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
One notable characteristic of Bitcoin: When you point out the flaws in the marketing of the product, the ratio of insults and ad hominum attacks to analysis you receive is very high.
There seems to be a lot of passionate criticism to your article. Bubbles are built on emotion. We might still be in the later part of the euphoria stage about to enter the profit taking stage but I could be wrong. Everyone on both sides of this debate should just invest their money accordingly.
First---I refer to it as a pyramid--different from a Ponzi scheme. A pyramid scheme just requires that the returns be predominantly from bringing in additional purchasers rather than production of value.
For a product to have a non-zero value, it is not enough for some people to have used it. There needs to be enough usage over time and sufficient value added to exceed the costs involved.
For the reasons I have outlined in the article and my responses to the comments, it is unlikely the achieve sufficient usage over time. There are far less costly technologies for moving funds. When one adds the environmental costs of mining and the social costs from its abuse, the long term value added is negative.
Goofy. I like this article for two reasons. One, it's inflammatory. And two, I'm a net buyer of BTC so keep up the negative press please.
Subjective belief of value is at the core of all currencies, stores of value, products. BTC is valuable for the same reason fidget spinners and USD are considered valuable, belief. BTC is a store of value if people accept it as a store of value. "That is silly and unsustainable", you might say. USD, EUR, diamonds, gold. "Those have objective utility", you might say. Oh my goodness please leave the econ textbook at home and look further. Why is jewelry valuable? Because we think it is!
BTC will remain a player in the space and will serve as a store of value. Fixed limit is the kicker. Watch USD M2 continue it's exponential path through bank issued credit (which it looks like you might be familiar with) and Abra Kadabra BTC keeps purchasing power. Why are gold and diamonds more valuable than other rocks? Subjective value and limited supply.
Check and check.
To the OP, did the CFA course not explain basic economics? The value of something is explicitly derived from two very important inputs, supply and demand.
As noted in most of the criticism here, there is value if there is a demand for bitcoin. The supply is fixed, which provides a more stable approach to storing value. Were you around when the first USD was issued? If not I suggest you go do a little research on it.
If bitcoin or any crypto eventually gets to mainstream, which I believe will happen, then merchants will begin to accept it and at that moment will realize the true value of the crypto at that moment.
Will it be bitcoin? Probably not. I do however can see a new crypto that is regulated through an international monetary org such as the IMF, begin to play out.
Wouldn’t you be interested in that? Think about it, you will no longer need to worry about your government politics and it’s effect on your local currency. Instead of converting local currency into foreign currency, products will all cost the same amount of bitcoin/crypto, no matter where you are.
It is disruption, and this post about bitcoin being a “Ponzi scheme” just shows an ignorance of economics.
Real currencies have usages, such as tax payments, that are mandated by governments. Furthermore, real investments generally aren't in the currency itself but in the capital structure of productive institutions (mostly firms and governments) that ultimately pay returns derived from the institutions' production. The currency is the unit of exchange.
Gold is an exception and over the past 200 years has produced low returns.
Many things have finite supply. That does not mean they are appropriate investments. A vast majority of them ultimately become worthless. A visible, but small minority become collectibles and museum pieces.
Even the case of collectibles or jewelry--I would recommend that they be bought for enjoyment, education, or display and not for investment. Few people buy Bitcoin to display or enjoyment, and the theme of my article is its validity as an investment.
Personally, I buy mineral specimens--for display and enjoyment and preservation of pieces of natural history. I just hope their value is high enough so that when I kick the bucket, my children find it worthwhile to find buyers who will preserve the best of them.
By your definition of a pyramid scheme the entire nature of Business and Investments then would come under scrutiny. Because manufacturers albeit Miners who sell to wholesalers/ retailers would all get together under your conspiracy theory to fixate price, outcome and policy ( and with no underlying technological analysis ). Now this pyramid scheme already exists with Fiat currency through the central banking system and fractional reserve banking - which is more like a Ponzi scheme than anything else.
But it’s all a matter of belief and manipulation of the masses to keep that power of money in the hands of a few and keep a Keynesian economy running that is much comparable to the game of Monopoly, except that you are able to live on indebted.
Furthermore, Bitcoin was the initiator, the pioneering sensation of a technological masterpiece that is the Blockchain technology 1.0. So all the System pawns are thirsting for the technology which is essentially Bitcoin but want to erase the name Bitcoin and keep Blockchain to themselves. It is all make belief, just as Fiat currencies are. The only thing backing Fiat is a gun to your head.
Why are the dinosaurs so adamant on bashing Bitcoin when it is like the first modem connected to your telephone in the 90s that just came out. Even then people like this were saying this Internet thing is useless. So let’s stop talking about Bitcoin alone and look at all the other possibilities with coins that are working as a new store of value and currency at the same time. Those coins where institutions like the SEC has a really hard time to figure out whether they are securities or something else. Well that something else is not possible to be seen when you have been indoctrinated all your life to think inside of a box and a narrative. It’s called cognitive bias. And unless you do not open your mind to a new world, the smartest and most savvy explanation will not even do the trick. If you wanted to understand without risking to ruin your own sense of identity, you would have. That is the core issue. Not what Bitcoin does or is, while completely ignoring how the different real Blockchains get its value in the financial sense. Rather talking about fake permission Blockchains that would just keep the foul financial system afloat for a little longer. And in conclusion just to inspire a little bit of open mindedness - How about every company has its own value and in the middle is a stable crypto..there are tons of new developments in this end where governments are not involved. Because Government work on taxes, that eventually all get into the hands of the few. Every public utility is paid for with disposable income and inflation. So who is the fraud ?
Thanks for this very good article.. I am not sure it is a pyramid scheme because the proper of a pyramid scheme is that you don't know it is a pyramid scheme (and usually supported by physical and/or financial assets). My biggest problem with bitcoin is that I see many reasons for downside and not that much (I mean zero) for upside.
Bitcoin is nothing that would last long. It is a new technology in financial pyramids and if someone thinks opposite he has his bullish deals open.
YES! Thank you! Someone finally said it. New legal financial ponzi. The overthinking blows my mind. Stocks are the same thing. Wealth is just transferring. Until the US Government deems crypto trading illegal, I think I’ll keep making money trading in this simple market.