3 mins read
Listen to this article:
Decentralized finance (DeFi) is everywhere. And while we love them, there is a latent problem with these platforms.
As we saw with the LUNA debacle, many of these platforms do not have strong enough foundations. The truth is many projects are just the facade of a pyramid scheme. We can see how their tokenomics are not as realistic as we would like them to be. And when their tokenomics do not explain enough, we are probably facing a case of ponzinomics.
Let's start by understanding what tokenomics is. The word is the union between token and economics. Thus, tokenomics points to the economics of a cryptographic token. Tokenomics reveal all the economic aspects of a cryptographic token. This data is usually disclosed in the token's whitepaper and is well known before the token's release.
In short, tokenomics are essential data that reveal crucial information about a project. It explains how they will distribute the token and in what timeframe it will be given to investors.
However, not all projects are born with a straightforward utility. Many bad actors create tokens with the sole intention of profiting from others. This situation gives rise to the concept of Ponzinomics.
The term refers to an economic dynamic inspired by the modus operandi of Ponzi models. A Ponzi scheme is a fraudulent financial operation.
In this type of fraud, those who join first profit from the investment of the new participants. These investors promote some sort of product or service to newcomers. This process, in turn, creates a chain reaction. The more people enter the scheme, the more money the fraudsters make.
To continue operating, they must constantly get more participants to join. In this way, they can continue to provide funds to those who joined earlier.
This redistribution of funds gives oxygen to the scheme, but it is not a sustainable system. When new participants stop coming in, the system collapses. The last ones to enter never recoup their investment.
Many Ponzi schemes seem to love the economic dynamics of many DeFi platforms. Yet, the situation is more complex than it looks. Not all DeFi platforms are a Ponzi scheme. Yet, we know that DeFi Ponzi schemes are more common than we think.
These schemes rely on the participation of new participants to keep operating. They often enforce buy and sell taxes to ensure they can maintain their operations.
The big problem is that these can be successful for a couple of months. And to be honest, a couple of months in the DeFi space seems like a long time. When people see these systems have been paying for some time, they decide to jump in. Yet, they don't know they are just bait for bigger fish.
They should be shunned not only because of what they represent but also because of how they work. These tokens usually play with the supply of tokens to have a false demand.
Once this false demand exists, more people get interested in the token. The more people enter the system, the higher the token's price. By doing all this, the system does not create a form of economic value, and here is when the Ponzi scheme started.
This, in turn, generates a loop that works — until it stops working. When they stop working, the new people end up holding the tickets.
We know that not every DeFi platform is a Ponzi scheme. Yet, that just means that we need to be wary of where we invest our money. Participating in a platform with ponzinomics may sound tempting. After all, an APY of over 1,000% is pretty hard to turn down. The problem is that with these projects, only one group wins: those who organized this scheme. We can lose our entire investment. If you are lucky enough, you might get out before everything falls apart. Yet, would you want to be part of a scam in which many people will be affected?
How can we avoid entirely a token that is based on ponzinomics? Do your own research. If you are interested in a project, sit down and read their tokenomics and whitepaper. If you read the whitepaper and see a red flag, no matter how small, that's enough to avoid investing.
Remember: if something sounds too good to be true, it probably is. DYOR and take care of your money.