Initiative Q – quite pyramid, very Ponzi, but actually simply a massive junk bond giveaway
November 9, 2018
The initiative Q e-mail address collection scheme has apparently seen waves of virality since June already. This week it reached my Facebook feed with about half a dozen of my friends sharing their referral links.
This social proof and FOMO almost got me to sign up and share it as well – as just another gold rush lottery ticket. But after reading the descriptions, I decided to opt out. Why?
a) The whole scheme makes absolutely zero sense, and feeds on very sticky, mistaken “economic models”
b) Unlike with Bitcoin and other cryptos, there doesn’t even seem to be a “ride-the-hype-and-get-out”-type short-term profit opportunity (aka “pump and dump” potential).
There is absolutely no reason why the implementation of the mentioned newest technological innovations for payments (i.e. transaction) interfaces needs a new currency (accounting unit).
The “economic model” behind the valuation is the good old myth called the “Quantity Theory of Money”, which is one of the most bullshit theories mankind has ever come up with. Hence, the described monetary policy instruments built around controlling the money supply are doomed for failure.
The policy instrument that can work is making the currency redeemable in USD – and this makes all the other monetary policy tools redundant. This is not an inflation control instrument as such, but a very basic form of exchange rate pegging. However, in the case of a private company doing it to their own “currency”, this means that the company is essentially issuing 2 trillion dollars in debt, i.e., junk bonds, as sign up incentives.
David Gerard did a decent job of explaining in his post how many of the payment technologies and innovations listed on the site can be and have been implemented on top of our current monetary system, and by no means require adoption of a new currency by a large pool of users (point 1).
To this, I’ll just add that the EU Payment Service Directive (PSD 1-3) is precisely meant to facilitate competition and innovation in payment solutions on top of the “accounting layer”, which we call banking. (And if you are buying into this “bank-free world” vision the Q initiative lays out, note that the “agents” the company’s plan mentions are effectively analogous to banks in our current monetary system. They just want to be the private central bank clearing the transactions between these agents.)
Mostly I’ll focus on explaining what this new “currency”, Q, is in practice.
Q IS A CORPORATE BOND, A VERY LAX AND AMBIGUOUS CORPORATE BOND WITHOUT LEGAL PROTECTION
Essentially, Q a debt bond issued by this private company: 2 trillion dollars issued in junk bonds as a mere sign up bonus – by a company with no product, no service, and no revenue.
Looking at it this way, initiative Q is probably already one of the most insolvent companies in existence. There is no exact information about the company’s assets, but assuming they’d have e.g. 20 M€ on their bank account, that would mean a debt ratio of 100,000,000% (x1M) – and 50 % is already an alarmingly high debt ratio in many industries.
Since the company aims at zero inflation while the Fed is targeting 2-3% inflation for the USD, this means Q should be appreciating 2-3 % per annum compared to the USD. In practices, this means that the company is promising 2-3 % interest on these junk bonds. (This zero inflation promise is a bit conflicting with the statement that 1 USD/Q would be the maximum potential for the value of the “currency”.)
Now, many news articles have misleadingly stated that the company hopes that the Q will eventually “reach” the value of $1 after some years. This is not the plan. As the founders say on the site and also clarify in their comment on David Gerard’s blog, the plan is for the Q to be worth $1 from the start, but only 1% of your reserved allocation of Q will be available initially. However, even this 1% means 20 BILLION dollars in outstanding Q, i.e., the company’s outstanding debt to signed up users – which the company promises to be redeemable fairly soon in USD.
THE QUANTITY THEORY BS – BUT FAIRLY IRRELEVANT IN THIS CASE
The “economic models” behind the estimate of a potential future market cap of 2 trillion behind such a “currency” is essentially the Quantity Theory of Money. This is the good old bed-time story that you’ve probably heard millions of times from different activists and even economics professors: That the value of money depends on its limited supply, that there is magical relation between the size of the economy and the value of the economy’s money supply, and that central banks control the value of money by controlling the money supply.
To put it bluntly, the Quantity Theory of Money, though intuitively appealing its simplicity, is one of the most bullshit theories mankind has ever come up with. The QToM is to economics what the “equal transit theory” is to airplane engineering.
I left a more in-depth explanation and some relevant links for yet further elaboration in a “coda” at the end of the post, if you are interested (or angered) enough to look into it.
I won’t go deeper into that here. This is because the third and the one “additional” monetary policy instruments that Initiative Q’s site lists – the “open market transactions and the redeemabiliy of Qs in dollars – make the other instruments completely redundant. This is the redeemability of Qs at a set dollar price:
“As an additional means of instilling trust in the long-term purchasing power of Q, the monetary committee will continuously offer to buy Qs in exchange for USD (and other currencies) at the target rate of 1 Q per 1 USD. This will assure sellers they can confidently accept Q as a payment method.
This requires the monetary committee to hold large reserves of USD. The reserve balance will be publically available, assuring members that they can convert to USD at any time, thus supporting Q stability. As Q becomes a global standard, and trust in its long-term value increases, the reserve ratio can decrease.”
REDEEMABILITY OF A CURRENCY IN ANOTHER CURRENCY IS AN EXCHANGE RATE PEG – A PRIVATE COMPANY’S REDEEMABLE “CURRENCY” IS A CORPORATE BOND
If you can promise that a currency is fully redeemable in another, more stable and trusted currency, that fully determines the price of the currency – as long as people believe in your ability deliver on that redeemability. The Initiative promises Qs to be immediately and fully redeemable in USD at a preset rate. In this kind of situation, the only way to sustain that credibility and to prevent (and to survive) a “run on the bank” (or rather, a run on the company/Initiative) is to maintain full 100 % USD reserve.
These kinds of open market transactions, essentially promising redeemability, are the standard way in which central banks maintain “pegs” to other currencies. However, when is the peg is set unsustainably high compared to the “natural” demand for the currency on the markets (which depends e.g. on relative interest rates, as well as the products and services sold in that currency), the peg eventually breaks, after the central bank has blown billions in public funds (especially foreign reserves) on its futile peg support mission. Famous examples:
However, in this case the whole notion of a “currency” is quite misleading. All currencies are units of debt. (Not a commodity acting as a “medium of exchange” – sorry Austrians, goldbugs, and BTC believers.)
A currency issued by a government or its central bank is the government’s debt to the extent that it is not backed by private debt in the market (as the money created by private banks is).
A “currency” issued by a private entity is essentially that private entity’s debt. So Qs could much more accurately be called corporate bonds – especially since the Initiative promises them to be fully redeemable in USD at a preset exchange rate.
This also demonstrates how there is hardly any speculative upside potential here, allowing the early adopters to ride the hype and exit at the top in the pump-and-dump style seen in most cryptocurrency and token ICOs.
(The initiative makes it very clear that Q is not even trying to be a cryptocurrency, so not even those “distributed medium of exchange” excuses are applicable. All the accounting is on the Initiative’s sheets, and they are directly making all the promises. Hence, Qs are very explicitly the Initiative’s liabilities – whether on its actual balance sheet or off it.)
There is no reason anyone would pay any more than 1 USD for Q, if that’s the price at which it is redeemable. (Even for the Quantity Theory believers, it is made very clear that the Initiative promises to release more Qs if somehow a “deficit” of the “currency” would risk raising its value beyond the target).
However, if faith in the redeemability goes down, Qs can be worth less than 1 USD – just like dollar-denominated corporate bonds trade at a discount reflecting the company’s bankruptcy risks. The difference with this kind of immediately redeemable bond compared to normal corporate bonds with longer maturity is that:
1. future earnings potential is not enough to appease the creditors – the company needs to have the cash at hand at any time, and hence
2. growing insolvency risks don’t linearly lower the value of the bonds, but result in immediate mass liquidation – the “run on the bank” – when the perceived risk premiums exceed the bond’s interest yield (2-3% in this situation).
ADOPTION DOESN’T MATTER, RESERVES VS REDEEMABILITY DO
So, before making the Qs anyhow tradable or redeemable, Initiative Q would need to gather 20 billion USD in reserves – and promise to be able to grow those reserves at the same rate as it makes new Qs redeemable.
Luckily for the Initiative, it can fully control the pace at which the full Q allocations become redeemable. The Quantity Theory story told by the Initiative is that the amount of Qs that will be released will be done hand-in-hand with the adoption rate. But, as said, the redeemability makes all other instruments and mechanics meaningless.
A corporate bond’s market value does not in anyway depend on its trading volume – even a Quantity Theory fanatic or Austrian goldbug should understand that.
It’s Initiative Q’s ability to gather those USD reserves (or tell stories about its ability to gather those reserves) that will determine how fast Q can be made redeemable. As long as the redeemability of Q holds (i.e., Initiative Q is not bankrupt, which it currently is, by billions), Q might have some value.
The company plans to make money out of transaction fees. However, it can’t make any money before the system is opened, and Q’s are made redeemable. So that won’t solve it.
For gathering reserves, the initiative emphasizes:
“Selling future grants of Q — This option is available to accredited investors who believe in the long-term success of Initiative Q. They can purchase (at a significant discount) the right to receive Qs in the future, that will be released according to the network growth — similar to the new members rewards.”
Essentially these are just similar debt bonds as Qs, just with a longer maturity and higher yield (interest) as a result of selling them at a discount.
So, in effect, they are planning to get the reserves to pay off their short-term debt (Qs) by issuing longer-term debt (future grants of Qs) at significantly higher interest. LOL. And where are they planning to get the USD reserves to finance these future Qs that are released when these grants mature? Presumably by selling more grants at high interests. Doesn’t get more Ponzi than that. (More on Ponziness later below.)
What about equity investors like VCs? Many commenters seem to speculate that the Initiative just gathers these e-mails in order to be able to raise a big VC round at high valuations.
But who would make a >20 B$ equity investment into a company that has no product and no revenue – and outstanding immediately redeemable debts of 20B$? That’s just essentially bailing out the creditors of a doomed company.
The e-mail list might have some value – but as David Gerard points out, the company’s ability to leverage this for actually achieving adoption for a payment service/network is highly questionable. Even more disturbingly, the value of this kind of e-mail list would be most valuable to get-rich-easy hoaxers. But still likely not worth 20 B$ – or is it?
Any sensible investor would just let such a company go bankrupt instead of funding the promises the company made as sign up incentives.
QUITE PYRAMIDY AND VERY PONZI-LIKE
First of all, I’ll have to remind everyone that pyramid schemes and Ponzi schemes are two very different things, though often Ponzis are mistakenly called pyramids.
A Pyramid scheme is a network marketing incentive system that might look (to the mathematically illiterate) like everyone wins, but practically only the ones at the very "top" of the structure (pyramid) win – on the expense of everyone else.
A Ponzi scheme is a fraud scheme, where investors are lured to commit money based on some investment strategy claimed to yield profits, but this investment activity does not really exist (or is not profitable), and previous investors' profits and principals are paid back utilising investors' "investments".
Of course, the same scheme can incorporate both pyramid and Ponzi traits – as we'll see here.
Quite a few people call “pyramid” on Initiative Q due to the fast-declining nature of the sign-up bonuses. However, these types of early adopter incentives can actually make a lot of sense. Especially for services with significant potential network effects, it might be sensible to compensate first-movers for putting in the effort before the network effects are their, and hence creating those network effects for people signing up later. E.g. PayPal made good use of generous sign up bonuses to reach critical mass. Creating such virality incentives are a major area of interest for me, and this curiosity alone made me consider signing up.
In this case though, even if this system ended up playing out as promised, the very early adopters would be getting a disproportionate reward: >150k$ for people signing up in June, vs <35k$ for people signing up now in early November – though no actual network effects (that would produce intrinsic value to the participants in the network) have actually kicked in yet. So, this incentive structure is already a bit pyramidy.
The inherent insolvency of this system could rightfully earn it a “Ponzi” stamp. In an actual Ponzi/Madoff scheme, earlier investors are paid with the money coming in from new investors. This is not quite like that, since they haven’t asked for any money from anyone, yet. However, in today’s “attention economy”, any company recognizes the value of user sign-ups and viral visibility. Most companies pay shitloads for them. So people are in fact “paying” with their signups and referrals. And what they are essentially paying for are practically worthless junk bonds. That’s not far from paying money for worthless shares in Madoff’s investment funds – just smaller sums and larger scale.
The final straw making this a full-on Ponzi is the afore-described plan to finance the USD reserves by issuing future grants of Q at discounts to investors, i.e. issuing longer-term debt at higher interest to pay off the short-term debt from the first “investors”.
A SOCIAL AND ECONOMIC EXPERIMENT FOR SURE
Initiative Q is calling itself "a social and economic experiment". It surely is one. An experiment that has already proven that they can get millions of people to sign up and ask their friends to sign up by promising them big numbers of the shittiest corporate bonds imaginable – just by wrapping them in a pretty package of technical payment system innovations, rudimentary Austrian economics, and the magical allure of the words "a new currency".
Would this have worked, if they'd just called it for what it is: Bonds. Debt.
Could Talvivaara or Glittnir have avoided a bankruptcy had they just called their bonds "Ts"/"Gs" and declared them a future currency?
Economic experiments are of course welcome. I just hope that bad one’s like this don’t ruin the chances of actually potential virality mechanics and early adopter incentives for rapidly launching services with major network effects. Luckily, even some crap ones can teach us a lot. Bitcoin and the overall crypto craze have, and will continue to – doing billions of damage and wealth transfers on the way.
And wait… junk bonds in pretty packages… hmm… Why do I get a déjà vu..? *krhm* (CDOs) *krhm* (mortgage-backed securities) *krhm* (2008) *krhm*.
I challenge Moody’s and the other credit rating agencies to add 3 new tiers for bond ratings: Q, QQ, and QQQ.
Let me know if you think I’ve misunderstood something or my logic is mistaken :)
CODA: QUANTITY THEORY BS ELABORATED
If you want to understand in more detail why the Quantity Theory of Money and hence all talk about controlling inflation by controlling the money supply is bullshit (and why current central banks have succeeded so well in achieving price stability precisely by primarily controlling real interest rates, not the money supply), you can check out these videos:
The Initiative claims to be better than central banks at controlling inflation, because it can control the money supply much more directly when credit expansion by private banks is not allowed. I hate to disappoint you, but current central banks have been precisely so successful in achieving price stability because they don’t obsess about the money supply, but instead control real interest rates on the markets with their own lending and deposit rates. (The is also why so-called Quantitative Easing is so ineffective as a monetary policy tool.)
The Quantity Theory is a completely nonsensical theory, which assumes that the ratio between actual economic transactions conducted by individual and the cash balances the individual holds (aka “money velocity”) has some magical tendency to stay constant or at least resist change – like physical spinning momentum. If you look into the logic 19th century economists laid out for this theory, they include the line of thinking that "money cannot circulate faster—at any rate in a pure cash economy—than a messenger boy can run; its speed cannot exceed that of a mail van, train, or steamer to which is consigned the cash used for making a payment“, as Knut Wicksell summarized it in his “Interest and Prices”.
Latest in this digital age, such follies should be seen what they are. “Money velocity” (a completely artificial measure) can theoretically drop from 1000 to 0.01 in a day. Nothing forces anyone to buy anything with their cash balances if they wish to hodl them, and, on the other hand, in the age of electronic banking, money actually only needs to exist for the split-second duration of the transaction.
Bitcoin, though its story and hype is strongly based on the Quantity Theory, itself is a great proof against it: The bubbling up of BTC’s market cap was in no way accompanied by a proportional increase in real economy transactions in bitcoin. The delay in the approval of blockchain transactions does in fact cap its “velocity”. (Ironically, bitcoin’s weakness makes it somewhat obedient to the Quantity Theory.) However, still a clear majority of these BTC transactions are speculative trading (between BTC and other currencies) instead of actual real economy transactions (e.g. buying drugs or services), which the Quantity Theory claims the value of money should be following. It’s not the need to buy goods and services with BTC that make people hodl BTC – it’s the speculative upside the hodlers perceive. And since Q is aiming at a stable value, there isn’t much upside in Q (apart from the “interest” explained earlier). Hence, this logic expressed by the Initiative is completely baseless:
“Despite these shortcomings, the market value of cryptocurrencies reached nearly 1 trillion USD. It is not far-fetched to assume that a currency that is designed to meet the market’s true needs (stability of value, ease of use, etc.), and is exclusively coupled to a superior payment network, should surpass this number.”