Merriam-Webster defines a pyramid scheme as “a usually illegal operation in which participants pay to join and profit mainly from payments made by subsequent participants.”
The former general counsel of the Federal Trade Commission (FTC), Debra A. Valentine, said the following:
Does a vehicle that provides no cash flows, transfers no tangible or intangible property rights, and is marketed through claims that new buyers can be persuaded to drive up prices fit this description?
I believe bitcoin is such an instrument.
Bitcoin is too inefficient to be a currency. Certainly, no government has any plans to use it as one. And when bitcoin fuels actual transactions — other than those of the speculative variety — it is often to keep the transaction off the radar of the legal authorities: think ransomware, skirting anti-money laundering laws, or evading capital constraints.
Thus the sole way most promoters will realize value from their bitcoin holdings is through new entrants into the market. Public statements by speculators illustrate this:
Store of Value?
The “store of value” argument also depends on new buyers coming in to support those who want to liquidate their holdings. Again, this suggests a pyramid scheme, albeit one that doesn’t promise explicitly high returns. Whatever it is, it is not a legitimate investment.
Stock appreciation ultimately implies that people owning the shares earn increasing profits. Commodities are more than just “stores of value.” Governments require the use of fiat currencies. With a few notable exceptions, governments stabilize their currencies and don't sell them to the general public as speculative investments. For these exceptions, more stable currencies are available.
Some say bitcoin is similar to gold. In the best of cases, should ownership stabilize, bitcoin and gold would share certain characteristics: Both would be volatile investments with poor long-term returns.
But gold has other uses: To fashion jewelry and other art, for example, or even as doomsday currency should electricity and internet become unavailable. Bitcoin can’t serve either of these roles.
More likely, after the supply of new buyers is exhausted, the final investors in the pyramid will find themselves with assets that decline in value as others sell because the one thing that they expected from bitcoin — higher prices — ceases to materialize.
Social Value?
Does investing in bitcoin have any social value? Investing in the securities markets provides capital to firms, governments, and other entities. Speculation in commodities creates markets that allow their users to hedge their exposure to price fluctuations.
Bitcoin can help people evade government restrictions on currency and capital. But even that dubious distinction rarely enters the discussion among bitcoin supporters. Still, we cannot ignore laws and regulations we disagree with or governments we disapprove of. Furthermore, the same mechanisms that can help people avoid capital controls through bitcoin can also help them avoid government sanctions against unsavory regimes and engage in money laundering and ransomware schemes.
Perhaps these excesses could be tolerated if they were mere side effects. But other than for speculation, bitcoin has no utility beyond such activities. No doubt some will point to blockchain and claim that it is the silver lining to the crypto cloud, and demonstrates bitcoin's merits as an investment. But bitcoin provides no rights to use or profit from blockchain technologies. Whatever they have to offer, one does not need to purchase cryptocurrency to use blockchain.
So encouraging the purchase of bitcoin by invoking the benefits of blockchain is clearly misleading.
How is bitcoin different from other pyramid schemes, say, those run in penny-stock boiler rooms? The only distinguishing characteristics are the record-keeping method — a “proof of work” blockchain — and a large marketing effort that uses the media instead of the telephone.
In my view, most of those who invest in bitcoin are effectively participating in a pyramid scheme either as a future victim or a perpetrator. Some no doubt truly believe that bitcoin will function as a currency for enabling transactions, rather than a “store of value." But I wonder whether such people truly understand economics, our monetary system, or our business environment
These critiques are not unique to bitcoin, but apply to all cryptocurrencies. Some could offer value as electronic coupons to purchase yet-to-be-developed services. However, that does not constitute a new asset class, but rather an existing asset class with a new record-keeping system. So investors must apply the same due diligence as for other investments to assess what legal rights they are purchasing and the ability and willingness of others to deliver on their commitments.
It is not my intention to play the thought police here. My point is investment managers need to consider these issues before investing in or promoting cryptocurrencies. So should those responsible for personnel decisions about managers.
Because the fact is, if it looks like a pyramid scheme and sounds like a pyramid scheme, we should treat it like a pyramid scheme until proven otherwise.
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61 Comments
Excellent reply Qiyang!
"Bitcoin is too inefficient to be a currency."
What is the author's level of expertise on Bitcoin? Bitcoin is less efficient in terms of computing resources (which are cheap and getting cheaper all the time) It is more efficient in terms of being able to make irreversible, global payments in any amount. Bitocin is not a static entity - it has improved massively over the years and continues to improve in terms of efficiency, scalability, and security.
It would be nice if Bitcoin critics would give scenarios in which they would admit they were wrong about Bitcoin. Otherwise they can continue to move the goalposts as Bitcoin continues to grow and improve.
"Thus the sole way most promoters will realize value from their bitcoin holdings is through new entrants into the market."
Actually, one of the reasons that bitcoin is so undervalued is because many people (such as the author of the article above) don't yet understand the value. Bitcoin has network effects - like Uber or Facebook, it becomes more valuable as more people use it. Pyramid schemes are a specific thing where payments are made up through a hierarchy. Bitcoin does not have a hierarchy. Bitcoin is not centralized - it is decentralized.
"The “store of value” argument also depends on new buyers coming in to support those who want to liquidate their holdings."
This isn't true. Existing holders of bitcoin may want more. Long term holders of bitcoin do not want to liquidate their investment. they may want to sell a portion, but the idea is that they have a new form of money. They don't need to go back to an old form in order to buy goods and services.
"Again, this suggests a pyramid scheme, albeit one that doesn’t promise explicitly high returns."
Bitcoin itself doesn't promise high returns, or even a profit. This is because it isn't a pyramid scheme.
"Whatever it is, it is not a legitimate investment." The author admits he doesn't know what Bitcoin is. Why does he think it isn't a legitimate investment?
"With a few notable exceptions, governments stabilize their currencies and don’t sell them to the general public as speculative investments. For these exceptions, more stable currencies are available."
In those places, Bitcoin may be available while stable foreign currencies are not available. In those cases, bitcoin outperforms the local currency consistently, while having other desirable characteristics (suitable for fleeing the country even when destination is unknown).
"But gold has other uses: To fashion jewelry and other art, for example, or even as doomsday currency should electricity and internet become unavailable. Bitcoin can’t serve either of these roles."
Gold is used a hedge against inflation. Bitcoin is used as a hedge against inflation. Why did the author leave this out?
"But other than for speculation, bitcoin has no utility beyond such activities."
Bitcoin has many other uses. When people all over the world use Bitcoin, they don't feel the need to notify the author. The author must actually do some research and not merely assume his conclusions.
"Whatever they have to offer, one does not need to purchase cryptocurrency to use blockchain."
This is literally what owning bitcoin gives you the right to do - it gives you the right to write to the blockchain. If you don't have any bitcoins, you cannot write to the Bitcoin blockchain. If you make a centralized blockchain, it has no reason to exist.
"How is bitcoin different from other pyramid schemes, say, those run in penny-stock boiler rooms?"
Bitcoin isn't a penny stock, and it isn't sold via boiler rooms. That was an easy question.
"Some no doubt truly believe that bitcoin will function as a currency for enabling transactions, rather than a “store of value.” But I wonder whether such people truly understand economics, our monetary system, or our business environment"
I understand economics, our monetary system, our business environment. I also understand Bitcoin and I know that it already functions as a currency for transactions.
"These critiques are not unique to bitcoin, but apply to all cryptocurrencies."
Some cryptocurrencies are similar to Bitcoin, while others are wildly different in terms of monetary policy, governance, and structure. The author doesn't understand Bitcoin - and now he is making statements about all cryptocurrencies?
"Because the fact is, if it looks like a pyramid scheme and sounds like a pyramid scheme, we should treat it like a pyramid scheme until proven otherwise."
It has been proven otherwise. Bitcoin has no one running it, it doesn't have a hierarchy or mandatory payments, it doesn't promise profits.
The author could start with my article here:
https://medium.com/@d.ameli/13-common-misconceptions-about-bitcoin-45e1…
Some points to consider:
The commenter writes:
"Bitocin is not a static entity – it has improved massively over the years and continues to improve in terms of efficiency..."(sic)...
When new hardware makes Bitcoin's proof of work more efficient, the algorithm must increase the difficulty required to validate blocks, or attackers will be able use the efficiency to take over the network. Proof of work requires consuming resources for security; and it requires expending far more energy than any attacker could, because the good miners must keep working every hour of the year, while an attacker could disrupt the network over just a short time.
Furthermore, the comment ignores the fact that fiat based methods of payment are becoming more efficient and faster. With new services I can send money to anyone domestically instantly and to many foreign countries within a day. I can withdraw funds from a US bank account at an ATM in Africa.
When people compare the "costs" and time of bitcoin transactions, they just count the fee charged for changing the blockchain records. They don't count conversions to usable currency. They don't count effort spent upfront on customer service, marketing, fraud prevention, or anti money laundering controls that aren't reflected in the fees recorded in the blockchain. These account for the vast majority of the costs of money transmission, which is accomplished by sending digital signals anyhow. All of these activities are needed for any money transmission service to be something other than a plaything for a few technologists.
The commenter's logic has been widely used in the past to promote Bitcoin. I wonder if similar logic were used to sell an equity or debt issuance whether the promoter could avoid lawsuits or prosecution for misleading investors?
The author write: ". If you don’t have any bitcoins, you cannot write to the Bitcoin blockchain. "
This seems like circular reasoning. If I don't own Penny stock, I can't get entered into the ownership records and can't transfer it to get someone else's name entered. Why would I need or want to write to the Bitcoin blockchain?
You can create your own blockchain using open source software. That is what a number of companies experimenting with blockchain do. In fact people unhappy with how the Bitcoin blockchain works have cloned it and created may other blockchain.
With respect to places that have unstable currency-- The commenter states: "In those places, Bitcoin may be available while stable foreign currencies are not available."
In these countries, stable currencies are available, although government interference may force a lot of the activity to black markets. They are used far more heavily then Bitcoin. The only potential advantage Bitcoin has over a stable fiat currency is when the interest and usage is so minimal that the governments ignore it. Claims that governments can't interfere with Bitcoin are just untrue. They can shutdown public exchanges, forbid transactions and force it into the same black market that more usable currencies trade in.
Google search trends bear this out---Bitcoin interest from countries experiencing currency stress peaked during the successful promotion in late 2017 and have fallen since then, in spite of increased concern on inflation. Searches for "dollar" and "euro" are a more common response to inflation concerns. See Argentina as a an example ( https://trends.google.com/trends/explore?geo=AR&q=bitcoin,dollar,euro ) where searches for "Euro" dominate.
What really is a more likely use case is for governments of countries like North Korea or Iran to attempt to use Cryptocurrencies to evade sanctions. If the US government were to fail to respond. Should investors be assisting in this activity by buying Bitcoin?
The fact is that after 10 years, Bitcoin, because of its flaws, is still little used as a currency. Furthermore the rate of legitimate usages outside of speculation does not appear to be increasing. This is why the promotions now focus far less on its utility as a transaction mechanism and more on the possibility of getting SEC approval of a Bitcoin ETF or bringing in institutional investors.
There are many more misleading statements made by this commentater and others promoting Bitcoin. Even the decentralization claims are misleading. A handful of mining pools control a majority of the hash power--i.e. the resources dedicated towards guessing a random number that allows a new block to be created. This means that if they collude, they can change the rules that govern what goes into a valid block. In fact the representatives of these mining pools and Bitcoin software developers do negotiate changes in these rules.
In the case of another cryptocurrency, Ethereum, unelected leaders of the community agreed to change their blockchain to undo a transaction that they viewed as theft after a hacker found a means of siphoning funds from an investment vehicle created as a smart contract. (see https://en.wikipedia.org/wiki/The_DAO_(organization)#Proposals )
Your comments themselves are gold, and you should compile them into a followup post in its own right.
The author has done a great job bringing out his point on why he believes BTC is a pyramid scheme. Although some of the comments above resist such thoughts, it is important to notice that these are the views in the larger asset market. Managers are being faced with going with the notion of FOMO or perform the required due-diligence as done for other asset class. Such concerns are valid and should be looked at in depths.
Based on our research and simple Quants concerning market share and cap of major high cap Cryptocurrencies , estimations disclosed facts which could be taken as a simple but efficient indicator in portfolio managers toolbox. But the purpose of such 30 minutes effort is something else. Based on Bitcoin market share of 56.2%, the average productivity has been estimated around 0.034% which is based on machine hours, number of nodes, network hashrate, machine processing power and taking some discrepancies into consideration. The same methodology has been used for Ethereum by having 10% market share and 169.8% average productivity. And XRP? But the productivity has got a limit when hitting network DMR. This is the point where new nodes have to be engaged to lag DMR. But what would be the next limit and how about consequences? Concerning scalability, according to electricity consumption estimates and profit margin, there would be no incentives for miners. Credit Suisse’s ballpark figure assumes that 80% of the expenses of bitcoin miners are spent on electricity. [https://bit.ly/2Dcvcr3] and Bitcoin’s current estimated annual electricity consumption is 61.4 TWh, which is also equivalent to 1.5% of the electricity consumed in the United States. [https://bit.ly/2JRnhRn]
Nevertheless, even if scalability and electricity consumption has been resolved, another issue will rise, regulatory regimes. And it's degree of importance will be disclosed considering Bitcoin’s Market Valuation Outpaces the IMF’s Special Drawing Rights Reserves. [https://bit.ly/2Qy9i5w]
In reports published by "CFA" Institute,
The Future State of Investment Profession
[https://cfa.is/2z2vSfU] and Investment Firm of the Future [https://bit.ly/2QwZNUd], four unique scenarios has been created which offer a road map for leaders in their strategic decision making as they seek to chart a course for the future of their firms and provides insights for professionals interested in becoming future industry leaders by identifying the traits and abilities that will be prized by future investment management organizations. Concerning Crypto Assets, I would like to pop up a question which is still challenging to answer without taking the "CFA" reports into consideration.
* Blockchain technology, a WORM (Write Once Read Many) ledger constructed by a composition pattern including a linked-list and a tree with underlying algorithms, has been created to operate in a peer-to-peer trustless environment which eventually its state will be shifted to trusted. Considering its potential use in today's problem solving in variety of domains, how the upper layer could be aligned with future state of investment industry and profession?
Regulating Bitcoin by Japanese government demands its own research and analysis which this Bloomberg article could help in such due diligence. [https://bloom.bg/2GOVoLq]
Economies in isolation will not survive. Scarcity of resources threatens all countries in the world. Implementing a finance ecosystem by not considering societal wealth and well-being not only hurts domestic economy but global sector. It is time, maybe a bit late, to rethink and restructure our thoughts, collectively.
Thank you for your time.
There is in fact fundamental value in bitcoin. It costs an increasing amount of electricity to "mine" the marginal coin. That cost is reflected back to older coins as the new marginal cost. No one will mine unless market exceeds cost. Some people set up their operations in hydro rich countries to arbitrage electricity cost. Now, you may think bitcoin is a silly idea as a currency, and I do, but the thing has an embedded value as a pure collectible. Why anyone would want to collect them is beyond me, but this is what it is.
The author makes valid points, but the fatal flaw of the argument is the critique comes from the persoective of a US based investor.
One needs to realize that bitcoin is a truly global currency that does not care about borders. It has extremely low barriers to entry for the average participant. Just an internet connection.
For counties with stable governments, strong institutions and a stable local currency the appeal of bitcoin is more speculative.
However for people who live in countries with unstable governments, weak institutions and an unstable local currency, the appeal of bitcoin as a means of survival is immense.
If you do a google trends search on bitcoin look at the countries with the highest search activity. Many are not what you would typically expect.
So yes, speculative and ponzi like activity has played a huge part in the rise and fall of bitcoin prices. But that is true for any asset bubble that rises too far too fast. There will always be an underlying demand for bitcoin due to the fact it is the first borderless global currency. What is the appropriate price is another story.
The fatal flaw in this comment writer's reasoning is that he approaches it from the perspective of technologist who likes Bitcoin.
The term "borderless currency" is a misnomer. The dollar is widely accepted in many countries, hence is as borderless as any cryptocurrency.
Perhaps the writer really means "not backed or governed by any government", which does describe Bitcoin. It is controlled, not by a government, but by an un-elected clique of individuals who oversee a small number of mining pools and software development.
I wonder what the comment writer thinks readers would expect would be the locations where Bitcoin has the highest search activity? Over the past year, stable countries dominate the list. More recently less stable countries will periodically jump to the top, but this is because searches for Bitcoin in the more stable countries have plummeted so dramatically since late 2017. Even in these less stable countries, the search activity is almost always now far less than it was during the the great price runup. It is generally lower than that for Euro or dollars, which people are more familiar with and less likely to need google to learn about.
Even if we accept the claims of the great increase in Bitcoin transactions in Venezeula--the increase is from near zero. In Venezuela, which has suffered high inflation for years, the current claimed exchange volume represents about 1/1,000 of its shrinking GDP, even though it has been used to steal free electricity for mining. Even Nathaniel Popper, a journalist and author who follows and has been favorable towards Bitcoin and cryptocurrencies a acknowledged in a tweet "...I would think that more people in crypto should be asking why Venezuelans haven't turned to Bitcoin.." . See https://twitter.com/nathanielpopper/status/1042887245202505728
As I mentioned in response to earlier comments, Bitcoin and other cryptocurrencies' only potential advantage to people in unstable countries is that the usage is so unsubstantial the governments might not bother restricting it. At the first hint of it becoming a threat, the government crackdowns will relegate it to the same black markets where other banned currencies trades. There it will be at a great disadvantage to currencies whose value is steadied by their heavy usage in stable countries.
The "low barriers to entry" is a major misconception. I am presuming the writer is referring to whether one can use Bitcoin without an intermediary; because when one goes through the banking system, bitcoin has no advantage over regular currencies.
The claim that Bitcoin can be used without an intermediary is from the perspective of the small minority of people with great technical knowledge. The average person would have to learn how to acquire and maintain the right software and protect the Bitcoin private keys from loss or theft. Even the elite group of technologists has found it challenging to avoid losing Bitcoins to hacks and mistakes. Almost all users and speculators go through intermediaries like Coinbase.
The shift in the dominant driver of bitcoin promotion and usage from adoption as a currency to "store of value" or the arrival of institutional investors indicates that few who understand monetary economics have bought into the idea that Bitcoin is a true global currency.
You are building a straw man here. I’m not comparing bitcoin to the US dollar, I’m responding to your assertion bitcoin is a Ponzi scheme. Since there is demand for bitcoin in countries where people wish to move or store their money in a transportable, unanimous manner, there will be demand. A ponzi asserts the underlying value is zero. I assert the underlying value is not zero. It’s certainly not worth several thousand dollars but it is not zero. Whoever thinks that bitcoin will replace the dollar is clearly delusional, but that was not the original argument in the first place.