Thread by @smdiehl

Lets talk about how pyramid schemes like #bitcoin have historically exploded and the public damage that happens when they do. (1/) 🧵

A pyramid scheme is a type of fraud whereby investments are solicited from the public on the pretense (implicit or explicit) of offering high returns on their investment. Normally returns far beyond that of normal markets. (2/)

The secret sauce that makes it all spin is that returns are paid to the early investors out of the funds received from those who invest later. (3/)

From an accounting perspective the scheme is insolvent from start, the assets exceed liabilities and since the scheme has no cashflow, other than new bringing in new investors, the scheme requires constant recruiting and promotion to sustain the illusion.

Sound familiar? (4/)

Later investors are drawn in by cherry-picking anecdotes about the returns of early investors while ignoring (often due to obfuscation) the macro cashflows of the entire scheme. (5/)

Eventually when late investors try to get their money out of exchanges or brokers they discover the truth about the scheme being insolvent. The operators of the scheme usually flee away with the remaining funds and it all quickly collapses leaving a wake of victims. (6/)

The best historical example of this trend at scale is in Albania in 1997, and this story has eerie premonitions for the future collapse of the cryptocurrency market. (7/)

Albania excited from a communist system in 1991 directly into a free market economy, with very few institutions to protect or regulate the new market.

Effectively it's the pure libertarian economy most crypto cultists dream of. A greenfield scammers paradise. (8/)

Several large "funds" emerged that promised to take retail investment and use the funds to invest in other developing enterprises and infrastructure in the nation. They promised large yields with low risk, and the public lept into these schemes without much due diligence. (9/)

Many of these schemes were outright run by government officials and promised to serve as rudimentary financial service providers in the developing economy which lacked many of the services found elsewhere in Europe. (10/)

This reached its zenith in 1997 when over 10% of national GDP was locked into these schemes. And by that time the the schemes were making promises of truly absurd yields of 40% monthly to draw the last few victims in. (11/)

People who are personally invested in a pyramid scheme will fight tooth and nail to legitimize it. They want to believe. Conmen don't see you facts, they sell you emotion. And naive investors will will post-hoc rationalise nearly anything that promises them free money. (12/)

Not surprisingly these schemes were indeed nothing but thinly veiled pyramid schemes that kept soliciting more and more public money until they eventually broke the entire economy, the government collapsed and the country soon descended into anarchy. (13/)

All throughout this era, the corrupt government stayed silent about the scams (just like the SEC and the federal government does today), adding fuel to the meme that the pyramid schemes were legitimate. (14/)

The story of Albania is a omen about what can happen when a public obsessed with quick riches not tied real economic activity chases schemes that are simply economically impossible. Speculative manias always end badly most people because they're unsustainable. (15/)

In today's crypto "market" theres no longer a stigma associated with pyramid schemes. You shill your dog token of choice because you want it to go up, and that's pretty much all there is to it. It's naked pump and dump, no longer backed by any narrative of value creation. (16/)

The moral of this story is that a competent government, strong regulation, and a financially literate public are the only forces that can stem the frenzy before pyramid schemes damage economies and markets. (17/)

We need more people with the audacity to call out crypto pyramid schemes for what they really are: Economically unsustainable investment fraud that hurt innocent people and destroy lives.

/fin