Tether Goes Full Ponzi

No Ponzi schemer tells anyone exactly how it works. The purpose of a Ponzi scheme is to trick people, to take the money and run.” - Mitchell Zuckoff

Charles Ponzi’s actual birth name was Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi. If the length of your name is a proxy for your lasting impact on society, Ponzi earned every surname and then some. By comparison, you can just call me D.

Mitchell Zuckoff’s book Ponzi’s Scheme: The True Story of a Financial Legend is a fantastic read. It seems almost unbelievable that people fell for Ponzi’s trick but fall for it they did. In fact, the same pattern has repeated itself countless times since Ponzi became the Kleenex™ of financial cons.

Originally from Italy, Ponzi lived in the US for a few years before finding his way to Montreal, Canada. While there, Ponzi managed to earn himself a three-year stint in prison for check forgery. He was released in 1911 and made his way back to the US. By 1919, he had found his con: postage arbitrage!

In theory, one could purchase international reply coupons (IRCs) in foreign countries for well below their par value and redeem them for face value with the US Post Office for a profit. The purpose of IRCs was to allow US recipients to more easily respond to foreign correspondence – think of them as pre-stamped envelopes without the envelope. Because of currency debasement relative to the US dollar, IRCs could be purchased opportunistically. In effect, Ponzi’s postage arbitrage was a currency arbitrage.

Not that it really mattered. All Ponzi needed was a story to sell. Ponzi started a company – somewhat ironically called the Securities Exchange Company, not to be confused with the modern protector of Ponzi schemes known as the Securities and Exchange Commission – and he set about task of raising funds for his arbitrage plan. He promised early investors he would double their money in 90 days and then made sure just enough high-profile investors were paid out (using new money to do so, since Ponzi hadn’t yet figured out the mechanics of how to redeem an IRC with the Post Office, a minor detail he kept secret). This, along with Ponzi’s charisma and the plausibility of his idea, led to an avalanche of new money pouring into his company. Investors no longer wanted their interest to be paid out, demanding instead that it be reinvested for even more fantastic profits.

Ponzi’s scheme grew well beyond what he could ever have imagined, reaching millions of dollars in short order – an unthinkably large sum for the time. When Ponzi had trouble getting proper banking, he bought a bank. When critics began to question the feasibility of what was going on, he sued for libel. Regulators began circling, worried that Ponzi had become a meaningful risk to the entire regional banking system. Money poured in nonetheless, as new investors couldn’t conceive that fraud on such a scale was possible nor resist the almost manic need to placate their fear of missing out.

The most striking part of Ponzi’s scheme was just how obvious the impossibility of it all was, even to the casual observer, assuming one was willing to look. The catalyst for the scheme’s collapse is generally attributed to the reporting of The Boston Post, who ran a series of provocative articles in late July of 1920. Here’s how Wikipedia describes it:

On July 26, the Post started a series of articles that asked hard questions about the operation of Ponzi's money machine. The paper contacted Clarence Barron, the financial journalist who headed Dow Jones & Company, to examine Ponzi's scheme. Barron observed that though Ponzi was offering fantastic returns on investments, Ponzi himself was not investing with his own company. Barron then noted that to cover the investments made with the Securities Exchange Company, 160 million postal reply coupons would have to be in circulation. However, only about 27,000 actually were in circulation. The United States Post Office stated that postal reply coupons were not being bought in quantity at home or abroad.”

When pressed to explain these obvious and powerful criticisms, Ponzi hide behind a time-honored excuse peddled by hucksters: he claimed his business secrets were proprietary – too valuable to be revealed. An iconic headline in the Fitchburg Sentinel captured the absurdity of the unraveling (hat tip to @bitfinexed for reminding me of it):

If only Ponzi had thought to create counterfeit IRCs. With his own IRC printing press, Ponzi could have claimed each coupon he printed was tethered to (i.e., fully backed by) real IRCs and stretched his scheme out a little longer. He could have even called them IRCTs. Alas, he was dealing with real physical objects; the possibilities born of the digital age had not yet been conceived. Ponzi was truly ahead of his time.

In other news, Tether and Bitfinex went to court this week, claiming the true nature of the (allegedly safe) investments backing $66 billion worth of tether stablecoins and the nature of their counterparties were proprietary secrets too valuable to be revealed.

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