Should we care what's in the box? May 3rd, 2021.

Imagine a box. No, a bigger one. Big enough to fit some people into, and maybe a few desks. It's like a little office, I guess.

The box has a door and a couple windows, and it has an internet connection, so basically, you can imagine the folks who inhabit the box getting up to any sort of business.

For the purposes of this thought experiment, whatever they're doing will always take roughly the same shape: Customers can come to one of the windows and hand over dollars, and in exchange the box workers will hand back a ticket. At some later date, maybe subject to some rules, the ticket can be handed back to the box workers, and some amount of dollars will be handed back.

What's written on these tickets is not that important, but you can assume it's at least some identifying information about the buyer and how much money they paid. Using this information, as well as whatever they're doing in there, the box folks will be able to determine the amount of dollars to hand back when the ticket is redeemed. For simplicity, play along and assume that these tickets can't be modified, duplicated, or forged, but can be transferred to parties who aren't the original purchaser.

With that all established, let's play around with a few business ideas. The first is a simple bank. You deposit X dollars, they give you a ticket saying what the amount was, and later you can bring the ticket back and exchange it for your X dollars. This is a bit different from a normal bank, in that the money doesn't sit in "your" account, but in that way it's just like a real bank in that the money doesn't sit in your account. It's also different because you can give someone "money" (or really, an IOU from the bank) by handing them your ticket. This is like writing a check. It's even more like signing over a check you have, at which point we realize the tickets for this particular box business are cashier's checks! Fun.

Careful readers are wondering about security here. I mentioned before that the tickets are magically secure from fraudulent behavior, but there is the sticky detail of storing what could be a tremendous amount of cash dollars from theft. Say the enterprising box gals and guys want to pay for security. Now, when you bring back your ticket after depositing X dollars, you get back X minus Y dollars, where Y is your share of what it costs for security. Well, also, we forgot to pay the bank people, so your share of that too.

At this point you should be wondering, shouldn't I be paying the bank to hold my money? And of course in real life, you do, somewhat through dumb fees like overdrawing accounts, bounced checks, and ATM surcharges, but also and more primarily because the people inside the box are smart enough to go make money using your money, and they pay you a small cut. What they earn more than offsets those Y dollars you'd pay for your share of maintenance.

Here we come to where things start to get interesting. If the people in the box are enterprising enough, they can take your money (which now we realize is not a deposit, but an investment) and use it to go make more money themselves. As you sit and ponder on what it means for you to do something that feels risk-free–money in/money out–and then for the people inside the box to go do something risky–invest and only possibly make money–you get to why banking is something the government ultimately needs to prop up. But that's for another time.

We didn't question it before, but it seems fairly important to not just ask "What is the deal I'm being offered?" but also, "...and what, exactly, are they doing in that box?" Fairly unambitious box operators might take your money, loan it to big banks overnight, and make something like 0.1% (these days) on the money, with essentially zero chance of ever losing your money. More risk-seeking or arguably irresponsible boxers might go to a virtual Vegas and put all the funds on red such that half the time they profit wildly and the other half they're instantly insolvent.

If you were inside the box, your day-to-day work would feel different running either of those businesses, but you as a customer outside the box would have a hard time telling the difference. If there were multiple boxes, and were you able to observe the box employees come and go, maybe you would notice the boring, workaday clothing of the conservative people and the fancy cars of the gambling ones, but only if they were playing to stereotype. Mostly, it's a box with work hidden from view, and probably only by observing the proper workings (X dollars in, X dollars out) over a long period of time, maybe years, would you know to trust the box staff with your money. Those taking inordinate risk would go out of business, while the trustworthy ones would stick around.

Now we come to a special box, that even after long observation looks and feels like the bog standard banking box, but has a risk structure much more like the gambling one. The box team make the same promise as before, to hold and faithfully return your money. And they choose the unadventurous path, paying security and keeping the dollars on-premise, not to be gambled or risked in some investment enterprise beyond what's needed to sustain the business. But, they secretly decide to steal dollars, slowly, undetectably, from their reserves.

What's interesting is, if customers regularly returned looking for all of their money, this theft, no matter how small, would be found out quickly. However, people mostly let their money sit, and history has taught us that banks need only a small amount of capital at any one time. Our fraudulent box bankers can be pretty aggressive about stealing these dollars, perhaps taking more than half of the reserves over time, and they would probably not be detected.

There is another natural element of cover for the theft: So long as the business appears to be operating normally and without incident, more customers will arrive and will happily deposit dollars, believing them to be safe. These new dollars can "replenish" reserves, keeping them above a safe level that the people operating in the box believe is the maximum amount of money they'd ever have customers demand all at one time.

How would you detect this con? The individuals entering and leaving the box each day would extend their deception to how they carry themselves and to how much income they report, and every customer redeeming a ticket would leave satisfied with the service offered. It's likely the issues would only be discovered a long time, maybe decades later, when the number of new customers starts to dwindle, or when in a crisis lots of customers come calling for their capital simultaneously.

It's here that I should pause and make something clear. This latest business is obviously a Ponzi scheme. We know ponzis are bad, and the people who run them, like Bernie Madoff, are bad too. We hand out long prison sentences for them, not only as punishment for having the gall to run one, but also as a deterrent to other would-be con-people who might otherwise try.

There is apparently a clear line between what's happening in the ponzi box and what's happening in the bank box, in that I called the ponzi activities "theft", and the bank ones "investment". But the line is a little bit blurry.

Say the boring bankers were unlucky, and the interbank overnight rate dropped or went negative. The bankers would be in an unfortunate position of now running an unprofitable business. To the extent that they are taking money to pay themselves, is that theft? If they have a buffer of profits to draw from, certainly not, but maybe yes otherwise? On the other hand, later the interbank rate might increase so much as to offset these losses, and then they would be profitable again. Should we punish the bankers for having the rates go down and then up, rather than up and then down? To you as a customer, there's no difference in service provided.

On the other hand, say the ponzi schemers, in an attempt to maximize on the con, chose to take some of their stolen wealth and use it to make a bet that paid off big. Their conscience might tell them to use the windfall to pay back into their reserves enough to make the enterprise whole, at least temporarily. Did the business transform, in that moment, from ponzi to legitimate? Again, to you as a customer, there is no difference in service provided.

Now things are complicated. If it's that easy to swing from fair to fraudulent and back again, how can we trust anybody in any box? And from where do we get enough factual and then moral clarity to declare one enterprise as upstanding and another as illegal?

In the United States, we get at these issues by setting a standard for fair operation: It is the obligation of the people inside of the box to describe what it is they do, and to regularly report on how it's going to all the ticket buyers, past, present and prospective. To the extent that you tell someone you are making wild gambles with their money and they still want to buy a ticket, great. And conversely, if you say you're doing something boring like storing it, your audits ought to show just that. The fraud comes not from losing money or from being unlucky in your enterprise, but in claiming one thing and doing another. Easy.

Where this framework runs into trouble is, sometimes people are happy to be lied to. Imagine a box business where you are promised simple money storage, but where everyone who redeems a ticket receives some extra dollars for free. A carefully designed incentive well-balanced with a disincentive to withdraw (one example: the bonus is determined in part by how long you have kept your money in storage) will invite few questions and many happy customers. The simplest underlying operation here is that Ponzi from before, stealing from one customer to give to another. But despite the obvious lie that there's no funny business, you would not find many (any?) customers excited to run to regulators to investigate and potentially shut things down. Their ability to eventually redeem is contingent on allowing the lie to live on.

Another piece of trouble for the "transparency is fair" framework comes with a new type of box operation we haven't talked about, where rather than having tickets that represent some claim on future dollars, they instead represent a claim on the economic profit of the box business itself. Assuming a well-run box, you can see how such tickets would be valuable, and in the case where what's happening inside the box is risky, these shares of the business directly expose the customer to the risk, which seems ideal.

The company within the box take the dollars to go out and do something productive, so they let the customers know that their ability to redeem the tickets will be limited, maybe only once a year or even more rarely. This is somewhat inconvenient, but not a huge deal since the tickets are transferrable. Ticket owners can sell them to others as a way to "redeem" the value. The price that the tickets trade hands at would, presumably, be tied to the buyer's belief of future profitability of the box.

What's new is that these non-box-involved ticket transactions happen based not on what's happening in the box, but instead on what outsiders believe is happening in the box. If they're doing anything halfway interesting, even the people in the box are unlikely to know with full clarity what is going on, but the people outside the box are even less knowledgeable, even if they are receiving the regular box audits and reports.

The same readers who might have wanted to run within their box an elegant ponzi scheme now have realized the opportunity to run something much, much better. One of these share-for-ticket businesses can effectively be operated with no real work beyond manipulating the beliefs of outsiders. As the insiders want to cash out, they can do so at any time either by selling more tickets out of the box window, or by taking some of the tickets held for themselves and trading them with interested outsiders at whichever venue their customers are transacting. However, the savviest insiders would almost never sell; the value of their tickets would increase so long as they could convince others of the increasing value.

The news is better for these clever folks than it would immediately appear, because not only would they have their own promotional efforts to help increase the trading price of the tickets, but as partial owners of the box, every ticket holder would likewise be incentivized to promote the business as well. By the end, you might not expect the the box people to even go into the box at all, their work having been completed by getting tickets into the hands of a mass of enthusiastic customers who eagerly trade them back and forth on the speculative increase in value of the enterprise.

At that point, running a not-a-company, they could spend their days in recreation and reflection, proud of their creation and its limitless profit potential. The only hint of challenge or concern in their otherwise trouble-free lives would be their search to answer the biggest question of our era:

"When should I sell my Dogecoin?"