Rule Breaker's Guide to Cryptocurrencies, Part 2: What Is BitConnect?

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In this Rule Breakers podcast, Motley Fool co-founder David Gardner recruited Fool analyst Aaron Bush to help him with Cryptocurrencies 101. Turns out that a fair number of his listeners wanted more. So this week -- with bitcoin trading at more than twice the level it was for the previous episode -- he brought Aaron back for a more advanced encore.

In this segment, they respond to a listener who is concerned that the BitConnect platform is a Ponzi scheme. And in their view, this Fool is no fool to think so.

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A full transcript follows the video.

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This video was recorded on Dec. 6, 2017.

David Gardner: M. Stewart writes about BitConnect. I know you've done some homework, here, Aaron and it's interesting, so you'll share a story with us in a sec. But M. Stewart wrote, "Thank you for broadcasting a most informative call. Here's a question I would love to see addressed. There's quite a buzz surrounding BitConnect."

Now that's all one word. CamelCase, which gives me an opportunity, once again, to make sure everyone knows that there's uppercase. There's lowercase. But then, if you didn't know, there's CamelCase, where you have something like iPad, where the "P," all one word, the "P" is capitalized in the middle of the word. So BitConnect is a CamelCase word with a capital "C".

"There's quite a buzz surrounding BitConnect," M. Stewart writes. "What can you tell us about it and the role it plays within the ecosystem? I assess it to be a Ponzi scheme."

Aaron Bush: And I think you are right, because I also assess it to be a Ponzi scheme, and that's not something I say lightly.

Gardner: OK, so five points to M. Stewart for ferreting out a Ponzi scheme. Aaron, what did you find when you looked further into BitConnect?

Bush: Right, so, BitConnect is a bitcoin lending platform with so-called guaranteed returns. How it works is that people trade their valuable bitcoins in for BitConnect tokens, and then as they hold their BitConnect, they get paid interest in bitcoin.

And so, two things I immediately take issue with. First of all, those BitConnect tokens are pre-mined. They don't have miners. Instead, they're owned by the team. And so when you trade your bitcoin for BitConnect tokens, you're just giving bitcoin to the team, essentially. Not the greatest incentive model.

And second, the bitcoin that you receive in interest is really just taking back fractional pieces of what you just gave them. And the system, where people can make more interest in bitcoin than they initially put in, which really is their value proposition, that only works as long as new people are joining the network and they're giving more bitcoin in exchange for BitConnect tokens. And as soon as people stop doing that, the whole thing falls apart, because then they won't be able to pay those interest rate payments and people will pull out in masses. And it could be a while until that happens because people are pretty hyped about it, and I think regulators so far have been pretty slow to touch this. To me it seems to be a pretty clear Ponzi.

Gardner: That's obviously, on the one hand, very disappointing and disturbing, and I'm glad that you called it out. I'm glad that M. Stewart called it out. And then, on the other hand, here we are even talking about it. I mean, in a sense we're kind of giving some publicity to it, and that's part of what happens with scams, is that they need to get people aware of the possibility and the opportunity in order to sucker them.

So we're definitely not doing that here. I'm glad that we've received this note. I'm glad that you looked into it further, Aaron. I'm hoping that the average person could see this on their own and not participate. How easy is it to create a Ponzi scheme through cryptocurrency?

Bush: Well, it's obviously fairly easy if something like this can come up, and they're probably not the only players doing something like this. And I think part of why organizations like this are getting away with it is because there's not much institutional money at play yet. And that probably will change over the next year or two, and I have a feeling schemes like this will probably have much shorter life spans as institutional money flows in.

Gardner: I remember when we first started The Motley Fool, that was early days in the internet and there was a lot of concern, and rightly so, about so-called chat rooms in which penny stocks were being hyped. And particularly from the mainstream media and some of the bigger players within finance, they all kind of viewed the internet as a Wild West. Crazy. This is all a Ponzi scheme itself. And all of the chatter, a term that was consistently used in cyberspace about stocks was clearly of no value or was just hype.

Now, we were there saying there's a lot of value, here, and you have to do it right. But there's no question there was a lot of penny-stock hyping. This is kind of the same thing, just at the dawn of this technology.

Bush: Yeah. What makes this slightly worse is that there are referral programs for something like BitConnect, so people will be able to receive even more payment the more they get people onboard and using whatever their key is, which just makes the problem worse.

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