Bitcoin is a digital currency that allows people to transfer money to other bitcoin users anonymously and securely (although there are ways (opens new window) of tracking unsuspecting users if they don’t know how to cover their tracks properly). There are two main pieces of technology that allow Bitcoin to work.

The blockchain that Bitcoin uses is like a database that makes it very hard to edit the data once it’s been written. In the case of Bitcoin, that blockchain stores information about every transaction that has happened using Bitcoin. The database, or blockchain, is literally a chain of blocks of data, each one connected to the previous one and linked to it in a way that is tamper resistant. Bitcoin’s blockchain is distributed, so thousands of people around the world have a copy on their computers, and this helps make sure nobody tries to edit it.

Bitcoin mining is a way of adding some security to the blockchain by getting people’s computers to do some work on the security of each block. In exchange for this work, miners are given a small amount of the currency, and this is how new Bitcoin is added to the system.

Ponzi Scheme?

So, why do I think that Bitcoin is like a Ponzi scheme? Firstly, what is a Ponzi scheme?

A Ponzi Scheme is a financial scheme that makes false promises of profits, and requires a stream of new investors in order to keep the scheme going. Usually with Ponzi schemes lies are told to potential investors about the interest they could make from investing their money in the scheme. However, although they may have been told that their money has increased in worth, in reality the money is either sitting in a bank somewhere making little to no interest, or has been spent on buying the scheme’s creator a shiny new Porsche. The biggest problem for someone running a Ponzi scheme is that some people will eventually want to cash out their money, including the profits they’ve been promised. The scammer will often try to convince the investors to keep their money in the scheme, either by reminding them of the amazing profits their money is making them or by offering them an exclusive new tier of investing with even higher margins. For those who insist on cashing out, the scammer finds themselves having to escalate, signing more and more new people up to the scheme to bring in enough money to pay those who are leaving it. Eventually the whole thing will collapse.

And why do I say that BitCoin is like a Ponzi scheme? Well, Bitcoin is a very volatile currency that is currently being used more for speculation and to make a profit quickly than to actually pay for goods and services. There are many people out there warning that it'll eventually collapse because of a lack of anything underpinning it beyond the collective agreement between its users, and because its price is being pushed up by investors who are looking for a quick buck. My understanding with Bitcoin is that its current rate of increase in worth is not sustainable.

So, it's definitely not a Ponzi scheme, but it's a lot like a Ponzi scheme because a) it appears to have a lifetime that's limited by the lifespan of investor confidence - and unlike most traditional national currencies, it has a small worth and there’s no country underwriting or controlling it, and b) most people who have invested are likely to eventually lose their money when the next crash occurs. Like Ponzi schemes, some people will make money from investing and divesting at the right time, and many more will lose out by not cashing out in time. So you’re either going to lose your money, or you’ll be making money off the backs of other people who lose out - it’s not like owning shares in a company, where the company is creating revenue and all or most investors can make a profit.

In the early days it was quick, easy and cheap to generate new Bitcoin, but over time this has become harder and harder. What used to be simple to do with a computer’s CPU, its brain, eventually used more money in electricity to create than the coin was worth. Computer’s graphics cards are now used, as they have hundreds of specialised chips that can do the work in parallel - and ASICs (application-specific integrated circuits - tiny chips built to just do one single type of calculation really quickly, unlike CPUs that are built to do lots of different types of maths but slower) are often used in large Bitcoin mines in warehouses where electricity is cheap. As a result of this, bitcoin mining is becoming bad for the environment. I’ve talked to Siouxsie Wiles’ husband about this before - he’s an expert in cryptographic systems - and he suggested that mining really should have been linked to useful CPU work rather than just churning almost for the sake of it, and wasting huge amounts of electricity. Also, because transactions are linked to this mining, each bitcoin transaction, no matter how big or small, currently uses around 700 kilowatt-hours (opens new window) of power - that’s around $200 of electricity in New Zealand dollars.

So, overall, like I've said before, I’d treat these kinds of investments like gambling. Don’t invest what you’re not willing to lose, as another crash seems likely - and nobody knows if the currency will survive another crash, or if some other technology will replace it.