Of Smoke and Mirrors.. Part I
A Game-theorist’s guide to Ponzis, the Cryptoverse, and Everything in Between.
Welcome dear friend.
I bet you are weary from the adrenaline-packed rollercoaster that is travelling around the Cryptoverse.
From the volcanoes exploding with 100x returns, to the icy plains of winter Rugpulls, there is hardly an opportunity to quietly rest and reflect.
In these uncharted backwaters, every day brings such overwhelming FOMO from the potential opportunities- and with them, lethal danger at every turn.
North-Korean agents hiding like snakes in the grass.
Russian hackers, roaming the dark forests like big grizzly bears. In fact- watch out — there’s one just there behind you!!
Nevermind, it was just an obese metrosexual.
You have likely been asking yourself all sorts of questions lately-
**How have the brightest stars of this universe all spectacularly collapsed in fiery supernovas?
**Does anyone actually know what they are doing here?
**Is there really a ‘there’ there, or is it just Ponzi Turtles all the way down?
There are many questions worth asking.
But for the sake of our short attention spans- riddled with A.D.D. from all the constant scrolling, speed-reading, and 2x podcasts we consume in order to keep up with everything — I shall cut straight to the chase.
Here is the Answer to the Ultimate Question of the Crypto Universe.
It is: (-4,+2).
Chapter 1: The Answer to The Ultimate Question
(X,Y) is a payoff function in game theory notation.
After they act in the game, Player1 ends up with X, Player 2 ends up with Y.
The simple truth of the world is that in most games- for someone to win.. well, someone has to lose.
Most types of interactions in the Cryptoverse are not just Zero-Sum- but after including participation costs- are in fact Negative-Sum.
So (-4, +2) put simply:
When you see 2 Lambos being minted by a ponzi, it took 4 Lambos worth of admissions tickets by those who will be left empty handed.
Where are the losses? This is in fact ‘Smoke and Mirrors’ at its’ purest.
Collective losses can hide in illiquidity until they get realized.
This answer might not intuitive, especially for participants taking smaller sized positions.
They can see the liquidity is enough for them to exit. But there are many in the same position, and there are never enough musical chairs when people rush for an exit after the ride is over.
Pooled resource games are as old as history, evolving over the centuries to more and more effectively exploit our ingrained Homo Sapien wiring:
•Our survival instinct to accumulate more resources and ‘make it’.
•Our social desire to belong to a community.
• The spiritual calling to be a part of something greater than ourselves.
As we enter a Web3.0-Era where everything around us is becoming increasingly financialized and tokenization runs rampant, the mechanics only get more complex and bizarre to disentangle.
So put on your seatbelt and hold on tight, as we go for a hyper-speed tour around the Cryptoverse, starting with an expedition to the three Laws of Ponzinomics.
Chapter 2: The Three Fundamental Laws Of Ponzinomics
In physics and specifically Thermodynamics, a ‘Closed System’ describes a system in which particles are completely isolated from the broader environment.
From this, let us introduce the concept of a ‘Closed Ponzi System’:
A game where participants are *only* participating because of an expectation to make money.
The First Law of Thermo-Ponzinomics:
The amount of money in an isolated system can be redistributed in PvP fashion, but cannot grow more than the amount that is put in.
So while there can indeed be individual winners, it is only at the expense of participants who lose.
Zero sum games can have pockets of cooperation as people gang up against others, in the end the Hunger Games. But in the end they are antagonistic. Player vs Player. Or in the digital realm- Anon vs Anon.
Furthermore, when factoring in the costs of running these systems, the games are not only Zero-Sum but actually Negative-Sum, which leads us to the next foundational rule-
The Second Law of Thermo-Ponzinomics:
The Entropy loss in an Closed System keeps increasing over time
Value gets lost as rent-seekers won’t even let users PvP in peace. There are various potential sources of entropy in Crypto:
Gas costs, milking you for gwei,
30 bps of Fees, when Uni swap away,
Smart Contract hackers, Hats all Black,
M.E.V. bots, launch a sandwich attack,
HFTs arbitrage, the blocks all full,
And always watch out, for a Rugpull!
As time goes on and the costs keep piling up, players can win less and less of the pool.
In any poker game with rake (entropy cost), if players keep playing for long enough, eventually all the money on the table will be eaten up by the house.
And as the loss in the system keeps stacking up, we get to our third and final law-
The Third Law of Thermo-Ponzinomics:
As the amount of money in the system starts to decrease, the activity of the system spirals down to Zero alongside it.
Closed Ponzi Systems rely on new revenue to keep coming in — at least enough to make up for the Entropy Loss of the Second Law. Because as soon as the momentum wanes, a death spiral commences.
As the ponzis keep growing- sometims into the $Billions, it takes exponentially more capital to keep the game going. The amount of new entrants needed merely to sustain the system’s organic loss creates a gravitational pull too large to overcome.
Losing the driving hope of future riches, all of the buzz, the communities and mindshare spiral down.
Examples of this dynamic playing out have been the countless Defi forks. Not adding anything particularly useful apart from a logo and perhaps a new chain deployment, they enter the ponzi cycle. Momentum builds as aggressive rewards in the form of liquidity mining attracts users to farm, increasing the Total Value Locked (TVL).
But without open system inflows, eventually the death spiral takes over- the farmed tokens get dumped more than TVL can go up, leading to lower yields and TVL reduction- next stop, Goblin Town:
Digest the Three Laws and when you’re ready, join me as we go deeper into our journey in Part II!