The mention of Bitcoin generally elicits contrasting reactions, and among them, the confusion with a Ponzi pyramid is frequent. This misconception is fuelled by a lack of thorough thought about the true characteristics of a Ponzi scheme and the technical functioning of Bitcoin.
In this article, we are going to objectively study the characteristics of a pyramid scheme to determine if Bitcoin is indeed a scam of this type. You will discover that the differences between the two systems are fundamental and that the idea that Bitcoin is a Ponzi scheme is largely unfounded.
What are the characteristics of a Ponzi scheme?
The term “Ponzi scheme” has now become a generic term for anything that looks like a scam or remotely similar to a scam. However, while the Ponzi scheme is indeed a scam, not every scam is necessarily a scam. Let's look at the characteristics of a Ponzi scheme together.
The Ponzi pyramid is a financial fraud strategy that offers attractive returns on an investment product. One of its essential characteristics is that the promoter of these financial products suggests that the risk taken by investors is low, or even non-existent. In a Ponzi scheme, the high returns promised are not generated by value creation, but are taken from the investments of new entrants. The success of this system is based on the continuous flow of new investors who contribute the funds needed to pay the promised returns.
Even if it is not its inventor, the name of this fraudulent arrangement comes from Charles Ponzi, an Italian who operated this scam scheme at the beginning of the 20th century in the United States.
In an attempt to maintain high demand for their products, the creators and promoters of this type of financial package use aggressive marketing techniques. The aim is to attract new investors by promising them big profits.
However, when the demand for the product falls, the capital needed to pay the returns can no longer be collected, causing the entire pyramid to collapse and the total loss of participants' investment.
Is Bitcoin a Ponzi scheme?
Bitcoin is simply a peer-to-peer electronic cash system. This means that its operation is not based on a central authority, but on all its users. Since no entity has control over Bitcoin, there is no organization that could benefit from the proposed financial product, raise funds from investors and organize the redistribution of returns. By nature, Bitcoin cannot therefore be a Ponzi pyramid.
The core element of the Ponzi scheme is the promised return. It is this return that makes the product attractive and increases the number of investors. However, there is no guaranteed return on Bitcoin. There are many people who will tell you that The price of Bitcoin will go up, or it will go down, but they don't represent the Bitcoin system itself.
It is certainly true that the first adopters of Bitcoin, who had the audacity to buy or mine Bitcoin in the early 2010s, are now benefiting from a sharp rise in the value of the cryptocurrency. However, this added value was by no means guaranteed. They took a risk, and are now being rewarded in proportion to the risk taken.
It is not the new entrants who are funding the rise in value of Bitcoin. This price increase is only happening because individuals are ready to buy Bitcoin at this price. It is a classic mechanism for setting the price according to supply and demand. These people are ready to buy Bitcoin at a certain price because they find it a form of marginal utility. The estimation of this utility and the appreciation of the value of Bitcoin are therefore necessarily subjective, and can fluctuate from one individual to another in relation to many complex factors. It is then possible that you will not find any use for bitcoin, but that does not make it a Ponzi.
The demand for Bitcoin is not fuelled by a promise of return, as in a Ponzi scheme, but by the value offer of the protocol. In this case, Bitcoin has some interesting characteristics to use it as a monetary system: incensurability, unseizability, finite monetary offer, confidentiality, probabilistic irreversibility, lower fees...
However, just because Bitcoin is not a Ponzi scheme doesn't mean its price can't fall. It's not a magic asset. Like any other currency, its price fluctuates freely according to supply and demand. If one day no one uses it anymore, then its value will plummet. On the other hand, if a lot of individuals adopt it, then its price will increase.
Differentiating Bitcoin from its environment
The origin of this received idea probably comes from the Bitcoin environment. Indeed, the cryptocurrency sector is often the scene of scams of all kinds, bankruptcies and Ponzi pyramids.
One of the most infamous examples is the investment platform BitConnect, with its cryptocurrency BCC, which operated from 2016 to 2018. This company offered its customers to deposit bitcoin on their platform in order to exchange them for “BitConnect Coins” generating high returns every day. According to them, the return came from a revolutionary trading robot. In reality, it was the bitcoins of the new entrants that made it possible to pay such returns. When demand for this investment product started to fall, the whole financial package collapsed.
These scams sometimes use Bitcoin as a currency, but they don't embody the Bitcoin protocol itself. Just because Bitcoin is not intrinsically a Ponzi pyramid doesn't mean that no pyramid system can be created around it.
This characteristic is obviously not reserved exclusively for bitcoin. The biggest Ponzi scheme in history was operated using the American Dollar. Indeed, Bernard Madoff's famous fraudulent system, orchestrated from 1990, was based on the Dollar monetary system. However, when it fell in 2008, no one considered the American Dollar to be a Ponzi scheme.
It is therefore important to clearly differentiate the Bitcoin system itself, which is nothing more than an electronic cash system, and its environment. As with any other currency, it is possible for businesses that revolve around Bitcoin to operate Ponzi schemes, but that doesn't make Bitcoin a pyramid scheme.
The best way to protect yourself from these fraudulent entities offering you returns is simply to avoid using their services. To do without trusted third parties, you can choose to keep your bitcoins yourself by securing your cryptographic keys giving access to them.
When you have your bitcoins in standalone custody, no one but yourself can access them. Thus, you are naturally protected from Ponzi pyramids since your bitcoins belong to you. Nobody can use them to pay other users' returns.
To help you learn about self-custody, we created the category” Securing your bitcoins ” on the Bitstack blog. You will discover all the fundamental principles of autonomous Bitcoin custody, but also security tips and detailed tutorials.
Conclusion
Several elements allow us to affirm that Bitcoin is actually not a Ponzi pyramid:
A Ponzi scheme must be created and managed by a central organization, but there is no such entity on Bitcoin;
To organize capital flows, the company initiating a Ponzi scheme must have control of the funds. However, on Bitcoin, the user physically owns his funds;
To grow, a Ponzi scheme promises extraordinary returns, but there is no promised return on Bitcoin;
The Ponzi scheme must use aggressive marketing strategies to maintain a growing flow of new entrants. Naturally, there is no marketing operated by Bitcoin since it is only a brainless computer protocol.
By its nature, Bitcoin cannot be a Ponzi scheme. On the contrary, its distribution surely makes it the financial system that strays farthest from the characteristics of a pyramid system. So when you hear a person say this cliché, you'll know that they either didn't understand what a Ponzi pyramid is or they didn't understand what Bitcoin is. Or maybe she's just trying to discredit him with spurious arguments.
