The rise of crypto token investment schemes has created a thriving ecosystem of frauds. And much like the ecosystem of a septic tank there is now a such a diverse set of flora that we can start categorizing the various classes of outgrowths that have arisen out of the financial sewage. These more or less fall into two subspecies A) intentional scams perpetrated by charlatans B) unintentional scams perpetrated by the naive. The Type-A variety we’ve seen since as long as markets have existed, however the Type-B variety were traditionally a much a rarer species. With the rise of unregulated dark markets they may become the dominant species in this new world of internet finance.
Multi-level marketing (MLM) schemes share quite a bit in common with crypto since they’re a form of enterprise in which cashflows consist only of paying out old investors from new investors via recruiting more suckers in. MLM businesses are a type of legal pyramid scheme in which non-salaried workers purchase wholesale products (cosmetics, health food, vitamins, etc) out of pocket from a company to do direct sales to friends and family. They make a small commission on these sales.
However the secondary (and overwhelmingly primary) revenue stream is by fractional commissions from any other people that one has recruited into the same scheme, called one’s “downline distributors”. The person who recruits people into the scheme gets a percentage of their sales. This pyramid structure incentivizes recruiting more than sales. If you recruit four people into the scheme to recoup your losses, then those four people have to do the same, do this 16 times and you have recruited every person on earth to sell skincare. The math and economics just doesn’t work out.
It’s now widely known that doing this as a line of work is an absolutely terrible idea. The FTC released a report on the economic problems of MLM schemes, and not surprisingly the findings were that 99% of people involved lose money. They’re a predatory wealth transfer from low-information people recruited into the scheme directly to the company upper ranks’ pockets.
Similarly, crypto businesses sell utility tokens in the same way that MLMs allegedly sell vitamins. It’s tenuous legal cover for what mathematically can only be a scam and which funnels money upwards in the pyramid. Massively negative-sum token investment schemes and pyramid selling schemes present as the same phenomenon just through slightly different mechanisms. And yet somehow because of regulatory capture in the 1980s and corruption in the Reagan administration we’ve decided just to let these businesses get a free ride. Many other countries have simply banned them outright.
The curious thing about MLMs is that despite this information being widely available online, they continue to recruit in droves. And most of the people involved in them absolutely would not fit our mental model of a scammer. They’re the normal people at your church picnic, your nextdoor neighbors, and just regular salt of the earth people who run around selling these products blissfully unaware that they are the mechanism by which this predatory system perpetuates itself. And not out of any malicious intent but purely out of ignorance.
This exact same phenomenon is perpetuated everywhere in crypto investment offerings. In a remarkable display of courage Jackson Palmer, the creator of Dogecoin (a meme token which is a parody of bitcoin), gave a scathing indictment of how the investment he helped launch has accidentally become something terrible. In his words cryptocurrency is a “get rich quick cult” designed to “extract money from the desperate and naive”. And just like MLMs that’s exactly what it is.
Now does anyone think this is what he intended to happen? No. The more likely reading of history is that some 20-something programmer (much like myself) just accidentally created the digital pyramid scheme equivalent of Frankenstein’s monster by changing a few variables in the bitcoin codebase. And now millions of people have lost their savings and destroyed their lives gambling on his accidental creation.
And this is just one example, Bloomberg wrote a scathing piece about the exponential rise in pump and dump schemes and the billions that are being pilfered from the public every day. There is an entire channel on Youtube that for the last few months has done nothing but shine a light on influencer scams. And he’s only uncovered the tip of the iceberg. There are billions of dollars sloshing around behind Instagram and TikTok for people to promote what are unapologetic pump and dump schemes and exit scams. Even A-list Hollywood celebrities have gotten into the exit scam business.
One need only look at the Fyre Festival disaster to see a similar variant of the phenomenon that manifested in every single crypto initial coin offering ever done. You have a bunch of disreputable but starry-eyed charismatic people with grand visions for building the “The Luxury Music Festival To End All Festivals”, “A New Pied-Piper Open Internet”, or “Friedrich Hayek’s Vision of Self-Soverign Money”. They suck in ever-increasing amount of investor money staked on that prospectus and then fall on their faces when they realise the real world has limitations, and it all blows up catastrophically. Are these true-believers scammers? Is this just a case of willful blindness? Or are they just fools? The line becomes very blurry at a certain scale.
And why is this so prevalent now? Because if there is any innovation in the crypto sector it’s in the fact that it allows any teenager in their bedroom anywhere in the world to launch a bespoke pyramid scheme or do securities fraud in about 5 mouse clicks. Couple that with a complete lack of regulation, and what we see is rampant rug-pulls and pump and dump schemes from people who have either no shame or have become completely desensitised to fraud by a nihilistic worldview.
Corruption and charlatans don’t scare me. We’ve dealt with them since the beginning of civilization and commerce. Money undeniably corrupts even the most principled of men. Yet what scares me far more is an economic system based around a technology that has the capacity to turn so many good people into blind agents of corruption. Crypto is now the spiritual successor to multi-level marketing and it victimizes exactly the same demographic. What we see in the crypto market today is simply MLMs mutated to adapt in the brave new world of the global internet and social media.
The duck test is all that matters. If a business model looks like a pyramid scheme, swims like a pyramid scheme, and quacks like a pyramid scheme, then it probably is a pyramid scheme. Sprinkling digital signature schemes and techno-utopianism on top doesn’t change the economics. Intention in business models doesn’t matter; the road to hell is paved with good intentions. All that matters is outcomes.
People often ask me if I think everyone involved in crypto is a scammer. The answer is an emphatic “no”. But for me the far scarier proposition is that so many people can be part of a scam and not even know it. If there’s one thing we as technologists must keep in mind the most it’s that immensely inhuman evil is done by corrupt systems composed of the most blissfully unaware people.