Thursday, May 31, 2018

Ethereum is full of ponzis, is that a problem?

Charles Ponzi

Ethereum is being used as a platform for a bunch of ponzi schemes. Is this an indictment of the system; or is it a sign that it is generally working?

For those who aren't familiar with it, Ethereum is often described as a distributed computer. A network of independent and anonymous nodes keep the system running, and on top of it developers can write smart contracts and distributed apps, known as Dapps.

If you go to dappRadar, you can see what sort of apps are currently active on Ethereum. There are casino apps, including vDice, Etheroll, EOSbet. There are a bunch of distributed cryptocurrency exchanges, like IDEX and ForkDelta. And a whole range of games, the most famous of which is probably CryptoKitties.

There are also a collection of ponzis and pyramids. At the time of writing, PoWH 3D was the largest with around 4,500 ETH committed ($2.3 million). There is a gang of other smaller copycat ponzis including EthPhoenix, Proof of Community, Gandhigi, POWM, Proof of Fair Launch, Proof of only Hodling, Revolution1, and more.

Nouriel Roubini mocks the collection of apps built on Ethereum:

Roubini has a point. We've been told that cryptocurrencies like bitcoin and Ethereum were supposed to deliver the unbanked, protect Venezuelans from inflation, help end dictatorships, destroy the banking cartel, take over online commerce from Visa and MasterCard, and undo insidious money transfer businesses like Western Union. But all it's given us are a bunch of games and ponzis. Hardly world changing stuff.


I'm going to try and provide a qualified defence of Ethereum's ponzis. First, I'm going to draw a distinction between ponzi games and ponzi schemes. Let's start with the former. Like a poker game or a lottery, a ponzi game is a zero-sum financial game. Whereas lotteries reward whoever happens to have the winning set of numbers, ponzis reward early birds at the expense of late comers. An honest ponzi game is transparent about this. It doesn't try to camouflage itself as win-win investment opportunity, but flat-out declares that participants can only win if someone else joins the game.

Ponzi games are maintained by an administrator. Their job is to diligently distribute all of the incoming money from new entrants to old entrants. Just like a poker dealer gets a bit of the poker pot, the ponzi administrator gets to take a small cut to compensate them for their time and effort.

Ok, now let's do ponzi schemes. A ponzi scheme is a bastardized version of a ponzi game. First, it isn't transparent. In order to recruit more entrants, a ponzi scheme will market itself as an investment—say a high-yielding everyone-wins-game—not a zero-sum game. As for the administrator, rather than paying out each cent of the late money to the early entrants, he/she is likely to perform what is called an exit scam. This involves fleeing with a large chunk of the funds that are due to game players, thus bringing the game to an early end.   

As I suggested here, the public has an ever-present demand to play ponzi games. This may seem odd, but it's no different from the public's demand to play poker or lotteries. For many people these games are a fun escape from reality, a chance to fantasize about making a big win. Given a demand for ponzis, the world is probably better off with more of the game type and and less of the scheme type. Ponzi schemes hurt people, honestly run games don't. Which is where Ethereum comes in. It seems to be pretty good at providing honest ponzis.


It's worth exploring Ethereum's largest ponzi, Proof of Weak Hands 3D (PoWH 3D), which at its peak on April 3, 2018 had a pot of 16,000 ETH, around US$6.4 million. It has since been depleted to 4,500 ETH as depositors are in full flight.

PoWH 3D isn't structured like a traditional ponzi game. With a traditional ponzi, players buy in at say $1 and cash out at $1 (assuming there is still money left). Before cashing out, they are paid a steady stream of funds from the pot, until the pot is all used up.

With PoWH 3D, the ponzi token has a floating price rather than a fixed one. To begin playing, a participant needs to own some of the already-existing Ethereum payment medium, ether (ETH). By sending some ether to the P3D smart contract (more on smart contracts later), the player get some P3D tokens. The smart contract determines the price at which the purchase is made. For every token purchase the contract will raise the price by a marginal amount, and for every token sale (i.e. sending tokens to the smart contract and getting ether back) the price will be reduced.

So while PoWH 3D is no doubt a version of a ponzi, innovations like the fluctuating price probably make it more fun to play than the traditional type. Below is a chart showing how the price of P3D tokens has behaved over the last few months:


In addition to the floating price mechanism, all purchases of P3D tokens incur a 10% tax. This tax gets distributed to all existing token holders. So if you were to buy ten ETH worth of tokens, one ETH of that would be automatically sent to everyone who is already in the game. The same goes for a sale. If you want to cash in one P3D token, for instance, and the price is 1 ETH, you only get 0.9 ETH, the remaining 0.10 going to all remaining token holders. So the "strong hands", the ones who keep holding, are provided with a constant stream of ether from the "weak hands."

The game is implemented via a smart contract, a bit of code running on top of Ethereum. The advantage of running a ponzi game using a smart contract is that everyone can see the code, and thus understand the rules of the game. Even if a would-be player can't understand the code, they can always find someone who can. The point is, Ethereum ponzis are auditable. And since the code can't be changed, all game players are assured that the rules of the game will stay the same. (The caveat here is that the code can't be buggy; if it is, the pot might be drained by an attacker.)

Proof of Weak Hands 3D is based based off an idea called Ponzi Token, conceived by Jochen Hoenicke in 2017. Writes Hoenicke:
"This is a Ponzi Token. Early investors are paid by the fee later investors pay. All in all it is a zero-sum game. This means, if you make money using the token, then somebody else loses money. If you don't understand this, it is much more likely that you are the one who loses money, in the worst case, your whole investment." 
That's an admirable amount of transparency for a ponzi scheme, don't you think?

So Roubini's derogatory reference to Ethereum ponzi schemes needs to be asterisked. People like to play poker and other zero-sum games like ponzis. PoWH 3D and its many different versions (Revolution1, EthPhoenix etc) fill this need. They aren't "schemes" as I earlier defined them. They are ponzi games. Because they are implemented transparently as smart contracts, they can't be disguised as an investment. Nor can the administrator perform an exit scam. So these are safe, perhaps even innovative, zero-sum games for gamblers to participate in. They're certainly superior to the alternative: scummy underground ponzi schemes.


In the U.S., the SEC has declared all ponzis to be fraudulent. So any ponzi game has to go underground lest it be pursued by the law. And that's exactly when ponzi game administrators are most likely to go rogue and set up an exit scam. When a business is driven underground, the typical trappings of a legitimate commercial entity—a fixed place of doing business, advertising, and branding—are no longer present. So the standards of doing business are lower than they would otherwise be. This means that fly-by-night operators will find it easier to introduce dangerous ponzi schemes, say like Sergei Mavrodi's MMM.

As a decentralized system, Ethereum can't be shut down by the authorities. Nor can the authorities request that certain Dapps be disabled. So legitimate ponzi game administrators can safely re-establish a fixed-place of doing business—on the Ethereum blockchain—without having to fear incarceration. And instead of laying low, they can advertise and brand themselves. A non-sleazy alternative emerges. 

In some sense, Ethereum may be playing a role here that is akin to those charities that provide free needles to drug users. Both drug usage and running a ponzi are punishable offences. Since criminalizing drugs doesn't stop usage, perhaps the best we can do is provide a safe environment for drug users, say by offering free needles and a medically-supervised place to shoot up. This reduces the harm that drug users do to themselves and society. Likewise, Ethereum provides a safe haven for ponzi players to congregate, hopefully displacing some of the more dangerous underground fly-by-night operations that would otherwise attract, and hurt, players.

Providing the world with an open backup platform seems to have some value. Sure, it would be nice to see something more substantial than ponzis and games cropping up on Ethereum, especially given the massive amounts of electricity being sucked up by these distributed systems.

On the other hand, if Ethereum Dapps are a symptom of crackdowns and prohibitions, maybe we should be happy the network doesn't seem to be getting much use, apart from a few games and ponzis—a lack of Dapps might indicate our society is (still) fairly free. Maybe Ethereum is sort of like a fire extinguisher. Just because a fire extinguisher spends most of its time in a closet unused doesn't mean that it is useless. There are certain moments when it could save our lives.     


  1. "it's no different from the public's demand to play poker or lotteries. For many people these games are a fun escape from reality, a chance to fantasize about making a big win."
    I cannot put it eloquently enough, but others have:

    1. Gotta love the blogosphere.

      Eliezer Yudkowsky doesn't like the fact that people have preferences for playing lotteries. I find this predilection unfortunate too. I would never throw away my money on a lottery ticket. And I tell my friends and family the same.

      But what are the options? Ban it? Then people will try to find underground lotteries, and these will be even worse. I suspect that Yudkowsky's New Improved Lottery is tongue in cheek, but if it isn't--that's probably the right approach. Try to improve the existing lottery model.

    2. "I think people should have a right to be stupid and, if they have that right, the market's going to respond by supplying as much stupidity as can be sold."---Greg Burch
      The second half is known as Burch's law.

      In my opinion, gambling and other negative-expected-value stuff are either straight-up bads, or ...have a negative "externality" that falls on the consumer? (If you do composition over society, it doesn't matter whether it's really external.) Thus imposing a deadweight loss on them can be socially beneficial. Especially if the "ban elasticity of demand" is high, because then the equilibrium quantity falls sharply enough to make up for the fact that the remaining consumers get an even worse deal. Pigovian taxes could work as well.

      My preferred solution is to educate people, so that they don't want lotteries and other negative-expected-value games in the first place. I readily admit that my views on education are unusual; if I were to decide on what the high school curriculum contained, I would introduce basic economics, among others. How can we expect people to participate meaningfully in policy debates, if they don't understand the policies and the arguments? How can they understand the congestion charge, if they don't have the faintest idea what the tragedy of the commons is? Absent that idea, they tend to think of VMT as an exogenously given variable and thus oppose it. They see it as an attempt at rent-seeking.

    3. "In my opinion, gambling and other negative-expected-value stuff are either straight-up bads..."

      Poker too? Or bridge? Chess? What about playing tennis? One person wins a tennis game, another loses, and they have to each pay a fee to play. But both players come out ahead because it's a fun way to pass the time. I don't see why poker or other types of gambling are any different. I suppose that any game played in excess becomes a bad. And that's when education is important, and organizations who can help addicts break the cycle.

    4. The value (enjoyment) provided by these games can be divorced from anything pecuniary. If you sit down with a friend and play a match, you are not doing it because you expect to win money. Try a nonpecuniary lottery: it's free to play, we draw random numbers, and if you match them: congrats, you win nothing. I don't think it would be nearly as appealing as a "real" lottery.

      Hm... I was about to say "that's why these games are really selling a(n imaginary) pecuniary return, that people _way_ overvalue". Perhaps the solution would be to allow shorting the lottery? Then its price would be the expected value + the market-determined volatility premium.

      A different take is to say: if lots of people tendentiously overestimated their odds, and lost their money on betting they will win the match, I'd oppose poker. Because then it would be the case that poker-for-money was somehow built around exploiting a mistake of thinking; a superstimulus with harmful side effects.

  2. New Gaming Boom: Newzoo Ups Its 2017 Global Games Market Estimate to $116.0Bn Growing to $143.5Bn in 2020

    Nouriel Roubini:

    Indeed the top DApps are Ponzi/Pyramid Schemes, silly or casino games... what a brilliant success for Ethereum after raising $10bn of funds form clueless investors!

    1 billion of the investment may have been be justified for game and casinos. Not anymore, that was then.