Are LUNA and UST a Ponzi Project: Explained

LUNA and UST a Ponzi Project

Remember when scams were just some lonely Nigerian Prince looking to toss you some cash? All they really wanted was friendship… and your Social Security number. The scam used to be so simple, so pure. Just give me some money. No extra steps are needed. But today’s scams are complicated. It’s tough to even know what constitutes a scam or a Ponzi.

With the latest $40 billion crash of the cryptocurrencies Luna and UST, there has been a whirlwind of comments calling the project an outright Ponzi. But is it really Luna and UST are Ponzi? I feel like I intuitively know what a Ponzi is. Some entities collect money from new investors to pay out old investors until the money runs dry and then the whole thing falls apart.

Is Gold is Ponzi

However, by that logic, wouldn’t gold be a Ponzi? Let’s think about it. Gold doesn’t produce any value. Like buying gold doesn’t pay you any cash. And because of this, investors only make money when they sell gold to a new investor at a higher price. By that logic, it kind of sounds like a Ponzi. But that can’t be right. I mean, gold is useful. We put it in electronics, and it’s scarce. The world only has so much.

What about Social Security retirement?

This one is controversial. In the US, Social Security is a system that uses current workforce wages in order to pay the current retired workforce’s income. This system is betting that workers will continue to pay retirees and that this will just keep working through the generations. Is that just a more complicated version of new investors paying old ones within a system where no profits are generated? Then we have crypto projects like the failed Luna and UST. It looks similar. New investors pay old, prices higher and higher until the music stops. The answer to all this is far more complicated and fascinating than I would have ever expected.

What is a Ponzi

In researching this, I needed to first understand what is a Ponzi. I mean, I can’t find a straight answer anywhere, so I need to build a Ponzi checklist. So I decided to start at the beginning. Let me tell you about the first recorded scam in history. It was done by a fellow named Hegestratos in 300 BC. He was a sailor who took out an insurance policy on his ship. Yeah, they had insurance back then, weird enough.

What is a Ponzi

The policy was actually called a bottomry, which sounds like another word for diarrhea, but we’re getting off track here. So his idea was to drown his crew and pretend to sink the ship in order to collect insurance money on it. Well, his crew found out and he ended up jumping off his boat only to drown himself.

As ridiculous as this story is, it helped answer one thing. All ponzies are scams, but not all scams are ponzies. Hegestratos was promising no investor return. So a couple of thousand years go by and scammers start getting better at scamming.

In 1903, a young man emigrated to the US, arriving with just a few dollars in his pocket. But he wasn’t your run-of-the-mill street criminal. He had a good understanding of arbitrage and he came up with this fascinating offer that looked like the opportunity of a lifetime. He promised investors 50% to 100% profits in his business of buying postal reply coupons in other countries and then redeeming them for the full value in the US.

And it seems somewhat believable, this guy was buying coupons for a few cents and selling them for like $0.25. Except for the plot twist, he didn’t actually do any buying and selling. Instead, he just took new investor money and paid out old investors. Word spread like wildfire of the fantastic returns this young, brilliant man could get you. And he ended up scamming $20 million in a year before the scheme collapsed. That’s $271 million in today’s money.

And you might be thinking, Jesus, how haven’t I heard of this guy before? What’s his name? Well, his name was Charles. Charles Ponzi.

Charles Ponzi

Seriously, building our Ponzi checklist, we can definitively say a scam must pay old investors with new investor money. And Ponzi schemes are insolvent. There’s never enough money in the system to pay off everyone.

Now we need to fast forward to the largest and most successful Ponzi in history. This $64 billion scam spanned several decades and happened right under the nose of regulators. But how? Well, the man in charge, Bernie Madoff, had serious pull. He owned the fourth largest market maker, he helped launch the Nasdaq, and he was an adviser to the SEC. He was extremely well respected and almost feared.

How his scam worked was he’d take investor money with the advertisement that he was investing in something called a split strike conversion, which is basically just an options contract on big companies. But they needed to be able to show all this fake trading activity. This is what happened on the 17th floor. So when an investor asked for trading records, they would create this backdating trading report on the secret floor of his building.

Coca-Cola did well last week. Let’s say we invested in that. In reality, he simply took investor money and deposited it into a bank account, only to pay out new investors with that same money. The whole thing came crashing down in 2008 when investors were requesting more than $7 billion back. He didn’t have the money and his two sons turned him in. Bernie was sentenced to 150 years in prison.

So what can we add to our Ponzi checklist?

First, Ponzi will typically discourage withdrawals of money. Some will even have penalties. Ponzi generally wants your pullout game to be as weak as possible. And second, a promise of outsized returns. A Ponzi will promise returns above what you can get elsewhere. Otherwise, there’s no incentive to invest. And third, a Ponzi promises to be a real business with real returns. However, in reality, the scam just keeps cash in order to be as liquid as possible.

There’s one final Ponzi I had to look into before concluding my research. She was a socialite and restaurant entrepreneur with many businesses in San Diego. She had a ton of respect in the community and just kept expanding and expanding her businesses. But she had a little side project going on. A project that used the exact same tactics as Ponzi Madoff.

She created this service that would lend money to California businesses looking to get liquor licenses where the cost would be upwards of $100,000. Investors jumped at the opportunity to supply the short-term high-interest loans, but Gina had a secret. The deposit for the license was no more than 10% of that amount. This meant the bulk of the money was funneled into other businesses that Gina controlled, which she then used to pay back all investors.

Ponzi checklist

Like every Ponzi before it, this one came crashing down to reveal a nearly $400 million dollar scam. Maybe one red flag here was that she seemed to have these obsessive traits and blind optimism that things would just work out. Adding to our Ponzi checklist, we can see that Ponzi are voluntary. There’s no one forcing you to invest. It just seems like this great opportunity that happens upon your lap.

Second, Ponzi is an illegal scheme. And third, these schemes typically seem to have this single cult-like leader with a large ego. These leaders tend to be blinded by the massive ego, making it hard to realize that things can and will go wrong. So we have our checklist criteria in place. But I felt some reordering was needed into two categories. A section of must-haves to be a Ponzi and a section of indicators things that might be a Ponzi.

So let’s go back to our original questions. Is Gold a Ponzi?

If I use the checklist, I can really only check two boxes with certainty and one is borderline depending on who you talk to. What about Social Security? Is the whole system just one big scam destined to fail? Using the checklist, I can realistically check just one box. Yes, the current workers pay for old workers. However, they do make a profit they invest in themselves and government bonds, which is a whole different issue.

The government angle here is weird because if this wasn’t a government, it would wreak up Ponzi. But it is. And because governments are trusted institutions, they can do things that would make you scratch your head anywhere else.

Now, what about Luna and UST? Was it a Ponzi?

Do they pay old investors with new investor money? Arguably, yes. The value of the Terra ecosystem is investor money. Even the LFG reserves the money backing the system was built on Luna token deposits made valuable by investors. Okay, so what about their debts? Can they pay them back? On the one hand, obviously, they can’t. The whole system collapsed because of that. But on the other hand, it wasn’t always that way. There was a point when they had enough money in the system backing everything.

However, the system relied too heavily on investor money, so it collapsed.

What about the promise of outsized returns?

Yes, they did. Nearly 20% APY was absolutely above the industry standard. Now, in their defense, this was meant to be an introductory rate, like literally, every other platform does to attract users. But we still need to check that box.

Is it voluntary to invest?


Does it use an illegal scheme?

No? Under current regulations, there’s a lot of Gray area here. However, after this whole debacle, I would not be surprised if that completely changes with new laws and investor protections.

What I realized in this research is we could have something that checks every single box except the illegal one. And if it doesn’t check that box, you can’t really say this without a doubt is a Ponzi. There just has to be that illegal element. All right, next, discouraging withdrawals. I would argue no since you could remove funds at any time promises to be a real business, but isn’t. This one I sat and thought on for a while.

On the one hand, you could argue no, this isn’t legit, since the system is based on and paid for by investor money, but so is gold. On the other hand, they did have loan services that acted like real businesses and generated real returns. The issue was this part of the business didn’t make up for total losses. And finally, a cult-like leader with questionable judgment.

So is Luna and UST a giant Ponzi?

I would argue yes, but also no. What are your thoughts on this? I’ve realized in my research that Ponzis are a continuum. Something that checks every single box is 100% a Ponzi that should be taken down. But something could check five out of eight feel like a Ponzi, but not really be in a legal scheme. And to be honest, if we take out the criteria of a Ponzi needing to be illegal, nearly every system that requires trust and doesn’t produce cash is some degree of a Ponzi.

Not just gold and Social Security but also the US dollar, government-backed bonds, bank account, interest, coals, and cash. Our entire monetary system is built on trust and if trust runs out, the entire system collapses just like a Ponzi. What I learned is that Ponzis are a spectrum and context is everything here. Checking a couple of boxes isn’t the end of the world but the more boxes checked the more skeptical you should be from here.

Also Read:

Crypto Market Collapse: Bear Market Investing Guide

There is a plan that could get us out of this Terra ecosystem, Luna and UST crashed a mess

What is actually happening in Terra, Luna and UST, and how it will impact other cryptocurrencies

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