Test 2 in my investigation of whether Steemit is a scam, Ponzi and Pyramid schemes - as I said it's complicated.
Having worked in the finance industry, (and designed a few investment schemes myself) I’m examining, in a series of post, whether SteemIt is a financial scam or not.
To evaluate the true nature of SteemIt as a financial scheme, I am using five tests which can be applied to any financial scheme:
- Who is making money?
- Who is losing money?
- What happens when new investment ceases?
- Identifying the risk factors
- Evaluating the risks
In my previous post SteemIt passed test 1, with conditions: someone else has to be willing to convert Steem to real world currency and will charge for that transaction. Still, 70% (as a random figure) of something is still better than 100% of nothing, so SteemIt passes test 1.
Test 2: Who loses money.
This is a key test, because if the answer is ‘me,’ I’m out of here. On first examination, Steemit looks like either a Ponzi scam or a Pyramid scam. To adequately answer this question we need to examine in detail the nature of these types of scams.
Is SteemIt a Ponzi scam?
A Ponzi scheme is like a house of cards, pull one out at the bottom and the whole lot comes crashing down. It’s another name for a ‘Robbing Peter to pay Paul’ scam. Those who are early adopters (Pauls) earn great returns, supposedly from the scheme administrators making superior investment choices. In reality, the payouts for those at the top (Pauls) are funded by the investments of those entering the scheme below them (Peters). As long as there are an ever increasing number of new investors (Peters), encouraged by the rave reviews of early adopters, those above (Pauls) earn great returns.
Also, as the business becomes viewed by the financial world as increasingly successful, the company shares gain in value, enabling the business to borrow money to repay investors. Obviously, this is not a sustainable business model.
In December 2008 Bernie Madoff was revealed to have defrauded his investors to the tune of $20 million. He had kept up his Ponzi scheme, defrauding the rich and famous, for decades. The fact he was only defrauding the rich and famous means most people are ambivalent to what he did.
The most infamous example of a Ponzi scheme, because is defrauded ordinary people and caused real poverty for his investors when it collapsed, is the Securities Exchange Commission scheme run in the 1920’s by Charles Ponzi, hence the name.
To escape detection, each new Ponzi scheme needs to be more complicated than those that went before. Steemit certainly looks complicated, and relies on a made up crypto currency too. So is SteemIt a Ponzi scheme? Let’s follow the money.
New investment is turned into Steem Power for which early adopters or those with the most existing Steem Power earn a larger percentage then those below. However, SteemIt is not solely reliant on new investments in order for the platform to work and for Steem Power to be awarded. Also, the scheme is transparent as to how a Peter can become a Paul, either by investment or by ‘work’ (more about that later).
No, SteemIt, though complicated, does not appear to be a Ponzi scheme. If not a Ponzi scheme is it perhaps a Pyramid scheme?
Is Steemit a Pyramid Scam?
In a classic Pyramid scheme, existing members are paid a proportion of the joining fee of those they recruit. They also receive a proportion of the joining fees of those whom they recruited recruit. Like a Ponzi scheme, this scam too relies on an endless stream of new recruits willing to pay the joining fee.
As SteemIt does not charge a joining fee and no commission is paid for recruiting others, SteemIt cannot be a classic Pyramid scheme.
However, there is a variant which SteemIt does resemble. This is a Commission Based Pyramid scheme. This is often associated with the sale of cleaning products. In this model, when products are sold, the agent receives a sales commission. A percentage of your sales commission is also earned by the person who recruited you; the person who recruited them also receives a slice of your commission, and so on up the pyramid.
The difference between this and a classic pyramid scam is that real goods are being bought and sold – if you like, ‘work’ is generating the commission. Peter’s sales are subsidising Paul, but not robbing him. Also, as you recruit more sellers you start to receive a percentage of their commission as your earnings – Peter becomes a Paul.
These commission schemes are considered to be a legitimate business model, similar to a franchise business. The obvious flaw in this business model is that most sellers are only making sales to friends and family so the sales reach of the business in limited. Also, successful sellers, who wish to forgo the back-office support of the scheme, can make more profit by leaving the scheme and going-it-alone, keeping all their commission for themselves.
Given that those who have the most Steem Power on Steemit earn the largest percentage of the overall Steem Power payouts, Steemit would in deed appear to resemble this type of Commission Based Pyramid scheme, which as I said is considered to be a legitimate business model. SteemIt members can, through hard ‘work’ or investment, move up the pyramid, possibly to the very top, but as the scheme is based on blockchain technology, leaving the scheme to go-it-alone is not an option.
Test 2: Who is losing money?
Although it is possible for those who invest real world money, but are not prepared to create or curate content, to lose money in SteemIt, those willing to ‘work’ by creating and curating content and can make money or increase their investment. For me, that means test 2 is passed.
In the next post I will look at what happens when new investment ceases. Will SteemIt hold up, or collapse like a house of card?
Image by giphy.com
Other posts in this series:
Is Steemit a scam? Test 1
Is Steemit a scam? Test 3
Is Steemit a scam? Tests 4 & 5
Is Steemit a scam? What I'm really doing here