Dr Duncan Riach

@duncanr

Is Bitcoin a Pyramid Scheme?

Photo from pexels.com

Cryptocurrencies are important and valuable. Distributed blockchain technology, as pioneered by bitcoin, is important. The future of money really is cryptocurrencies, possibly led by bitcoin.

I’ve been getting into a lot of discussions with supporters and promoters of bitcoin, who tell me that the price of bitcoin is going up so fast because there is a limited supply and an increasing demand. Their argument is that only a small percentage of the world currently has bitcoin, and that everyone will eventually need to use bitcoin.

It’s true that prices reflect the difference between supply and demand. There is a limited number of bitcoins, and there is a great demand for them, so the price is shooting up. However, what these proponents of bitcoin seem to be missing is the reason for the demand.

It’s clear that the most significant reason, by far, for the massively increasing demand for bitcoin is that people want to own it because they think that it will go up in price. They think it will go up in price because increasing numbers of people are going to want to buy it. The reason that they think that more people will want to buy it is that those people are going to believe that it will go up in price. This is a self-fulfilling prophesy.

This is also a demonstration of the standard operation of a bubble. It looks like a Ponzi scheme or a pyramid scheme. If I buy bitcoin today, it will be more valuable tomorrow because others have bought it at a higher price. As an existing “investor,” I am benefitting from others getting in. Meanwhile, what I’m actually owning is a bitcoin. Don’t get me wrong, bitcoin is valuable, but it’s not worth $10,000 per coin, or even $1,000 per coin. It’s a currency. It’s not Amazon or Apple stock.

If you bought Apple or Amazon stock early on, then you bought something that had a massive hidden future value, and as that value was revealed, you benefitted by investing in it very early, before the value was apparent. Apple and Amazon are companies which generate revenue and profits, and a share in these companies represents ownership in something that is growing.

I have friends messaging me asking, “What do you think about bitcoin? It’s so expensive right now, but I feel like if I don’t get in now then I will regret it later.” Notice this emotional state, this panic. Everyone is behaving like this is an emergency. Everyone and his dog is buying bitcoin. This is a form of mania. And the price is reflecting that. The number one rule of investing is don’t follow the crowd. When everyone else is buying, it’s time to sell. When everyone else is selling, it’s time to buy.

I’m probably a little bit older than many of the readers of this article. I remember the dot com bubble. Everyone was buying dot com stocks. The prices of those stocks shot up, and when many companies went bankrupt, people lost all of their money. There were also stories in Silicon Valley about receptionists and other admin staff at start-ups whose exercised stock options were being valued so highly at tax time that they ended up owing hundreds of thousands of dollars in federal tax through the Alternative Minimum Tax (AMT) mechanism. After the prices of the stocks crashed, before they were able to sell them, those employees still owed all that money to Uncle Sam. Many regular folks ended up bankrupt.

You might argue that people who invested in companies like Amazon during the dot com bubble didn’t lose all their money, and actually probably made money. Well that’s not necessarily true. I trusted some stock brokers at that time who persuaded me to cash-in my NVIDIA stock options and buy stocks that they “liked” such as Avaya and EMC. Even though their brokerage firm was a market-maker in NVDA, they didn’t know what NVIDIA was. Those dot com stocks also rose with the dot com bubble, but they didn’t become worthless after it popped; they did, however, halve in value. I did lose hundreds of thousands of dollars on those stock purchases, and I had cashed-in NVIDIA stock to buy them, stock that would now be worth tens of millions of dollars.

I believe that bitcoin will be around in the future, and that it will not go to a zero price. I believe that other cryptocurrencies will come to the fore which are more able to handle the transactional needs of a larger number of people than bitcoin can.

I think it’s important to realize and remember that this is a bubble. Your coins are going up because the sucker after you is buying coins. And they’re only buying them because they think that the price will go up.

Another sign that this is a bubble is the way that those who own bitcoins are trying to persuade everyone who doesn’t own them to buy them. These people might persuade themselves that they are motivated to help others, but I believe that the true reason is that they know that the more people are buying bitcoin, the more the price will go up. So they’re trying to keep the bubble growing. When you buy bitcoin, you’re potentially going to make some gains if you can get out again before it crashes. However, once you’re a convert, and you get into the swing of this, you’re going to stay in and work on persuading others to buy. It looks just like a pyramid scheme from this standpoint.

With true investments, such as a stock in a solid company with great leadership, a company that will grow and succeed massively in the long run, we want to keep it secret. We want to be able to keep buying the stock at the lower price. We don’t go around recommending to everyone that they buy the stock, because that would only lead to the price being driven up, making it harder for us to buy in at the low price.

It’s like going to a casino. If you can go in and put down a bet, win, and then take the winnings and walk out of the casino, then you can do well with bitcoin. The problem is that when most people get a big win, they plough it back into the system. Just as with a casino, bitcoin (at these elevated prices) is a system that is designed to extract your wealth from you. If you get in and get out, you can extract some wealth from the suckers down the line from you. However, the more you get in, and stay in, the more likely it is that you will be one of the suckers holding the bag when this thing crashes.

How will it crash? This bullish mania will suddenly flip. When all these regular people who have their life savings in bitcoin notice that the price is dropping, they will sell, probably at a loss. This will make the price go down further, triggering more panic, and the negative spiral will begin. The same mechanism that has led to this run-up, a form of mass hysteria, will also potentiate a massive sell-off and crash. This is because the bubble mania is a two-sided coin (pun intended).

My advice is to pay as much attention to your internal state as possible. Notice the fear of missing out. Notice the panic, the excitement, and the drive to promote bitcoin. This is a great opportunity for self-awareness. You might want to convert some of your dollars into this currency for fun, but make sure you only convert as much as you would be happy to lose, which for most people is nothing.

Before you post a response trying to persuade me that there is not a bitcoin bubble, remember that by doing so you will actually be reinforcing my hypothesis. If you think bitcoin really is a great investment, then you will want everyone to believe what I have written, and to steer clear of it.

Please give this article some claps, and follow me on Medium.

Update: The Chief Investment Strategist at Wall Street Daily quoted this article and called it “the loudest Bitcoin detraction.”

More by Dr Duncan Riach

Topics of interest

More Related Stories