Hand-in-hand with offering a chance of high returns, bitcoin has an ever-growing community of supporters who passionately praise the technology behind the digital currency and encourage others to join in what they describe as nothing short of a revolution.
Without a doubt, it is fair to say that the cryptocurrency market exhibits many of the behavioural traits you can expect to find in ponzi or pyramid schemes. However bitcoin is becoming distinguished from these schemes through several primary aspects, explored in detail below.
Often grouped together by a similar approach in advertising very high or fixed periodical returns, ponzi and pyramid schemes are structured quite differently to each other but both inevitably fall victim to collapse that sees investors and new supporters lose out.
Understanding these operational structures is critical to independently identifying risks, but also lays the foundation for evaluating where there are distinctions in other promising projects that may also sound too good to be true.
Please note, there does exist a great deal of concerning cryptocurrencies and projects out there, and indeed some that are virtual currency based ponzi or pyramid schemes. This article specifically addresses bitcoin (BTC) and the bitcoin blockchain only.
At a high level, ponzi schemes purport to use investor funds in the undertaking of some form of profitable activity, sharing the returns with those who invest. In reality, ponzi schemes do no such profitable undertaking, but instead use the capital contributed by new investors to pay returns to older investors and give the false impression of a successful operation.
Ponzi schemes can be difficult to identify, as they generally claim to use proprietary technology that cannot be easily understood or transparently disclosed due to its claimed competitive edge. An example may be an ‘artificial intelligence based trading algorithm’ that can reliably trade across foreign markets to produce significant and continued returns, sometimes guaranteed.
Though not always the case, it should always be considered a red flag if there are no individuals publicly associated with the business, or profiles such as on LinkedIn lack little information or activity.
Another factor to consider is why a company claiming to produce guaranteed, positive and high returns, would elect to deploy considerable resource is managing thousands of investors and accounts.
A much more cost-effective solution would be to seek the same level of investment from just one or several venture capital funds. A large fund would surely jump on an opportunity this good. Perhaps it's safe to assume it's because they wouldn't pass the due diligence process of an informed, specialised fund that has the subject expertise to evaluate the business on it's merits.
Pyramid schemes differ to ponzi schemes by heavily incentivising the recruitment of new members. The pyramid shape comes from their tiered operational structure which sees revenue flow to the top handful of early adopters and highly skilled influential members.
These can be difficult to identify, as many businesses that would fall under the illicit classification for being a pyramid scheme have managed to skirt around this definition by adding the sale of a tangible product.
By doing this, they circumvent clear punishments for operating a pyramid scheme, and instead argue their business is not a pyramid scheme but rather operates a ‘multi-level-marketing’ framework, where members earn money by selling products.
These days, when people speak of avoiding involvement in a pyramid scheme, they generally mean a businesses which unsustainable due to the heavy focus on membership recruitment. Members of multi-level-marketing businesses are heavily encouraged to use the product themselves, but a far greater importance is placed on the recruitment of new members to ensure an ever growing pipeline of new recruits to invest and grow product and training package sales.
While defensible to regulators, the issue lays in the fact that the business model of pyramid scheme or their not too distant Multi-Level Marketing cousins, is unsustainable.
When sales in business is reliant on recruitment as the primary method of growth, they eventually collapse due to the finite amount of people on the who will join, and reach this tipping point once recruitment of new members dries up.
This can take considerable time, and many pyramid or multi-level marketing business are able to grow into having a global presence. It is not a requirement that total collapse occurs for investors to lose money, as many who join are never successful enough to generate a return on the time and money they invest, through bulk orders of product that ends up sitting in their home unsold, or training packages designed to increase their people and recruitment skills.
Bitcoin (BTC) is a digital currency. The bitcoin blockchain is the digital network that maintains an accounting record for every transaction of bitcoin moving between people, and this is updated every time a transaction is made. Rather than using a central authority such a bank to manage this accounting, the process is undertaken by a global network of computers. This is done to shift trust away from a central entity.
Computers deploy computational power to check, validate and process every transaction that takes place, in a process called mining. In return for producing reliable security in the network and enabling a way for people to trust in the outcome, they are rewarded by earning bitcoin.
This network is ‘decentralised’ in nature, because no single entity is responsible for determining truth or accuracy within transactions. Each computer in the network independently completes this function, and checks the work of others.
This article will not focus heavily on the perceived value proposition of bitcoin as an alternative currency against the fiat dollar, nor will it consider other ways that the bitcoin blockchain can be leveraged such as it’s use to store messages of information sent within transactions.
Instead, let’s look at the operational structure of the technology, review the transparency it offers and consider how this is distinguished from that of a ponzi, pyramid or multi-level-marketing scheme.
There is no single individual or entity responsible for controlling bitcoin, but rather an entire network of participants. These can be grouped into seven categories, and each play a vital role in driving the success of the currency.
The above categories of stakeholders create a unique ownership structure for the bitcoin network, as without participation from each, the network will lose it’s value. This is how it was designed in the Bitcoin Whitepaper.
The bitcoin protocol contains the set of consensus rules followed by miners to validate transactions and secure the bitcoin blockchain. While the Bitcoin Core development team is responsible for issuing changes or upgrades to the bitcoin blockchain, if they don’t have the support of miners the changes will not be reflected. This is because each miner is required to independently upgrade to the protocol version they support.
Alternatively, a non-bitcoin core developer may issue their own upgrades and create what is called a hard-fork chain split, in which two versions of the digital currency will result, the original and a competitor. Both will have the same record of past transactions, but with differing changes for what valid transactions in future look like.
This occurred in November of 2018 when Bitcoin Cash was created and split from bitcoin. This came after four years of debate for how to improve transaction speed on the blockchain. The proposed changes for Bitcoin Cash were contentious, because some argued they reduced the security of the network and gave too much power to the miners as a result.
Out of this, we were left with two blockchains, the bitcoin (BTC) blockchain, and the bitcoin cash (BCH) blockchain.
Individual users now have the power to decide which coin they want to support by buying it, and through the process the market is able to establish which each coin is perceived to be worth. This creates pressure on the retail businesses who must now decide if they wish to offer support for the newly created Bitcoin Cash cryptocurrency. A balance must be found where they make the decision to support new currencies based on alignment with their users.
Lastly, exchanges will generally support any cryptocurrency with enough demand for people to trade it, as they generate revenue from trading fees, though not always. Retailers and exchanges are at risk if they choose to support a cryptocurrency deemed more widely by the community to be an attack of bitcoin or a scam all together.
The end outcome is this; no single entity controls bitcoin, and if any stakeholder attempts to perverse the game in their favour, there are a number of checks and balances in place that limit any individual or participant category from achieving it. It’s a direct result of the distribution of power by held by the different participant categories, and is a strength that has seen bitcoin survive for over 10 years despite numerous attempts at de-throning and claims of defeat.
To generate a return on bitcoin, one needs to accumulate bitcoin at a lower price before selling it for a higher price. Simple. But there is no entity able to advertise or guarantee a return on investments made into bitcoin. The historical performance of bitcoin is clear and public, with several instances of declines in price exceeding -85%.
The long-term method to increase the value of bitcoin over time comes down to the above participant stakeholders to work collaboratively in building a balanced ecosystem where each is valued fairly and the community as a whole is able to receive benefit and reliable utility from the network.
While it is fair to say that the greater demand for bitcoin, the higher the price may become, no individual is rewarded for introducing more people into the ecosystem. The scale of bitcoin is now so large that introducing a few friends is not enough to move the needle in any reliable or predictable way.
In saying this, the network effect that results from the bitcoin community spreading it’s message more broadly is certainly what has moved the needle and driven the price higher over time - but this is no different to any valid asset class in any established market. All markets see demand and supply determine market price through price discovery, and with global accessibility, bitcoin is now a globally accessible and tradable asset.
The most common argument likening bitcoin to a pyramid scheme lies on the notion that bitcoin offers no intrinsic benefit, and that it’s resulting value is propped up with those that encourage others to join selling their bitcoin to exit as the price grows to the new investors who are deciding to take the plunge. This argument relies entirely on the assumption that there is no intrinsic benefit, and has been widely debated in the 10 years following bitcoin’s inception. So here’s a few intrinsic benefits for you to consider.
In addition to this, there is an enormous wealth of resources online to assist people in understanding the intrinsic value proposition of bitcoin. Core developer Jameson Lopp maintains his own bitcoin information and resources list to serve as a solid starting place for people new to the space, and this community made video does a powerful job at explaining the key concepts of bitcoin.
The protocol of bitcoin and how it works comes down to open source computer science. While there is a very high likelihood that price manipulation does occur with very large businesses and individuals in the space, the evaluation of the underlying technology and any proposed changes are open source and available for everyone to see and critique, and is free for anyone to contribute suggestions for future development towards. Bitcoin is removed from any centralised control such that all transactions are treated equally and each bitcoin, or fraction thereof, is treated the same all others.
In summary, bitcoin fails to meet the requirements for being classified as a ponzi or a pyramid scheme. There are no promises made on the technology that can’t be transparently verified or understood, nor any reward incentives directly available for recruiting others to join. It’s operational structure, value proposition and process to evolve and iterate is open and transparent and free for all to participate and contribute towards.
This categorisation, or rather lack of, does not mean that it is a safe investment, and it is fair to say that a portion of those who invest, especially during times of great excitement and extreme price climbs, could well be the same type of people most susceptible to investing in ponzi or pyramid schemes
It is important to recognise that the technology, while innovative, is experimental in nature. It is true that there have been periods of enormous gains in market price value, with arguments it’s the best performing global asset class over the last 10 years but there has also been several historical cycles of very significant price decline exceeding -85% The market is extremely volatile and can be high risk, but there are positive signs that this is aligned to natural market cycles, and that bitcoin’s price fluctuations can be reflected upon to offer insight at future potential.
People have lost and gained money investing into bitcoin, but this neither has been the result of bitcoin being a ponzi or pyramid scheme.
The eternal-bull crypto trader. James drives operations and growth at HiveEx
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