Bitcoin is a Pyramid Scheme: Truth or Myth?

10 Feb 2018

Bitcoin is a Pyramid Scheme: Truth or Myth?

There are lots of skeptical talks about cryptocurrencies in general and Bitcoin in particular. It's often the case that someone writes an angry comment under any Bitcoin successes news  regarding that Bitcoin is a pyramid scheme and that it takes a fool to invest own money in it.

They say that the bitter experience of MMM and other pyramids hasn't taught anybody, and that some fraudsters cash in on trustful investors again.
Well, let's sort it out. First, here's the definition of pyramid scheme given by US Securities and Exchange Commission (SEC):

  • Financial pyramid (Ponzi scheme) is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors to create the false appearance that investors are profiting from a legitimate business.
This definition follows that an important factor of the pyramid is that early investors gain returns not by means of actual increase of value but by means of money from new participants. Herewith, there's a centre joint of the pyramid — the benefitor of the scum who gains maximum profit for himself at the end.

Another thesis is that the most important thing to identify the Ponzi scheme is total amount of liabilities and total value.
Let's take the same MMM as an example. New people who had been promised that they would gain huge returns for their investment start participating in it, hence, total amount of liabilities of the pyramid increases. But value of MMM is zero because the money is not multiplied, it's only distributed between the participants within the system. Therefore, the value doesn't increase and disproportionality between liabilities and value grows larger and larger because amount of liabilities increases constantly and requires more and more of new participants to be attracted to fulfill these liabilities.

As a result, one day the pyramid collapses because it becomes non-profitable for its benefitor. Consider: he has access to the money and can run away with it. This money stock becomes larger and larger, and then increase of number of participants stops and the stock begins to decrease. At this moment, the organizer's pyramid game stops to make any sence as his money start vanishing. That's why he closes it and runs away with the money and 99% of investors are left with nothing. All the factors come out here: amount of liabilities has grown very large, no value has appeared, and the benefitor is willing to run away.
When it comes to cryptocurrencies in general, it's more correct to divide Bitcoin and other cryptocurrencies, the so called altcoins, from each other in the very beginning.

So, it's undeniable that some alternative cryptocurrencies ICOs are the forms of Ponzi scheme nowadays. The cryptocurrency market is still not regulated in any way, and there are lots of fraudsters making profits out of popular feature, building pyramid schemes or frauds looking like new revolutionary companies developing fantastic technologies of the future. Most typically, the value of such cryptocurrencies is based exceptionally on speculation and fraud.
But it doesn't mean that absolutely all altcoins are fake. Some altocoins have quite clear and transparent mode of price formation. Actually, nowadays such cryptocurrencies as Ether, Dash, Ripple, Litecoin, NEM, Monero have real value and their prices are conditioned not only by pure speculation.

When it comes to Bitcoin, fantastic growth of its price obviously keeps thrilling its critics, but actually, everything is quite simple about it.
The first and the most obvious distinction of Bitcoin from Ponzi scheme is that there's no central benefitor of it. Theoretically speaking, very old wallets containing very large amount of Bitcoins may exist and may be called benefitors to some extent. But there is no any official central benefitor from the very beginning, and the Ponzi scheme makes no sense without his presence.
The second important distinction is that Bitcoin's value increases alongside with growth of number of user and amount of money invested into Bitcoin because value of any economical system is directly connected to number of its users. Moreover, given the fact that size of economy is always proportional to the square of the number of users but not to the number itself, value of Bitcoin grows much faster than number of users and it has nothing to do with inflation of any bubble.
The last factor is that Bitcoin has no any liabilities. It means that Bitcoin hasn't ever promised anything to anyone and it can't collapse like a pyramid. Bitcoin is just a financial protocol for implementation and validation of  transactions performed between the participants and storage of information about them in the network. The code of Bitcoin is open-source, every participant may research the logic of operation of the network, and any specific participants can't just capture other participants' Bitcoins.
Given the above said, we can make a conclusion that Bitcoin is not a Ponzi pyramid. As a matter of fact, it's a form of digital currency used by participants of the network, and the number of the virtual wallets storing it is already exceeding 11 million throughout the world. There are lots of factors forming the price of the currency and one of them is it's demand level and number of its users. That's why it's natural that while the number of the users of the network increases, the price of Bitcoin keeps growing. It's natural for any currency, and it's no need thinking of Bitcoin as of some suspicious anomaly.