Analysis on the Principle of the “MLM Token” and a Guide on How to Identify Scams, Part 1| Ponzi Study
In Part 1, we delve into the take-over strategy used in Pyramid Schemes. The stability of the strategy will be discussed alongside two case studies: (1) The ‘Indestructible ’Herbalife and (2) Jiugui Liquor’s Encounter with the Black Swan.
Written by Wang Runyu, a researcher at X-Order, an innovative research institute that attempts to combine cross-disciplinary fields such as distributed computing, computational game theory, artificial intelligence and cryptography to discover future extended orders. It was founded by Tony Tao, who is also a partner at NGC Ventures.
Some people think that all digital currencies are a form of Pyramid Scheme. While some think that all but Bitcoin are pyramid currencies. Some even think that A-shares are inferior to these pyramid currencies…
The frequent emergence of “MLM Token” — a cryptocurrency that is fundamentally a Ponzi Scheme that employs various ways to induce parabolic price growths and also sustain its price from collapsing — this year has further convinced the public that the entire cryptocurrency industry is a pyramid fraud.
However, such one-size-fits-all judgments are always biased.
This article hopes to break away from the traditional definition of Pyramid Schemes. It also hopes to break down the two most common strategies used in Pyramid Schemes — Take-over and Ponzi.
Take-over Strategy: Brokers’ Games of Raising Prices
In general economic theories, it is widely assumed that the price of goods is determined by the buyers and sellers. Producers compete with one another to provide high-quality and low-cost goods, and consumers select those that meet their needs.
In reality, the trading of goods is not so simple. Before the goods are delivered to customers, they usually go through a lot of intermediaries and dealers. Producers not only have to meet the needs of consumers but the “transaction needs” of the intermediaries.
In order to maximize their own interests, the next layer of intermediaries who takes over will be naturally inclined to raise prices.
In such “take-over” transactions, the more difficult the intermediary transaction is, the less easily the transaction demand can be met, and the more easily prices will be distorted and manipulated.
This kind of take-over strategy happens more in the real economy, especially in the field of consumer goods. As the origin of Pyramid Marketing, the United States also separates it into MLM (Multilevel Marketing) and Pyramid Schemes. The latter is actually the extreme version of the former, which can easily lead to fraud.
What about the stability of such strategies? Let’s take a look at the following case studies.
The ‘Indestructible’ Herbalife?
Herbalife is the classic case of a take-over strategy.
In 2012, Bill Ackman publicly announced his plan to short Herbalife. He pointed out that most of Herbalife’s products are sold to retailers at a high price with the take-over model. It was difficult for retailers to make a profit by just selling the products, they needed to attract customers to pay to join the membership or become retailers under them. In this vicious cycle, the company would eventually be abandoned by investors and bankrupt due to the slowing growth and fraud.
However, after multiple investigations, Herbalife’s business was not significantly affected. This fully demonstrates how strong Herbalife is under the take-over business model. In fact, regardless of how compelling Bill Ackman’s arguments are, Herbalife’s empire would never be destroyed if the following key points are not overturned.
Firstly, Herbalife expands rapidly through the take-over model, and there is not much distribution of profit to retailers for the sale of goods. The company earns most of the profits while retailers only get a small amount of commission and base salary.
The key strategy to take-over business model lies in controlling the profit-sharing ratio, that is, the percentage of profit that the project owner rewards for marketing. Successful consumer goods companies will strictly control this percentage to prevent pressures from their marketing channels.
Secondly, about 30% of the retailers will bankrupt because of losses and excessive stocking of inventory. Yet, the failures of this group of people do not affect the company’s growth nor does it increase its moral hazard. This is partly due to the growth brought by the company’s overseas business.
The vast majority of the retailers who take over at the final stage are those who lack business competency, illegal immigrants, or those who want to make a fortune overnight. When a business fails to develop, bankrupt distributors either admit their incompetence and leave, or try to safeguard their interests. However, for those with illegal immigration status, they lack channels for safeguarding their interests.
In this context, is the take-over business model in real economy indestructible? Not exactly.
The next case will show us that the project will discontinue only when the manufacturer is forced to shut down or the industry suffers a fatal blow.
Jiugui Liquor’s Encounter with the Black Swan
The liquor plasticizer incident in 2012 led to the continued depression of the liquor industry as a whole.
The domestic liquor industry has been developing rapidly since 2009. Jiugui Liquor is one of the typical examples. Beginning in 2011, the performance of alcoholic drinks has been rising at a rate of 100%.
Although it is not a pyramid scheme project, it's market pattern is somewhat similar to the take-over strategy.
It's business model was to attract retailers to continuously buy liquor through instilling the expectation that demand exceeds supply, hence, prices would rise. As revenue increased, retailers, in turn, purchased its shares in large quantities. Even investors were buying the company’s liquor, making liquor prices and sales revenue grow hand in hand. As a result, share prices naturally rose.
At the end of 2012, the Black Swan event occurred. The quality supervision bureau detected that the percentage of plasticizer in Jiugui Liquor’s products exceeded the standard. Under the pressure from the industry, capital market, public opinion, and supervision, the entire liquor business was almost completely destroyed. While the ‘passing the parcel’ game among retailers came to an abrupt end; Jiugui Liquor, known for its radicalism, were also facing trauma. Although it did not shut down as Sanlu Group did, it suffered from the loss of revenue and deteriorating company performance.
When the industry recovered in 2016, retailers started to play again.
Take Maotai Liquor as an example: at present, the retail price is close to 2000 yuan, while the company announces a factory price of only 969 yuan — retailers earn nearly 100% of the factory’s revenue. This was revealed in one of the statements when the chairman of the Maotai Board of Directors was expelled from the Party and dismissed from his position. “Providing convenience for retailers to illegally sell Maotai liquor in violation of regulations, led to serious damage to the market environment of Maotai liquor.”
The take-over strategy was born together with trading. It originated from a large number of intermediaries and distributors brought about by the transaction demand. It thrived in the consumer goods industry and flourished in the United States, which is a country known for Pyramid Schemes.
It will only end if coercive measures are forcefully taken by external agencies.
The main risk these firms face is bankruptcy and withdrawal from the market once the industry enters a recession and they lose their market share. Antique trading, futures speculation in the past and sneakers trading holds the same principle.
In Part 2, we delve into the Ponzi strategy used in Pyramid Schemes, and its differences with the Take-Over strategy. We also discuss the operations and investments in the MLM Token.
Stay tuned as we bring to you more case studies in the next few series.
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Translated by (via our WeChat Account): Xu Xinyue
Editor: Daphne Tan
