Bitcoin is a pyramid scheme” says a former bank executive. 1 But what is a pyramid scheme? Is Bitcoin one of them? Let’s identify three properties of pyramid schemes and analyse which of them Bitcoin shares.

When faced with the pyramid scheme allegation, the cynical crypto enthusiast often replies with far worse insults about the traditional fiat money system. Unfortunately, these insults don’t address the point. What if Bitcoin is, in fact, a pyramid scheme?

“Bitcoin has become nothing more than a giant pump-and-dump scheme.” 2

Do you want to be cool?

To better understand how a pyramid scheme operates, let’s build one. My scheme is called “be cool”.

As the name implies, members of the scheme are classes as “cool”. There’s only one way to become cool in this scheme. You have to purchase a rare invite from an existing member. Once you have received an invite, you can join this coveted in-group. You are now cool. As a new member you’ll also receive two invites to sell to your friends.

I’m already a member of the “cool” group. Would you like to be “cool”, too? I’ll sell you one of my invites! Imagine a flashy website, snappy video and polished logo designed to lure you in.

A cool person
Do you want to be cool? Buy one of my invites, before they are gone.

Now if you’re a social thought leader, you’ll probably say yes to this offer, because you want to be the first in of your friends to be “cool”. If you’re a social thought follower, you might say yes too, because your friend is already in the “cool” group. This dynamic is precisely why pyramid schemes are popular. We all tend to jump on the bandwagon.

The Pyramid’ 3 Elements

In our hypothetical “be cool” scheme there are three essential elements you find in any pyramid scheme: Newcomers, Oldies and The Promise. Let’s define those terms.

Newcomers: People who invest money.

In the “be cool” scheme, the investment is buying an invite.

Oldies: Members who receive money from Newcomers.

Members selling their “cool” invites are the Oldies.

The Promise: Newcomers are promised to earn more money than they invested.

As Newcomers look to sell two invites, but only pay for one, they are promised a positive return.

Make money from home
Everyone wants to make easy money. The promise of a typical online ad, which often leads to a pyramid scheme.

 

A pyramid scheme promises Newcomers large future payments for a small upfront investment. The Newcomer’s investment pays off the promise to their recruiters, the Oldies. Contrary to a regular business, the scheme does not offer products or services in return for payments. Once no more Newcomers can be found, the scheme collapses, resulting in lower levels of the pyramid (most participants) losing their investment. 3

The Pyramid’s 3 Elements in Bitcoin

Let’s compare the structure of our little pyramid scheme “be cool” with Bitcoin.

Newcomers: People who invest money.

Clearly, everyone who buys Bitcoin for the first time is a Newcomer.

Oldies: Members who receive money from Newcomers.

For each Newcomer buying into Bitcoin there must be an Oldie selling it to them. Miners can be thought of as Newcomers when they buy the necessary hardware, and Oldies when they sell their mined Bitcoin.

The Promise: Newcomers are promised to earn more money than they invested.

A large percentage of people buy Bitcoin because they believe Bitcoin’s value will increase.

Looking at the pyramid’s three elements, Bitcoin functions EXACTLY like a pyramid scheme.

Bitcoin functions exactly like a pyramid scheme.

There is an eerie similarity between recruiting new members of the “be cool” brigade and Bitcoin. I initially invested in Bitcoin because I was won over by smart technology people praising it. I thought they were cool. My friends invested in Bitcoin because they thought I was cool (at least that’s what I like to believe). And that’s how the pyramid grows. Because everybody wants to “be cool” and in on the latest trend.

So… it’s settled then, Bitcoin is a pyramid scheme waiting to collapse?!

The missing Piece of the Pyramid

Not so fast! I have skipped an additional trait of your average pyramid scheme.

No product or service: Invested money buys nothing of economic value.

In my “be cool” pyramid scheme, you as a new member would become “cool”. This membership has no economic value. It’s not a product (not scarce, no value) nor a service (nothing has changed).

In Bitcoin, it’s different. Bitcoin is scarce. Bitcoin is both a product and a service.

Bitcoin is scarce

We have a saying in Bitcoin space: There are more millionaires in the world today than there will ever be Bitcoins. Meaning, it’s impossible for every millionaire to possess a whole Bitcoin. If Bitcoin were a pyramid scheme, new Bitcoins would be created for every new member. But that’s not what happens. Bitcoin fundamentally differs from an ever-growing pyramid scheme. The price might be inflated or show signs of a bubble; but it will never collapse to zero as supply is limited.

Bitcoin is a product and a service

This second argument carries the weight of the pyramid scheme refutation. Bitcoin is both a product and a service.

Bitcoin as a product is a store of value providing real ownership. It is not someone else’s debt. It is not granted or guaranteed by a nation state. It is an unseizable asset. For these reasons, it’s nicknamed digital gold. It’s a desirable product.

Bitcoin as a service offers unstoppable, near instant, global transactability. The fact that unstoppable payments make Bitcoin attractive to criminals is an early indicator of the usefulness of the service. Instant global transactions are an unparalleled service. 4 Bitcoin offers a digital financial service.

Here, I must grant that most Newcomers to Bitcoin do not invest because they want to use Bitcoin as a product, or use Bitcoin as a service. Most Newcomers invest because they believe The Promise. However, much like a VC invests in a start-up that doesn’t have an adopted product or service yet, Bitcoin investments are bets on the future of its viability to perform these functions.

Bitcoin investments are bets on it’s future to provide widespread value as a product and service.

Bitcoin works like a Pyramid, but it isn’t one

Bitcoin shares core properties with pyramid schemes: It promises high returns and rewards for Oldies with fresh money of Newcomers. Most growth in Bitcoin stems from a speculative investment that works just like this. But Bitcoin differs from a pyramid scheme by having a long term economic value proposition.

Luxor Hotel Las Vegas looks like a pyramid
The Luxor Hotel in Las Vegas is a pyramid that offers economic value. It will not collapse.

I am excited to see how much economic value Bitcoin can ultimately provide, and how this will be reflected in its market price for the decades to come. 

Are you?

 

1 https://www.cnbc.com/2018/01/16/bitcoin-is-a-pyramid-scheme-warns-ex-wells-fargo-ceo-dick-kovacevich.html

2 https://www.forbes.com/sites/jayadkisson/2018/11/20/the-great-cryptocurrency-scam

Note: The term Ponzi scheme is sometimes used interchangeably with pyramid scheme. But there is a difference. A Ponzi scheme has a head or manager, who controls and handles payments. A pyramid scheme sees payments between the members. In a sense, a pyramid scheme is a decentralized Ponzi scheme.

4 Other instant global payment systems, like PayPal and credit cards, push debt obligations around. These can be reversed for a significant period of time before they are settled. Bitcoin settles almost instantly.

 

Contact: Paul@f5crypto.com

 

Smart ideas are likely copied from someone else.

Mistakes are all my own.

 

Paul Otto is a managing director at F5 Crypto Capital GmbH. The views and opinions expressed by Paul are solely his own and do not necessarily reflect those of F5 Crypto Capital GmbH. This post is for informational purposes only and should not be relied upon for investment decisions.

The author may hold long or short positions in the securities discussed.