Some Bitcoin skeptics claimed that Bitcoin is a Pyramid Scheme because of the gains that Bitcoin investors acquired. In this article, we would like to examine that claim closely.
What is a Pyramid Scheme?
A pyramid scheme is a business model that profits from recruiting new members who pay upfront the cost to be part of the business. The new members will act as salespeople and need to buy products being used in the scheme. To join the business, the new member needs to buy a certain amount of product. The product normally doesn’t have high demand but the new member has to buy the product to join the business. In some pyramid schemes, the members need to stock up inventories. This creates more supply than demand.
How does a Pyramid Scheme work?
To illustrate, let’s take the story of three fictional persons: Michael, Sam, and Anna. Michael joined the business through Sam. Michael then told Anna that he has a unique business opportunity. To join this business, Anna needs to purchase a starter kit and start selling their product. Not only Anna will get a commission from the product that she sold but if she recruits new members, she will get a fee too from their sales. Anna realized that if she recruits more members, she will make more money from their sales. So Anna then focused on recruiting more members instead of selling the products. When Anna successfully recruits new members, not only Anna enjoys the fees from recruiting, Michael and Sam also enjoy a portion of that fee. To continue being a member of this business, Anna also needs to continue to restock the supply of the products whether she can or can’t sell it all.
As we can see that new members are crucial and needed to keep the pyramid scheme going.
Characteristics of a Pyramid Scheme
To spot a pyramid scheme, you need to be aware of the characteristics of a pyramid scheme, such as:
- A promise of high returns with low risk
- Upfront fees are required
- Overly consistent returns
- Secretive and complex strategy
- Necessity to recruit more new member
- Members required to buy a lot of inventory
Is Bitcoin a pyramid scheme?
Let’s now explore if Bitcoin qualifies to be considered a pyramid scheme.
Bitcoin is a commodity or collectible
When bitcoin was first created by Satoshi Nakamoto, there is no emphasis/focus to provide a high return on investment. Satoshi Nakamoto sees Bitcoin as a commodity or collectible. Bitcoin is designed to be a precious “digital metal” that can store value. In one of his quotes, Satoshi said the following about Bitcoin:
“In this sense, it’s more typical of a precious metal. Instead of the supply changing to keep the value the same, the supply is predetermined and the value changes. As the number of users grows, the value per coin increases. It has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value.” – Satoshi Nakamoto
Bitcoin gains value from its limited supply and network effect of adoption. Early adopters are not receiving bitcoin or profit from the later entrants. To get Bitcoin someone can buy it in the crypto exchange or mine it without the involvement of anyone before them. In the early days, people can mine bitcoin using a laptop without any initial investment.
Unlike a pyramid scheme that promised a consistent return, no one can predict Bitcoin’s price movement. Bitcoin’s price purely comes from supply and demand – when there is more demand than supply, Bitcoin price goes up because people are willing to pay more money. Bitcoin price is affected also by the news and regulations.
Right now (2020-2021), Bitcoin price has become less volatile compare to the past because of the increase in market capitalization and user adoptions. Prior to this period of time, we have seen many instances where Bitcoin price suffered a massive drop (30% – 80%) in a short timeframe, only to rise up again stronger. The fact that nobody can predict Bitcoin’s price movement is one proof that it is not a pyramid scheme, but rather of a constantly growing network of value that is slowly replacing gold as a store of value
Bitcoin is open source and transparent
Pyramid Scheme usually employs a complicated structure and complex strategy that only the mastermind knows. To enter the Pyramid Scheme business, you need to follow the instruction from your recruiters.
Bitcoin is the complete opposite of that secrecy. Bitcoin’s program runs in an open-source environment. Everyone can view code and participate in developing the program. In a pyramid scheme, it is very hard to know the nooks and crannies of the business.
Bitcoin is distributed fairly
To ensure that Bitcoin is distributed fairly, Satoshi Nakamoto ensured that he/she didn’t get any pre-allocated Bitcoin. When Bitcoin network started in 2009, Satoshi Nakamoto has 0 Bitcoin and has to mine Bitcoin under the same rules as other miners/participants in the initial Bitcoin community. Because Bitcoin is open source and permissionless, anybody can mine Bitcoin in 2009 using simple laptop. This is different from other cryptocurrency projects where the founder allocated himself/herself a large amount of token from the beginning.
Bitcoin is leaderless
Bitcoin is a decentralized global network that does not have any company or legal entity. There is no organizational structure behind Bitcoin – there are only Bitcoin users and adopters distributed all over the world.
Bitcoin has no leader because it is decentralized. Satoshi Nakamoto stepped away from Bitcoin development early on. Today, Bitcoin software maintenance is continued by open-source developers globally, while the Bitcoin blockchain network is being secured by miners who organized themselves to gain mining profit. Being a leaderless and decentralized community, Bitcoin does not fall into a pyramid scheme model.
Bitcoin is a new and fast-growing monetary network that is safe and accessible to everyone. Because the price of Bitcoin continues to rise over the last 8+ years, people are attracted to buy and invest Bitcoin. The fast price appreciation of Bitcoin makes some people dismiss Bitcoin as a pyramid scheme. However, unlike a pyramid scheme, Bitcoin does not rely on recruiting new users to be functional. Bitcoin works based on sets of protocols called proof-of-work, and if Bitcoin users drop significantly, the Bitcoin network will still be operating. Bitcoin is also open source, transparent, leaderless, and fairly distributed. In conclusion, Bitcoin is not a pyramid scheme.
Alden, Lyn. Bitcoin: Addressing the Ponzi Scheme Characterization 2021