Bitcoin Was Not a Pyramid Scheme
But, Speculative Behavior Partially-Transmuted It Into One
I angrily posted this tweet a few weeks back on here and on facebook, where I saw friends busily investing money they didn’t have into crypto. It was pretty wild experience. Both friends and strangers lined up to call me an idiot at best, and…well, less nice things that I won’t repost.
I kept trying to reiterate that: I think blockchain as a technology is remarkable. It’s really really cool and can solve some tricky problems! (It can also reinforce some major ones.) But, my fear as a believer in the technology was that — while speculation helps bootstrap an expansion phase — excess speculation could doom it. I thought my pseudo-mathematical equation conveyed that.
I was wrong.
Filtering out the disparaging language, counter-arguments to my post boiled down to: “It’s not a pyramid scheme!”
That’s true. Bitcoin is valuable. As, Naval tweeted (and hodlers quoted to no end),
Invoking Tulip-mania was a bad analogy. I think that’s why it provoked a“YOU HERETIC!” reaction. But, mania is the driver of the recent price appreciation. My friends from high school desperately asking “what is bitcoin?” don’t mean, “explain how it works?” and “wow, this will change the world?” — they mean, “how can I get rich quick?!?!?”
That’s a problem, both in terms of a possible human tragedy and to believers in the promise of the technology. Robert Shiller captured it well when he said,
You just put an upper bound on [bitcoin] with the value of the world’s money supply. But that upper bound is awfully big. So it can be anywhere between zero and there.
So, it’s really easy to see the recent price appreciation as a reflection of the value under a transformed-World scenario. But, through the lens of pseudo-math:
If the price right now reflects an excessive mass on speculative appreciation, crashes and panics render crypto-currencies less trustworthy to those on the losing side. And, those on the losing side right now are the hordes of people who thought they would soon be rich. Again, bitcoin needs speculation as part of the bootstrapping process. But, excess rates of appreciation could sink it if subsequent (fast-moving) crashes and retracements result in cascades of distrust and disillusionment (w.r.t. getting rich quick).
This isn’t a novel idea. Everyone in the crypocurrency space knows it. But, blinded by both the promise and the profits, companies have lined up to take anyone’s money without consideration to what may happen to them.[1] Yes, they could make money. They could also take out a home equity loan to buy bitcoin, then lose their house.
Mania induces bad decision-making.
Ignoring and explaining away the mania — and, how mania creates a process that simulates a pyramid scheme — isn’t a good idea, either.
- An example. Coinbase, the epicenter in US investment — which has a $10 refer-your-friends program — sent out an “Invest Responsibly” email. Ignoring the absurdity of a subject line that evoked images of binge drinking Bud Light at a dive bar, the actual body of the message was quite stingy on the full set of risks. Their strongest warning: “We also wanted to remind customers of some of the risks associated with trading digital currency. Digital currencies are volatile and the prices can go up and down. Due to the rapidly changing price of digital currencies, some customers may not have sell limits that are sufficient relative to the value of total digital currency they are storing on Coinbase. Sell limits are one of the many measures Coinbase takes to protect client accounts and assets.” They never said, “you could lose all your money.”
