making is that the premium that used to exist for GBTC wasn’t real. It was a timing issue that has since been resolved by the market, but before it did, it led to people chasing the easy money and unintentionally, or intentionally, creating Ponzi schemes disguised as investment opportunities rather than building things that add actual value to the world.

Rather than leveraging new technologies, we’ve been leveraging greater fools, until the fools eventually ran out of money. And by no means is this only limited to the types of aforementioned lending platforms with their fixed APY’s. You can apply the same logic to any project that relies more on hype and fomo than it does on building useful tech. Theranos is a perfect non-crypto example of a company that defrauded investors by selling lies and preying on people’s greed rather than admit their technology was useless. Unfortunately, the crypto space seems to still have way too many Theranos copycats. Projects led by founders who minted tokens out of thin air, not to be used to deliver something that will improve people’s lives, but as a vehicle to sell unrealistic hopes and dreams to the uneducated while enriching themselves in the process.

My purpose in writing this series of articles isn’t to discourage anyone from looking into cryptocurrencies as an investment opportunity, but to share my thoughts with the hope of opening people’s eyes, so they know what they’re getting into.

Because I’m no cryptocurrency skeptic. I’m someone who truly believes this technology has the potential to unlock massive amounts of value in the future, but first we must stop giving our money and attention to the projects that don’t make any sense.

I believe that crypto can change the world for the better. I believe it can solve important problems that can change civilization as we know it. But I’ve also come to the conclusion that this isn’t easy to glean for most people. This is why in part 3, I will try my best to explain where I think the real value of cryptocurrencies comes from, and what needs to happen in order to fulfill the mission.

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