Is bitcoin a pyramid scheme?

Everyone from Jamie Dimon to the Pope is seemingly talking about whether bitcoin (“cryptocurrencies”) are good or bad. The increasing trend for “ICOs”, initial coin offerings, also sparks considerable debate.

a pile of coins

We’ve just been asked if we want to do an ICO for our business, PrimaDollar!

Would we like to sell a participation in our business denominated in a private currency – a cryptocurrency token? Trade finance is a hot topic – and ripe for being “blockchained”.

Like most people, we have always had an uncomfortable feeling about bitcoin, but it is very hard to zero-in on the precise issues.

Of course, the number of bitcoin is mathematically limited – surely that must mean it cannot be a pyramid scheme? Something does not feel quite right – what is it? Very few commentators seem to be able to put their finger on exactly what the problem is. In this blog, we collect up the arguments and have a go!

Just to make it easy to read, we refer to all these cryptocurrencies as “bitcoin”, but of course, there are many varieties.

  1. What is a bitcoin worth?

Why should a bitcoin be worth anything?

Let’s start by looking at gold.

Gold is ideally suited as a medium of exchange. It’s durable, divisible, combinable, homogeneous and scarce. These are all things which make it useful as a proxy for intrinsic value. It is a relatively convenient “something” that can be exchanged for something else that has inherent value, like goods or services. The value of gold is perhaps founded on its value as a medium of exchange: a proxy for the intrinsic value of other things.

Bitcoin, if we accept the robustness of the ledger system, has similar characteristics. But it is significantly easier to transact than gold. If we believe in the security of bitcoin wallets, etc., it is also easier to store. So, at any given moment in time, bitcoin can act conveniently as a proxy for the intrinsic value of something else.

And what about cash? Cash has similar characteristics to gold and to bitcoin. If we trust the sovereign note issuers and the banks (as facilitators of cash transactions in digital form), we can regard cash too as an effective medium of exchange.

Something can be valuable because it can be used as a convenient medium of exchange. But that is not the end of the story. We also want our medium of exchange to act as a store of value. 

If, today, I exchange something valuable but inconvenient to hold for bitcoin, will I be able to reverse this trade in the future? Will I be able to get back my intrinsically valuable thing in exchange for that bitcoin tomorrow?

The reliability of a currency to act as a store of value would be undermined if it suddenly became freely available because it was no longer scarce. Equally, it would be undermined if the process of exchange became unreliable or if it became difficult to store.

Our view is therefore: the value of any medium of exchange – gold, bitcoin, US Dollars or any other contender – should be based upon (a) how convenient it is to use as a proxy for other things that have intrinsic value right now, (b) whether it can predictably act as a store of value over time and (c) whether there is a process to re-exchange it in the future that we can also confidently rely upon.

  1. Is bitcoin a pyramid scheme?

Here’s a definition of a pyramid scheme from a UK police website: “Pyramid scheme fraud involves an unsustainable business which rewards people for enrolling others into a business that offers a non-existent or worthless product.”

This suggests a couple of useful lines of enquiry. Before diving into the details, there is an important point to make: the value of bitcoin is based upon supply and demand. Supply is limited mathematically even as efforts to mine more coins continue, but demand is based upon the number of participants (people who mine, trade and hold bitcoin). More demand should equal a higher price, less demand should equal a lower price.

Is there a reward for the recruitment of others? Getting more people to mine, trade and accept bitcoins increases its value because supply is limited (notwithstanding the mining of coins to create further supply – which offers ever-diminishing results). Therefore, present participants – those who hold bitcoin already – generate income from the recruitment of others because it drives the price up.

Is the product “non-existent” or “worthless”?

  • Existence?

    Well, bitcoins do exist – as strings of 1s and 0s in computers – but are not tangibly connected to anything that has external intrinsic value. What’s the difference between a ledger entry (recording membership of a bitcoin ecosystem) and a secure membership record evidencing participation in a pyramid scheme?

  • Worthless?

    Only participants (existing holders) prepared to mine, buy and sell bitcoins ascribe a value to the 1s and 0s. Inside the bitcoin ecosystem, clearly there is a value; but outside the bitcoin ecosystem, there is no value. The mere fact that the membership right is tradeable (and maybe is being traded) does not mean that it has an external value. The valuation is circular and entirely internal.

Proponents of bitcoin as a legitimate asset argue that it is not a pyramid scheme. Three main arguments are put forward: a) there is no central authority and no “guiding mind”, b) participants do not earn a direct return from participation and (c) pyramid schemes should offer unlimited scope for expansion.

Taking these points in turn:

  1. The absence of a “central authority”

    . A pyramid scheme needs promotion by its participants; the fact that promotion is practiced by the network rather than initiated by a guiding mind does not change the essence of the arrangement nor the way in which rewards are obtained.

  2. The absence of a “return”

    to investors in bitcoin. Simple pyramid schemes offer no more return than the recycling of the price of membership itself; rewards are obtained merely by increasing participation by others; this is the case with bitcoin as well. The more participation there is, the greater the return that is achieved through the appreciation in value of existing membership rights.  Seems like this holds true for bitcoin as well.

  3. But bitcoin is limited mathematically

    in supply. Clearly the number of bitcoins cannot grow forever; moreover, the potential for unlimited expansion is a defining characteristic of a pyramid scheme. As already mentioned, the price of bitcoin (the value of membership of the scheme) is based upon the number of participants on the one hand, versus number of bitcoins on the other; it is not the limit on the number of bitcoins that drives value but the potential for a large (practically unlimited) number of participants. There is an unlimited dimension at work here – which continues to drive values up until a limit is reached.

  1. When might the bitcoin pyramid topple over then?

Pyramid schemes collapse because the value of membership rights is devalued by a breakdown between supply and demand (so that there are not enough participants to sustain the pyramid). 

By the above analysis, fiat currencies are pyramid schemes too. Their value collapses when too much currency is supplied. Holders of Reichsmarks in Germany in the 1920s experienced this first hand, not to mention Hungary in the 1940s and Zimbabwe in recent years. We have to trust the sovereign controller not to oversupply the currency, and then the currency pyramid should not fall over.

So pyramids can go on forever. They fall over when a destabilizing event occurs. What might be the destabilizing event that topples bitcoin? Assuming that quantum computers are unable to break the ledgers apart (seems unlikely), it will probably be one or a number of scandals or breakdowns in the systems that are used to store and trade coins (wallets and exchanges) rather than the ledgers themselves. These are unregulated environments and such events have happened before, and surely are likely to happen again.

With bitcoins, the pyramid would likely topple over due to under-demand (drop in the number of participants) rather than over-supply (too many coins) – but it is the same result.


Debating these questions internally, and with professional friends, has been an interesting exercise. The views expressed here our necessarily our own. But our thoughts are:

  • Bitcoin may be a convenient medium of exchange, but its very characteristics render it suspect as store of value and this substantially undermines its usefulness.

  • Bitcoin has the core characteristics of a pyramid scheme. We have not tried to decide if it is illegal or not (and there are pyramid schemes which are legal).

  • But an ICO for


    ? – no thanks.

Tim Nicolle is CEO of PrimaDollar, a global provider of international trade finance.

Special thanks for the photograph used at the start of this blog to Scott at FoiledAgain, purveyors of high quality chocolate bitcoins. Their bitcoins are much tastier than the real things.

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