Bitcoin: New Asset Class or Pyramid Scheme?
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:
“Pyramid schemes now come in so many forms that they may be difficult to recognize immediately. However, they all share one overriding characteristic. They promise consumers or investors large profits based primarily on recruiting others to join their program, not based on profits from any real investment or real sale of goods to the public.”
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:
“If every millionaire just said, ‘I want one bitcoin,’ the price would go non-linearly higher.” — Bill Miller
“Even if they never believe in it as an asset class, they’re smart enough to recognize the alpha opportunity.” — Ari Paul
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.
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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60 thoughts on “Bitcoin: New Asset Class or Pyramid Scheme?”
Great article. Governments around the world would have to give up way too much power for this to work. Not going to happen.
The whole financial system and economics we know today will change. Banking system has long enough flourished. As we move forward towards a major technological change, we “humans” will discover new ways to become adapted to new technological advancements, one such is “Bitcoin”.
We will change the financial system to use technologies that make people’s lives better.
Because Bitcoin is less efficient and lacks the flexibility of alternatives, it will not be part of that change, except for some period where it is useful for evading laws & as a way for doomsayers to tie up their capital.
As long as I walk around with a pocket full of “Federal Reserve Notes”, I probably won’t join the chorus looking down at cryptocurrency. Wouldn’t you feel safer if the amount of “dollars” in circulation was limited to a fixed total (i.e. Bitcoin 21,000,000; Litecoin 84,000,000)? Take a look at Federal Reserve of St Louis FRED charts of money supply as they approach infinity. Now THERE is a Ponzi scheme.
Many of your statements are unsubstantiated and your logic is flawed. Where is the evidence to back up your claim that “no government has any plans to use bitcoin as a currency”?
In a case involving bitcoin two years ago, U.S. District Judge Alison Nathan in Manhattan rules, “Bitcoins are funds within the plain meaning of that term. Bitcoins can be accepted as a payment for goods and services or bought directly from an exchange with a bank account. They therefore function as pecuniary resources and are used as a medium of exchange and a means of payment.” (https://www.reuters.com/article/us-jpmorgan-cyber-bitcoin-idUSKCN11P2DE)
Further, Canadian government’s website clearly states, “Digital currency is electronic money.” (https://www.canada.ca/en/financial-consumer-agency/services/payment/digital-currency.html#toc1)
The Japanese government has been for the past years open to the idea of crypto and have established laws and regulations to oversee exchanges: “The Japanese government recognized bitcoin as legal tender in April and required cryptocurrency exchange operators to register with it.” (https://uk.reuters.com/article/us-japan-bitcoin/japans-fsa-gives-official-endorsement-to-11-cryptocurrency-exchanges-idUKKCN1C40T9)
Your claim that bitcoin “transfers no tangible or intangible property rights” is probably due to your lack of understanding of how bitcoin transactions are processed and recorded. The recording keeping nature of bitcoin in its current state is probably one of the most irreversible way of transferring intangible property rights.
Given your expertise in quantitive modelling, I’d recommend you take a look at Satoshi’s white paper and the current hash rate and then calculate the amount of resources required to undermine the finality of a bitcoin transaction after certain amount of confirmations.
To expand, bitcoin has even received legal protection in countries that are not seen as openly friendly to crypto. For instance, a Chinese court rules that bitcoin, considered a “valuable personal property”, is entitled to legal protection of property rights. (https://www.ccn.com/chinese-civil-court-bitcoin-are-legally-protected-property/)
You wrote that gold and bitcoin “both would be volatile investments with poor long-term returns.” Did you know that gold was used as money for thousands of years? If so, do you consider holding money a form of investment? If so then “investing” in gold would have proved much more profitable than “investing” in government money over the “long-term”.
The claim that bitcoin is a pyramid scheme is ridiculous. Bitcoin is a computer code that allows the transfer of information in a fashion never achieved previously; kind of like the internet. And just like the internet few decades back, crypto is in its early stage and has many challenges to overcome. Blindly labelling such a monumental advancement in technology hinders that process. You, as an educated member of the community, should know better.
I need to point to one of many potential points of confusion in the comments.
Generally legal tender means that the country establishes the currency as a means to settle all debts and accepts tax payments denominated in the currency.
In most countries some merchants will accept foreign currency . This does not make those ‘legal tender’ in any meaningful sense, even though some articles will misuse the term losely.
Likewise in the articles cited, countries are merely choosing to regulate the usage of bitcoin, not endorsing or mandating it.
In all of these countries your tax bill is determined in the local currency. Court judgments are determined in the local currency. Bitcoin does not have this status anywhere.
In fact if you check Google Trends, interest in Bitcoin has plummeted after late 2017 when FOMO drove a substantial buying spree. This is true in Japan also, where searches for dollar and Euro now exceed those for Bitcoin.
Bitcoin has been around for ten years. It has not achieved widespread usage and acceptance as a payment mechanism for two reasons. The validation mechanism and the requirements for maintaining the network make it a costly mechanism. Many of the costs are obscured because of the payments to miners in the form of newly minted coins. The other is that the usage of other payment mechanisms is easier.
I’ll just add that a noted CEO was sanctioned for making erroneous statements concerning his company. Should those who promote crypto currency be held to similar standards?
Regarding this comment: “In all of these countries your tax bill is determined in the local currency. Court judgments are determined in the local currency. Bitcoin does not have this status anywhere.”
FYI: The state of Ohio in the USA accepts Bitcoin to pay your tax bill. Same thing in municipality of Chiasso in Switzerland. The Arizona senate voted to accept Bitcoin as tax payment (Litecoin as well).
Can you please update that statement in your article?
Otherwise this is very well written, and I appreciate you looking at both sides of the discussion.
Thanks for the comment.
I don’t see that the Airzona Senate Bill ever passed the other house and became law.
Actually Ohio does not accept bitcoin for any taxes. Because the treasurer is owns crypto, he has arranged for a private firm to accept bitcoin and convert it to dollars which are remitted to the State. The terms of service on the website state:
“You will not be relieved of your payment liability for the underlying tax obligation of your payment through the Services to TOS, except to the extent that TOS realizes final payment of the underlying obligation in United States Dollars.”
Proposals for cryptocurrency “acceptance” in other states, which have failed, also would have had similar restrictions. Acceptance of a payment mechanisms means that the state has to take position and take the volatility risk of the mechanism, otherwise it is no different from just the state offering a convenient mechanism of selling something.
I don’t know whether the Swiss towns hold the crypto for any length of time or have a provider convert the Bitcoin to local currency, but the taxes are still quoted and denominated in local currency.
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:
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.
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.
I believe you are correct. It’s a Ponzi scheme. There is a book titled “Extraordinary Popular Delusions and the Madness of Crowds” by Charles MacKay. It was first published in 1841. It should be required reading for investors.
Bitcoin seems like a better alternative to Social Security at least?
I still love how quiet some people I know are after loosing thousands when they were brainwashed to buy and believe the price would never go down from $20k. True though it is no more a ponzi scheme than the federal reserve is. To me i see it as nothing but a gamble like buying a stock. Some win, some loose.
It can be possible in the far future that Bitcoin can be seen as a new asset class. However, there is no surety about this. The whole economic and financial sector is going to change in the future, but the world has to give too much power to make it work. But, I agree it must be taken as a pyramid scheme until proven otherwise.
If it were to be seen as a new asset class, the fact that it is unproductive–except for a possible means of evading laws-still hold. It would just be a wider population’s capital being tied up with the negative yield (paying the maintenance cost).
Hopefully cooler heads in the investment community will speak out to insure this scenario does not unfold.
This has not aged well, has it? I’ll be back in another 3 years.
What hasn’t aged well?
The Bitcoin universe has consumed many terawatts of electricity. Every dollar someone “earned” from Bitcoin was just another dollar taken from another person. There is nothing produced that has any possibility of providing Bitcoin investors with current or future dividends or payments.
In addition to the environmental costs, we have suffered an epidemic of ransomware facilitated by cryptocurrency.
A bank is willing to take Coinbase’ money in exchange for providing services is irrelevant
Given that JP Morgan is the largest bank in the world by total assets and market cap, what has made you conclude that their decision is irrelevant? Is it not reasonable to assume that other banks will follow their lead?
In regards to taking money from other people while not producing anything, how would you justify your bank’s fees? https://www.td.com/ca/en/personal-banking/products/bank-accounts/chequing-accounts/
The lack of seriousness in this article is shown by how quickly you dismiss the comparison to gold with the specious argument that gold has some inherent value (jewelry). The percentage of people who purchase gold (as an investment) because it can be used for jewelry is infinitesimally small.
Moreover, most investors (and financial planners) who incorporate gold into their portfolio do not do so by owning the actual metal. Buying gold bars or coins is difficult, and storing (much less using or transporting) is hugely challenging. Instead, gold investors (who number in the millions) buy gold funds or ETFs. So, tell us how a gold ETF or fund is any less a “Ponzi scheme” than bitcoin? A gold ETF is literally nothing more than a bet on price appreciation. There isn’t a single other use of a share of a gold ETF, and yet I don’t see any articles criticizing investors (or financial planners) who invest a portion of their assets in a gold fund as participating in a Ponzi scheme.
Don’t take my word for it; just follow the actions of large institutional investors and financial services companies who are investing huge sums to establish a presence in this space. That’s not something typically characteristic of a Ponzi scheme….
I dont endorse gold as an investment either, but nevertheless it was used for ornamental purposes prior to it being used for money. In many cultures, such as India, having gold objects is a status symbol.
Only 20% of the above ground gold belongs to private investors. Over half is in the form of jewelry and industrial usages. This provides some reason to believe that there will be some demand for gold in the future; nevertheless it fails as a reliable inflation hedge and is volatile.
There are few institutional investors involved with Bitcoin and those that are are speculators betting on greater fools and cult like devotees.
No matter how many institutional investors jump on board, it remains a negative sum game with 2% of the market cap going just to pay miners.
Even if tomorrow every institutional investor dove in, you would only profit if you exited before they did, which they would when there are no new bagholders.
It’s been barely a month since your comment, and already it’s obvious that it hasn’t aged well. But that was predictable.
Leo: What aspect of my statement hasn’t aged well? Did someone find that miners earned a lot less than 2% of the market cap of Bitcoin in 2019? Did someone find anything that generates a return, other than bringing in new buyers?
How about your first sentence:
“There are few institutional investors involved with Bitcoin and those that are are speculators betting on greater fools and cult like devotees.”
This is wrong on two counts. The are not “few” institutional investors involved with Bitcoin; the list is growing by the day. The largest impediment to more institutional money in this space is the custody problem–which is being addressed by several companies, including the behemoth in the financial services industry (Fidelity).
It’s also inaccurate to say that those who are there are purely speculators betting on the greater fool theory. In fact, it’s pretty arrogant to presume to know what motivates institutional investors, but it ought to be pretty clear that financial services companies are spending millions of dollars building out their trading desks and subject matter experts to accommodate this large and growing segment of the Bitcoin investor community.
The whole premise here is just lazy. Bitcoin is no more a “Ponzi scheme” than any share of stock in a company with little to no earnings. Were you banging the table that Amazon was a Ponzi scheme from 1997 to 2001, when it was an unprofitable company? If so, you should turn in your financial advisor card, and if not, why not–after all, what’s the “inherent value” in a share of an unprofitable company beyond a bet that this company may one day become profitable or that you can find some “fool” to pay you a higher price than you paid for that share of stock?
The fallacy of your position is apparent in your analogy with Amazon. Amazon had and still has the potential to generate large profits for investors, who get the profits earned as a result of supplying goods and services. If no new investors bought Amazon for the next 50 years, the current ones would earn the profits.
With Bitcoin–the only way a holder profits is when new buyers are recruited, or a group of existing buyers increases their investment more than the amount required to pay the miners.
Re: your 12/1/2020 response:
And the fallacy of your argument is in ignoring that having “the potential to generate large profits” (to which a shareholder would be entitled to portion) sounds very significant when looking at Amazon today, but would you have said the same thing about etoys? Bitcoin is a “Ponzi scheme” but etoys was not?
You can comfortably say that about Amazon today because it has become a profit-generating behemoth. But that was not remotely assured back in the late ’90’s, when Amazon.com was not appreciably different from etoys.com. The potential to generate large profits didn’t seem to help etoys survive.
As for the notion that an asset is a Ponzi scheme if the only way you can make money on it is if some “fool” pays you more than what you paid, you have just relegated virtually every asset class to Ponzi scheme-status. Your house must be a Ponzi scheme. A plot of land must be a Ponzi scheme. A piece of art must be a Ponzi scheme. Every share of stock in an unprofitable company must be a Ponzi scheme.
This is why yours is a lazy argument. Calling it a Ponzi scheme is just a lame way to hurl a pejorative at something you don’t like. Had you called it a highly speculative investment I’d have had no issue with the characterization. It’s when you resort to what is the financial world’s version of an epithet that I will call you on the weakness of your argument. Just because something involves a bit of speculation does not render it a Ponzi scheme.
Here’s my take on Bitcoin’s claims:
Pyramid scheme? Yes. Bitcoin is a pyramid scheme from an investment
perspective. Enrolling others to invest in Bitcoin is what provides a return to
earlier investors. Bitcoin is also a legitimate going concern for businesses
who collect fees for providing foreign exchange and transaction oriented
services using the Bitcoin system. Unfortuntately, it’s not possible to
separate the pyramid scheme from the legitimate service provided by the Bitcoin system.
Equity? No. If Bitcoin dissolved, it has no tangible assets or reserves to
return. In contrast, if a company dissolves, it’s assets get returned to
Commodity? No. Bitcoin has no economic value like silver, wheat, oil, etc.
Currency? No. A useful currency has stable value relative to other currencies
and is a universal medium of exchange within an economy. Bitcoin is neither.
Fiat currencies like the USD are backed by the issuing country with gold
reserves, oil reserves, land, taxes, etc.
James: I agree with almost all of what you say, except for a fine point:
Bitcoin isn’t really efficient for FX or any transactions. Very little of the cost of transactions–domestic or foreign—are actually sending the funds. They are in fraud prevention, customer service, legal compliance, and risk management (including exchange risk).
Not only does citing a blockchain transaction fee neglect all of these services, but also leaves out the fact that miners are paid by newly minted Bitcoin (the mining reward). You can see on https://www.blockchain.com/charts/cost-per-transaction that the mining cost per transaction rarely is below $30 and we haven’t yet priced the rest of the process.
Just looking back at this article. The author does a great job stirring up the debate. I think the author misses many of the key points:
The argument that if “everyone said ‘I want to buy 1 share of Amazon’ the stock would go immensely higher” I does not mean its a pyramid scheme it just means people want to buy Amazon or ‘Bitcoin’.
You say “It is too inefficient to use as a currency”. Bitcoin is a layer 1 solution. In time layer 2 and layer 3 solutions will be built on top of it. TCP/IP was invented ~50 years ago and at first it was just a basic ‘layer 1’ idea (all it did was send packets of information between computers). Only when layer 2 solutions were build (HTTP and the World Wide Web, or SMTP and email), did we realize the true power of what TCP/IP was about to do. Bitcoin offers similar potential that we probably cannot realize.
Golds value coming from jewelry or industrial uses (I know you don’t reference industrial uses), probably accounts for ~3% of Gold’s value. Bitcoin potentially is far more efficient and advantageous versus gold (lower storage costs, divisible into 100,000,000 units, more scarce as there will only be 21,000,000 Bitcoins, vs. an estimated 5,950,000,000 ounces of gold, programmable, the list continues) If Gold has a $12 trillion market cap, there is a possibility Bitcoin could exceed this if it truly is superior.
Interesting article on what you see as a potential pyramid scheme. To me, I see something backed only by math and not a potentially corrupt, controlling entity. In countries such as Argentina, where the currency has been debased by the government many times, Bitcoin offers a reasonable potential alternative. Even in the United States of America, the Central Bank can inject a few trillions of ‘out of thin air money’ into the system to try to stimulate it from Covid effects. A senior citizen reliant on fixed income might get punished from diluted money (not suggesting senior citizens should put their money in Bitcoin)
again – I appreciate the article and it was a good read 🙂
A few points:
1) Amazon stock–if Amazon is successful both the buyer and seller can win. The seller gets the price appreciation up to the point of sale; the buyer will eventually get Amazon’s earnings through dividends or buy-backs even if there are no new investors. With Bitcoin, that doesn’t happen.
2) Gold- Private investment in Gold is only $3 Trillion. about 50% of the $12 Trillion cited is in jewelry, 20% in central banks, and some other amount in other industries. Real consumption of gold could buy-out private investors in 18 years–faster than I pay down my mortgage.
3) “layers” It is more efficient to build on top of a more efficient base layer. The energy consumption of crypto is huge, estimated to be comparable to that of the country of Chile, and the price run-ups also impact the market for hardware.
4) Inflation–gold has proven to be a poor inflation hedge and too volatile to be a reliable store of value; no reason to believe Bitcoin is any better. Bitcoin has had a minuscule impact in high inflation countries; alternatives such as dollars and Euros are far better. To extent they don’t work, it is due to regulations & CFA charter holders agree not to help people violate regulations in their countries.
Jonathan, you make some interesting points.
1) Amazon comparison – Bitcoin is the same thing, both the buyer and seller can win. The seller gets the price appreciation up to the point of sale; the buyer will eventually get to use this phenomenal technology (whether to send money to family as a remittance, as a store of value to save up for a Tesla, or just as a 6 month living expense emergency fund). Also nice your stock example is Amazon and not Kodak, Enron, Sears or Pan-Am Airlines.
2) Gold – Why exclude the 20% sitting in central banks? Bitcoin is the greatest reserve currency asset we have on earth. I look forward to the day the 1st central bank begins to accumulate Bitcoin (followed quickly after by other central banks adding it as a reserve currency. I think in France there are already rumors and whispers).
3) Layers – You cannot look at total energy consumption. They are hydroelectric facilities that are 500 km’s from any electric grid and they use excess energy to mine Bitcoin. Same thing with hydro dams in Quebec, where the government allows mining with excess energy that cannot be stored. Same thing at some of the hydro dams in China where they overbuilt. If you look at oil drillers in Texas, some of them used to flare off excess gas because they are not connected to a pipeline (now with Bitcoin mining they have a way to use it). Granted a good portion of Bitcoin mining electricity still comes from coal based sources, this issue could be solved by switching from Proof-of-Work to Proof-of-Stake, or Layer 2 solutions as I mentioned (where Bitcoin transactions will be moved off chain and use virtually no energy). On chain activity, might only account for major multi-million dollar transfers of value. On that topic, the legacy banking industry still uses an estimated 5X the energy consumption that Bitcoin does, so we also really need to clean up the dirty legacy financial industry (might need more cleaning than Bitcoin needs).
4) Inflation – LOL gold is a poor long term inflation hedge? Over last 130 years, housing prices have been in a tight range of ~200 ounces of gold to ~600 ounces of gold per house (even in biblical times, there are documents of houses being sold for ~500 ounces of gold). Meanwhile your USD is expected to deteriorate ~2% each and every year… Actually the USD has dropped ~95%+ over the last 100 years. If you are Apple and sitting on $100 Billion USD, you are expecting it to lose ~25% over the next decade just by keeping USD on your balance sheet. Not yet certain Bitcoin is superior, but there is a non-trivial chance that it is far superior to USD, EUR or JPY fiat money when used as a reserve currency.
source on gold vs. houses:
USD dropping by 2% a year is a feature, not a bug. Unless you keep your USD in a matress, it is a non-problem, because you invest your USD and earn interest or put it in riskier investment and earn profits.
Going from 200 ounces of gold to 600 ounces of gold in a short period is a huge change. If you look at the past 10 years, the amount of house you could buy for 600 ounces of gold has varied by quite a bit.
If you want a hedge against inflation, a portfolio of t-bills that is constantly rolled over works far better than gold at maintaining purchasing power.
Finally, despite the attempts at greenwashing, the fact is very little Bitcoin mining is done with truly stranded electricity. Such electricity could also power data centers and supercomputer farms
Show the source of your statement that France’s central bank is thinking of buying Bitcoin. The only movement is a petition started by a blockchain developer.
The rise of Bitcoin has been heavily driven by these kinds of rumors and lies about its efficiency and usefulness.
Your pyramid scheme criticism is beyond lazy, and your attempt to differentiate BTC from Amazon stock is exactly the same. Amazon has never paid a dividend. When was the last time it bought back its own shares? And what to make of investments in companies who are not profitable (yet, presumably)? Are those companies all pyramid schemes, too?
You’ve painted yourself into a corner. You either continue to double down on this absurd criticism, or you acknowledge you were wrong. Howard Marks had the character to do the latter (https://www.kedglobal.com/newsView/ked202103150009). Do you?
Bitcoin is guaranteed never to pay a dividend or buy back shares or produce anything.
Hey Jonathan – your comment “USD dropping by 2% each year is a feature and not a bug”…
You should update that to “USD dropping by 5.4% each year is a feature and not a bug”
The country of El Salvador just bought more Bitcoin this week. The Houston firefighters pension fund just bought $25MM of Bitcoin this week. George Soros finally bought Bitcoin this week. Jonathan, what do you use as your personal store of value or reserve currency? Real bond yields are mostly negative now on government bonds FYI
Hello Jonathan Harris,
Thanks for this post..
You had asked, This visionary question in 2018.
Bitcoin: New Asset Class or Pyramid Scheme?
But now in 2021 Bitcoin prove itself as New Asset Class.
Jonathan – US CPI now running at 6.8%. Are you still saying that the USD deteriorating 7% per year is a “feature, not a bug”
The Deutsche Mark deteriorating 90% each year last century was also a feature of the Deutsche Mark
Also last month the Bitcoin successfully completed the Taproot upgrade with Schnorr signatures. The greatest Store-Of-Value just keeps improving! USD never gets smarter. At best they just change the cotton polymer paper it’s printed on. Sometimes they print $3 Trillion of it just like it is leaves on a tree
Thank you again!
There is no doubt that this is a very cool scheme but with an investment. Nobody knows that how much powerful is this. You can invest in it with very short amount. You can get a lot more information about bitcoin with Bitcoinsensus.com this is a news and updates website of bitcoin. Where you can find its price change and exchanges information hour by hour.
You have given good information about the Pyramid scheme at the initial level. Looking for some more information about the Ponzi scheme.
Bitcoin, contrary to the claims of its critics, does not promise profit. The original value proposition of this cryptocurrency is a peer-to-peer system, the same one used in email, but applied to the exchange of value. This in itself is revolutionary, but it does not mean that its owners will get money in return. However, bitcoin, which is limited to 21 million coins, allows it to retain value. As a scarce asset, bitcoin can become the object of much speculation, as happened in 2017 or as happened with gold in 1979. Large profits attract “retail” investors, which in turn increases the number of investors, which causes prices to rise and becomes a positive thing. Investing in bitcoin requires risk management, a long-term horizon and a low percentage of capital otherwords it is said in newbies guide at crypto news site tradecrypto.com. Thus, one can benefit from the composition of long-term profits, and this will make the investment less sensitive to high volatility in the short term.