21st Century Pyramid Scheme: How Blockchain Technology Is Reinventing An Old Con
On November 28th, 2017, the price of Bitcoin surpassed $10,000 and made world headlines. No longer under the shadow of its past associations with the Silk Road and darknet drug markets, Bitcoin suddenly seemed a viable commodity, a speculator’s dream come true. A rush of excited new money flooded into the cryptocurrency markets, and within three weeks the price of Bitcoin doubled again, reaching a staggering $20,089 before slowly crashing back down to nearly $6,000 in a massive market correction. Skeptics, who warned of the Bitcoin bubble and made dubious comparisons to tulip mania, claimed victory. However, Bitcoin has already begun to recover and interest in the asset as an investment continues to grow, and with apparent good reason: Bitcoin increased 1300% in value in 2017.
Beyond the speculative nature of the cryptocurrency markets, there is the technology itself. Bitcoin’s sole function is that of a currency (or a store of value) — in contrast, there are hundreds and hundreds of projects utilizing blockchain or similar technologies for a plethora of real world use cases, such as supply chain, data management and security, financial services, and the backbone of the Internet of Things.
One surprising application to have emerged from blockchain technology are crypto-based pyramid schemes, touted as legitimate and trustworthy because they are built using smart contracts. At its height, the most popular pyramid scheme to date, PoWH or Proof of Weak Hands, had a contract balance of over 1,000 Ether (valued at over 1 million dollars), before crashing and burning in spectacular fashion.
Dr. Jochen Hoenicke is a computer scientist and research assistant at Albert-Ludwigs-University of Freiburg, Germany, and in many ways is responsible for this new generation of pyramid schemes. Hoenicke wrote a smart contract called PonziToken and published it on the Ethereum testnet. He then posted a private page on his personal website with instructions on how to interact with the contract using pretend Ether. “It is not linked from my homepage and I only shared this domain in some chat months ago,” says Dr. Hoenicke. “I was a bit surprised that someone found this contract.”
The concept was relatively simple: as people paid Ether for Ponzi Tokens, the price (value) of each token increased by 0.25%, and as people sold tokens the price decreased by an equal amount. A 5% fee was taken from every token purchase and distributed to token holders as dividends. In other words, you would start with a 5% loss, and in order to break even and become profitable, the tokens would need to increase in value from more people putting Ether into the contract (or as your dividends from those purchases increased). You could withdraw your dividends or sell your tokens at any time.
Because it was written in a smart contract, in theory this scheme could run perpetually — nobody could shut it down, nobody could exit scam with the contract’s funds. In theory.
Dr. Hoenicke warned people that the Ponzi Token scheme was a bad investment, a zero-sum game. “[If] you make money using the token, then somebody else loses money”. Hoenicke clearly never intended for his contract to be anything other than an amusement, a bit of testnet playfulness.
A popular imageboard site, The Guardian once summarized the 4chan community as “lunatic, juvenile … brilliant, ridiculous and alarming”. Members of the /biz/ subforum seized upon Dr. Hoenicke’s concept and in late January, 2018, the Proof of Weak Hands website was launched with an ERC20 smart contract published on the Ethereum mainnet. A few minor things were tweaked — token holders now received 10% dividends from token purchases — but otherwise most of the math and code was lifted directly from Hoenicke’s contract.
And it took off in a big way. The PoWH contract reached a balance of over 1,000 Ether in less than 24 hours. This was no longer test Ether, this was real, with a value of over 1 million dollars.
“I’m not very happy that someone made this idea go live,” said Dr. Hoenicke. “Especially since my name is kind of advertised in it…. They did not ask me, not even invite me to be the first investor.”
Aside from the many memes and jokes of the PoWH site — the whitepaper link took you to the SEC website warning about Ponzis — PoWH touted itself as an honest pyramid scheme because it functioned on a smart contract that, once published, could not be amended or removed. “The World’s First Autonomous and Self-Sustaining Pyramid Scheme”.
The PoWH site made no promises of a return on investment — it actually gave a warning before purchasing PoWH tokens that you were likely to lose money. Yet that didn’t seem to deter people, as Ether continued to pour into the contract days after its release. Many token holders talked in Reddit forums or Discord channels about holding for weeks or even months so as to accumulate dividends. And for a short time it did actually seem possible that this crazy scheme could run for weeks, months, or in theory perpetuity.
Then on February 1st someone named Arctek posted a thread on the PoWHCoin subreddit warning that the contract was buggy and at risk of being drained by an exploit. To prove his claim, Arctek used the exploit to drain the small balance from one of the many clone contracts that had emerged. Not long after that, someone (Arctek claims it wasn’t them) ran the exploit on the PoWH contract and drained it of 866 Ether. Everyone who put Ether into the contract — some put tens of thousands of dollars worth — lost their money in an instant.
And just like that, PoWH was dead. For the time being.
Some ideas don’t die easily though, and the concept of a smart contract-based pyramid scheme has captured the imaginations of a growing subculture within the cryptocurrency community.
Pyramid schemes have always been successful; there never seems to be a shortage of people lured in by the idea of easily doubling, tripling, or quadrupling their money. Even William Shatner was roped into promoting a popular pyramid scheme. However, this new generation of smart contract pyramid schemes operate quite differently than any that have come before. First, actively recruiting people to join the pyramid below you isn’t necessary. Second, because they run on a smart contract, they are demonstrability fair and secure (assuming the code is free of bugs). And third, they are entirely transparent about what they are — they even embrace the pyramid as a logo.
Nobody puts Ether into one of these smart contracts thinking that it’s anything other than a pyramid scheme. So why do people flock to join?
“I think there is this investment hype, you invest money to make more money,” says Dr. Hoenicke. “In particular you buy tokens in the hope that the price for tokens will rise, without looking at the fundamentals and if there is a viable product that has value. My contract takes this concept to the extreme, since it only makes money by selling itself not by producing anything useful.”
It is the Greater Fool Theory in its purest form. People are investing in something they know has no intrinsic value on the chance that someone else, a greater fool, will eventually buy it at a higher price. (Or in this case, that greater fools will put money into the contract after them.) It is a gamble, speculation based on nothing but get-rich-quick hopes and lambo dreams.
Shortly after the bug exploit and draining of 866 Ether from the PoWH contract, the developers (many of them receiving death threats) disbanded and disappeared.
Only one member of the original team remained behind. PonziBot was the meme creator and publicist of PoWH, and, feeling no personal responsibility for the bad code that the original devs allowed in the contract, quickly joined forces with experienced developers to create a newer, better PoWH contract: PoWH3D.
According to PonziBot and lead developer mantso, the new PoWH3D smart contract is a huge improvement over the original.
They claim the code has been audited by Arctek (discoverer of the original bug) and other experienced programmers, and will be made available for public review before launch. It is 100% secure and bug free, they say.
The biggest upgrade to PoWH3D is the implementation of a masternode referral system, wherein token holders will get 3% dividends of all token purchases made using their referral link. (I.E., for every 100 Ether put into the contract from their referral, they’ll receive 3 Ether in dividends.)
“This change is massive and will probably reach us Bitconnect levels of popularity,” says mantso, tongue in cheek.
In addition to their referral dividends, PoWH3D token holders also receive a split of 7% dividends from all token purchases and a split of 10% dividends from all token sells. The more tokens you purchase, the more dividends you receive. So long as you hold.
In trading vernacular, to have strong hands means to hold strong during a dip, and to have weak hands means to lose confidence and sell at a loss. Weak hands make strong hands richer.
As Proof of Weak Hands 3D launches, many a gambler and risk-taking speculator will test the fortitude of their hands. Some will approach it as a money making opportunity, and others will enjoy it as a source of amusement, another clever curiosity of the dawning crypto age.
While this phenomenon is hardly the most groundbreaking usage of blockchain technology, it does show how even the most unlikely of things can be improved upon by utilizing the blockchain: bringing the pyramid scheme roaring full steam into the 21st century.