In Part 1 of the MLM Cryptocurrency series, I discussed the basics about cryptocurrency MLMs. In this section, I provide specific information to help consumers stay safe.
UPDATE: After the writing of this article, the SEC has sued a Bitcoin cloud mining company and alleged them to be engaging in the unregistered selling of securities. The case is SEC v. Garza, et al. The case makes it clear that when the primary motivation leading people to purchase cloud mining packages is ROI, it will likely be considered an unregistered security. And when it comes to alt-coins, where there’s no real use for the coins in the general marketplace, ROI will always be a strong motivating factor. Lack of control was another strong factor that led the SEC action. The buyers of the cloud mining packages had zero ability to influence the results. In other words, the fact that it was purely a passive exercise for buyers / investors, the SEC is arguing that the program was phony investment scam. When it comes to network marketing programs, it’s best to steer clear of any program that involves cloud mining.
Before I get into the specifics, I want to answer three questions:
(1) What is cryptocurrency? Cryptocurrency is digital money that relies on cryptography. Instead of relying on a centralized company (banks) to govern the ecosystem, cryptography allows the entire network to exist publicly without triggering privacy concerns. In other words, cryptocurrency is an OPEN system that allows for the creation and distribution of digital assets (money, coins, tokens, whatever).
(2) What is a cryptocurrency MLM? It’s a network marketing program that either sells a Coin in exchange for money or provides some sort of ancillary service (i.e. cloud mining) that supports a Coin’s network.
(3) What is mining? Mining is the process of contributing your computer resources to ensuring the transactions on the Bitcoin network (or any other coin’s network) are authentic. Translated into English: Miners volunteer their computers to ensure that all activity on the network is clean. In exchange for this, miners are rewarded with Coins. “Cloud mining” is where you’re not using your own computer. Instead, you’re renting hardware offered by someone else that agrees to share the rewards.
Ponzi Schemes / Pyramid Schemes
Can a digital coin like Bitcoin, by itself, serve as a product for purposes of fueling an MLM? The answer is clearly NO. It would be similar to operating an MLM by selling ten dollar bills. The value of the piece of paper is clear: it’s $10. There’s no room for markup, no room for retail activity. The only way to operate an MLM by selling ten dollar bills would be to sell the paper for MORE than $10. This would clearly be a pyramid scheme where the “product” was merely incidental for the right to participate in the scheme. In other words, the price was inflated JUST to spice up a pay plan.
With Bitcoin and other alt-coins, the value is clearly established by online exchanges (Coinbase, Kraken, Bittrex, etc). The values fluctuate up and down based on market activity. The value is crystal clear; thus, there’s no opportunity for markup. And with the coins being freely exchanged in the marketplace, there’s no real opportunity for a company to claim ownership over the coin and use the coin as a proprietary product.
With cryptocurrency MLMs, there are very few coins (if any) that are publicly available via an exchange. In this scenario, the Coins must be bought exclusively from the company. How is the price determined? The price is manipulated internally, increasing over time based on “market demand” (determined by new enrollments into the scheme). See the problem? Ponzi scheme! Understand, in order for a Coin to have real legitimacy, there needs to legitimate usage in the marketplace. Consumers need to do business with the coins, transferring funds to merchants in exchange for products. As the Coin’s usage increases, its value will grow. If there’s no usage, there’s no real way to measure value. Why would a merchant ever accept an experimental coin without knowing its real value? The answer is obvious…it’s not about user adoption, it’s about the return on investment.
So there’s the first clue: In a ponzi scheme, the value of the Coin is determined in a CLOSED system, free from market tension. In a CLOSED system, the value is controlled / manipulated. The whole point of cryptocurrency is to be OPEN and operate in a TRUSTLESS environment where its existence does not hinge on a controlling entity (hence, the word “trustless” i.e. there’s no need for trust because it’s all in the open).
Second clue: we can look no further than the SEC. The SEC has written a solid article on the subject titled Ponzi Schemes Using Virtual Currencies. The SEC’s statement is included in full at the end of this article. If you’re reading this via email, click here.
The SEC writes, “We are concerned that the rising use of virtual currencies in the global marketplace may entice fraudsters to lure investors into Ponzi and other schemes . . . These schemes often promise high returns for getting in on the ground floor of a growing Internet phenomenon.”
The SEC provides several red flags to watch for when reviewing one of these programs. I’ve provided some commentary about the two largest and easiest to spot below.
Overly consistent returns
The SEC writes, “Investments tend to go up and down over time, especially those seeking high returns. Be suspect of an investment that generates consistent returns regardless of [external] market conditions.”
When it comes to alt-coins, one thing is guaranteed: price volatility. Cryptocurrencies are so new, the market is having a difficult time landing on a consistent value. Bitcoin has held a more stable value in recent months, due to the transaction volume increasing, which leads to more stability. But with all other coins, they’re a mess. If you see a company that’s promoting a coin that commands a predictable climb in value, stay away. It’s a ponzi scheme. The predictable “climb in value” is directly tied to new enrollments into the program. And if the coin is not listed on any kind of exchange, the company can manipulate the value, pretending that the token has more value than it really deserves. Investors, seeing an incredible return on their investment in the back office, pour more money into the schemes. If the gains are formulaic, stay way.
Difficulty receiving payments
The SEC writes, “Be suspicious if you don’t receive a payment or have difficulty cashing out your investment. Ponzi scheme organizers sometimes encourage participants to “roll over” promised payments by offering higher investment returns.”
If the company holds your money hostage via convoluted withdrawal requirements, there’s a good chance it’s operating as a ponzi scheme. What do Zeek Rewards, WCM777, TelexFREE, Cyber Kids, Zhunrize and eAdGear all have in common? They were all shut down as ponzi schemes within the past three years AND they all had auto-reinvestment components. In legitimate network marketing programs, rewards go out based on volume. There’s no need for the company to hold YOUR money. If you earn it, you get it. In a ponzi scheme, they need to keep cash inside the system to protect itself in the event enrollments (money coming in) slow down. What do these requirements look like? Daily withdrawal limits, percentage of your commissions automatically used to purchase more “product,” hold periods for when you can actually sell your “Coins” after purchase, etc. These measures are taken to keep cash inside the system, protecting itself in the event of a crash.
Bottom Line: If the value of the coins go up in a predictable fashion, steer clear. And if the company has requirements that make it difficult for you to pull out your commissions, steer clear.
So how can it be done legally?
So how can a company participate in the cryptocurrency movement without being pegged as a pyramid or ponzi scheme? It’s difficult. The answer lies in the selling of legitimate mining services. But even still, this is theoretical. The entire point of “mining” is where participants throughout the world lend their computers to the task of supporting the coin network. As transactions are processed, computers need to verify the transactions to ensure authenticity. As a reward for mining, miners are awarded coins. In a perfect world, the value of the coins would exceed the cost of mining. This is not always the case, as we’re recently seeing in Bitcoin where the costs are going up and the value is going down.
When it comes to alt-coins, the value of the coins dramatically swing up and down. It’s the wild west full of speculators trying to position themselves to ride a wave. If an MLM company were to be selling mining services for an alt-coin, the prices of the mining service would need to be less than the value of the coins being mined, otherwise it would be a pointless exercise. And with most alt-coins, the value of the coins are usually close to $0. See the problem? It’s a chicken or the egg thing. Without much attention, the coins lack value. But to drum up attention, MLMs need to (a) develop a coin with unique properties; (b) drum up interest from merchants to use the coin; and (c) slap a pay plan to the mining services. With network marketing, the pay plan needs to be somewhat competitive with other MLMs out there. Thus, the mining services are likely priced too high, well beyond the normal costs associated with mining a cheap, experimental alt-coin. All in all, it’s a problem UNLESS the coin has value out the gate (I’m not sure this is even possible).
Also, it’s unclear whether the SEC would view cloud mining services as unregistered securities. Securities exist when there’s (a) an investment of money; (b) into a common enterprise; (c) with an expectation of profits from the efforts of others. Are cloud mining companies engaging in the selling of unregistered securities? It’s such a new territory, nobody knows. An argument can be made both ways. The SEC, in my opinion, should provide a statement on this precise issue.
In a perfect world, the MLM company that sells cloud mining would (a) be mining for a coin that was OPEN and traded publicly on an exchange; and (b) be one of many companies providing mining services. If a coin is truly open, and there are other miners out there, there’s market tension that would ensure the fees being charged by the MLM company are competitive and legitimate. If the fees are too high, it goes out of business. Plain and simple. Bear in mind, this is a theoretical scenario. UPDATE: See the update at the start of the article. This theory is made even more of a stretch by recent developments. Bottom line: Avoid any company with cloud mining as it’s center-piece. And for those companies that “give away” coins as some sort of a “free prize” for buying the cracker jack box (i.e. online education), avoid those too.
There you have it. If the the Coin is the product, just steer clear. There’s a good chance it’s a ponzi scheme. If mining is the product, be very careful. It’s possible that it’s a pyramid scheme where the value of the mining service is untested and unclear. It’s also possible that the coin being mined is garbage. And remember, pioneers are the people that end up with arrows in their back. It’s fun to be first in some cases, and in others, it’s absolutely terrible.