Posted on: 11. April 2018

Is Bitcoin a Pyramid Scheme?

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Is Bitcoin a pyramid scheme?

This blog article tackles the question of Is Bitcoin a Pyramid Scheme?. We’ll look at the definition of a pyramid scheme and whether or not Bitcoin falls into this category.

A pyramid scheme is defined as a business model that only functions if there is an increasing number of users. Here, the metaphor of a snowball is used; rolling downhill and growing in size constantly. In this case, the system only generates money if new participants join and contribute.

Contributions are in the form of investing their own capital or generating additional capital. In addition to this, a pyramid scheme is characterized by a missing or overpriced product, making it an instance of fraud.

Alternatively, the concept of a Ponzi scheme can be considered. This term is mainly used by English speakers and was coined by Charles Ponzi, who earned around $150 million in the 1920s. Over a period of six months, he promised investors particularly high profits through sham investments by referring to an underlying business model.

Is Bitcoin a Pyramid Scheme? Banks as government-sponsored snowball systems

In 2012, Handelsblatt correspondent Norbert Häring investigated whether banks operate state-certified pyramid schemes. The focus of the study was Bernard Madoff, who until 2008, collected funds from investors, promising above-average returns.

If the money invested was not sufficient to pay out the return, Madoff paid out part of the original amount. This was to maintain the business model and continue to entice new investors. The approach enabled Madoff to generate long-term growth, but in 2008, he was accused of fraud. In 2009, he was formally charged.

This raises the question for Häring as to whether anyone with a banking license could pursue a similar business model. The conclusion was that banks could be defined as a government-regulated pyramid scheme. Whereas Madoff still pumped his own money into the system, the central banks rely on other banks to make new money.

This is done as soon as investors take their money out of the market. This withdrawal of money is called a “bank run”. In particular, the abolition of cash is intended to eliminate this phenomenon and prevent withdrawal of deposits. Afterwards, money is only available in the form of hard cash.

If the cash holdings of the euro were distributed across all inhabitants of Europe, there would only be 3,341.62 euros per citizen in cash reserves.

Is Bitcoin a pyramid scheme? The review

To answer this question, the individual components of the pyramid scheme definition are compared with Bitcoin. This will allow us to draw a conclusion. The basic prerequisite for a pyramid scheme is that there needs to be a steadily growing number of participants.

Otherwise, no further growth can take place. Bitcoin is already used today in payment transactions between consumers and retailers, performing the same function as classic fiat currencies. No new users are needed in order for the system to continue – this is because the system is already fully functional.

It is the basic characteristic of any currency that the number of users is limited. This arises from a governmental obligation to use respective means of payment within the corresponding payment area. As a rule, this payment area responds to respective national territories.

It is also referred to as the legal tender, since this is a currency prescribed by law. In particular, cryptocurrencies are not required by law, so Bitcoin has a voluntary user base. It can also operate globally, as users determine the currency area.

In principle, Bitcoin is the first global currency to be considered. The currency area of the Bitcoin is only determined by accepting or not accepting the currency. This means that the currency area cannot be defined geographically.

Is Bitcoin a Pyramid Scheme? Profits from Bitcoin

By definition, a pyramid scheme generates new profits solely by providing new capital. To answer the question of whether Bitcoin is a pyramid scheme, one needs to look at the profits. In principle, it’s the case that new market participants buy from already active market participants.

However, this is also the case with the real estate market, equities, general currencies and other derivatives. As such, there is no real snowball system here. Rather, in these cases, we’re looking at a network effect.

In principle, Bitcoin works without the capital of new investors as it generates a fundamental benefit. The benefit is the ability to make quick transactions in the context of purchases and sales, without a centralized system. In addition to this, privacy of users is guaranteed and a high level of security is assured.

Is Bitcoin a Pyramid Scheme? – the prdouct itself

In order to qualify this question, the final component of a pyramid scheme needs to be analyzed. This refers to the absence of a product or the presence of an overpriced one. If Bitcoin is considered, the product is a symbiosis of money resources and a payment system.

In terms of money, it is a coin with a defined inflation and a limited availability. In addition, there is a payment system that does not require intermediaries. Bitcoin is also voluntary as a means of payment, so users have the option to use different currencies.

Moreover, the value of money is not fixed, but is a function of supply and demand. However, Bitcoin also has features of a payment system such as PayPal or Visa.

Is Bitcoin a Pyramid Scheme? The Conclusion

Now that the definition of a pyramid scheme has been analyzed, it’s safe to say that Bitcoin is not a pyramid scheme – at least not in the conventional sense. In particular, voluntary action and the creation of an intrinsic value by definition ensure that there is no snowball system.

However, the fact that Bitcoin is considered a product as a symbiosis of currency and a payment system is worth remembering. This indicates a functional and accepted system.

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