An Observation on Crypto Cycles: Ponzi Financing, Negative Interest Rates, and Bitcoin, Part 1

Dec 22, 2019 · 8 min read

Written by Alan Zhang, a Financial Analyst at X-Order, an investment and research organization dedicated to the study of value capture in open finance. We strive to be a bridge between new finance and interdisciplinary fields with relation to science and research. It is founded by Tony Tao, who is also a partner at NGC Ventures.

In the previous series of our Ponzi analysis, we have established a simple model — the old school Ponzi model. In this model, we have made several intuitive conclusions:

1. Ponzi is essentially a process of cash flow management;

2. The existence of interest and compounding is actually a power-law function of the difference between cash inflow and outflow;

3. The ceiling of markets where Ponzi exists is the core factor limiting its life cycle.

Today, we continue to analyze the Ponzi financing model, and further study the paradigm shift of the three financing models.

1. Three Types of Financing Models: Ponzi Financing, Hedge Financing & Speculative Financing

Recently, there have been a growing number of Ponzi scams, such as the classic Ezubao Ponzi scam, the recently listed WeWork, the U.S. stock buyback trend, and even the U.S. debt and pension, have all been called Ponzi scams.

Search results related to Ponzi Scams

In essence, a Ponzi scheme is a game of term mismatchusing new money invested to return money to older investors.

When the scheme is incapable of sufficiently obtaining new money, the life cycle cannot be sustained, as shown in the following figure:

However, there are some differences between WeWork, U.S. stock buyback, and Ponzi scheme:

1. Difference in Intention

Ponzi schemes are definitely frauds. The ultimate goal is to obtain a large number of funds illegally by means of controlling cash flow. While other projects are mainly concerned with maintaining or expanding the development of the project.

2. Difference in Sources of Repayment

The source of repayment of Ponzi scheme is new funds, while the above-mentioned projects will at least invest the raised funds to specific activities. Interest or value-added income generated from these activities are then used to repay investors. The implied condition of Ponzi scheme is that the assets need to be held for a period of time, which will naturally lead to the shifting of deadlines, and by extension a possibility of mismatch.

3. Difference in Investment Earning Ability

Since Ponzi schemes do not make real investments, the earning ability of investments must be 0 or even negative. While for ordinary cash pooling business, although they do use the raised funds for investments, but all investments come with risks. Therefore, there is a possibility that the expected income cannot be achieved, and the principal cannot be repaid.

There is no problem when the investment income of the term-mismatched cash pool is able to repay the agreed principal and interest on schedule — the entire system can continue to operate. However, once there is a risk that the project might not be fully paid and must rely on new funds to “extend life”, it will inevitably transform gradually into a Ponzi scheme.

Of course, if the project can cleverly postpone payments, it can escape from becoming a Ponzi scheme when the earnings return.

In the book by Hyman Minsky, an American economist, “ Stabilizing an Unstable Economy “, it separates the above-mentioned financing behaviours into 3 modes according to the income-debt relationship:

(1) Hedge financing, that is, the debtor expects the cash flow from the financing contract to cover the interest and principal — this is the safest financing behavior.

Corresponding to “good investment” in the flow chart above, the common carry trade in foreign exchange and loans to those with good credit history can all be classified under this.

(2) Speculative financing, that is, the debtor expects that the cash flow from the financing contract can only cover the interest — this is a kind of behavior that uses short-term funds to finance long-term positions.

Corresponding to the flow chart above, new funds are used to finance the principal and interest until the return on asset is able to finance them. It can generally be understood as a bridge loan, and the recent growth of U.S. debt is also suspected of developing into speculative finance.

(3) Ponzi financing, that is, the debtor’s cash flow can neither cover the principal nor the interest. The debtor can only fulfill its payment commitment by selling assets or obtaining new finance again, which is bound to present a high financial risk. Once the capital chain is broken, the debt cannot be repaid, thereby potentially causing financial turbulence and crisis.

Minsky further defines Ponzi finance: it is usually associated with marginal and fraudulent financing activities, although its original intention is not necessarily scamming.

This corresponds to “collapse” in the flow chart above — due to the fact that some projects’ intentions are difficult to confirm at the initial stage, they can only be judged from the result (i.e. whether it collapsed).

2. Interchanging Among the Three Modes of Financing

There are no clear advantages and disadvantages to the three financing models, and they will always change. We can also find these changes in our daily investment life, which can be generally divided into three paths:

1. Hedge Financing → Speculative Financing → Ponzi Financing

P2P companies are typical of this transformation

Under normal circumstances, P2P companies invest a sum of money from users into a supply chain enterprise, which uses specific cash flow or collateral as a repayment source.

However, when economic downturn and other risk factors occur, supply chain enterprises will face cash flow problems. At this time, P2P companies need to raise new funds to repay the principal and interest from the previous financing to prevent default. Here, they will switch from hedge financing to speculative financing.

When the supply chain enterprise is sure that it can’t receive cash flow from downstream, it will tell P2P companies that “we do not really have money, maybe we can convert debt into equity, and you can get the income by selling shares.” Financing at this point will again transform from speculative finance to Ponzi finance (investment).

2. Hedge Financing → Speculative Financing → Hedge Financing

The typical case is the various types of banks — term mismatch will be beautified as term transfer in the context of banks. This is because in “speculative financing”, banks generally supplement liquidity through inter-bank lending and other ways, which effectively “extends life” for the bank, thereby transforming it back to hedge financing.

3. Ponzi Financing → Speculative Financing → Hedge Financing

Typical cases are various Internet start-ups — from the beginning of raising investments with the notion of “will die for dreams”, investors all know that a platform’s business model results heavily in cash-burning. However, as long as the “burning cash” can expand the scale of the project, they will not worry that they are unable to find someone to continue financing.

This process is a combination of Ponzi and speculative financings, such as the common ABCDEFG series of financing and listing, as well as private placements. If the revenue model is eventually verified by actual data and the economic records can be properly accounted for, it will convert into hedge financing. Otherwise, it has to continue the Ponzi model until it finally finds the largest Ponzi market audience or self-destructs.

For example, in the sharing economy, sharing power banks is considered to be the most unreliable project. This is because the price of power banks is cheap, and everyone more or less have them at home. Moreover, because of its relatively small size, it can be carried around easily. Why would people pay a higher price to charge their devices?

In such a seemingly puzzled situation, the whole industry still raised $2B RMB in 2017. To have experienced it personally, there are three characteristics in this industry: consumers do not carry a power bank with them all the time + demand for charging is inelastic + consumers are not price sensitive. This led to power banks sharing to become the most successful business in terms of economics accounting (cost recovery period), thereby changing from Ponzi to Hedge financing.

On the contrary, Ofo, in which the initial theoretical cost recovery period was only three months, considerable economics accounting, and a grand narrative — many capital providers paid for this “social welfare”, totaling $15B RMB in 8 rounds of financing. In the last round of financing, E2–1 raised $866M USD. E2–1 is more creative in name than any of the financing round, however such a creative naming still could not prevent the outcome of having unsound economics accounting. It was Ponzi financing all the way until the end.

There are many other negative cases, such as LeTV, Storm Codec (Baofeng), M&A of various listed companies in 2015, and so on.

What’s Next?

In Part 2, we discuss the investment logic of hedging and Ponzi, as well as the impact of negative interest rates on digital currencies such as Bitcoin.

Alan Zhang, Financial Analyst at X-Order

Alan Zhang is an investor and market gazer that leverages greatly on data technology in decision-making. He is familiar with the different financial markets of China including the stock, futures and cryptocurrency market. Further, he participated in the establishment of alternative investment markets like black tea since 2014 and was responsible for the private placement of Huangshan Tourism shares ( in 2015.

Originally published at on December 22, 2019.

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Translated by (via our WeChat Account): Xin Yue

Editor: Daphne Tan

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