Wednesday, March 31, 2021

From Circle-of-Gold to Mega$Nets to Bitcoin

We tend to dismiss chain letters as mere scams or frauds. In this post I want to get readers thinking about chain letters as a type of financial innovation, one that has been steadily updated over the decades.

Chain letters are lists. Players own a spot on that list. That list is governed by a rule: the first people on the list are to be paid by the latecomers. The chain letter stop working, or paying out, when no one else wants to join up.

The amount of money flowing to early-birds who joined the list is equal to the amount arriving from latecomers. No additional value gets created. That's why chain letters are zero-sum games.

The greatest technological strength of a chain letter is its decentralization. Each node, or participant, is independently responsible for receiving, copying, updating, distributing, and marketing the chain letter. Without a central schemer to indict, it's almost impossible for the authorities to stop the letter from propagating. Think of chain letters as the honey badgers of the financial world: tough, indestructible, and durable.

One of the most famous chain letters was the Circle of Gold letter. It reportedly started out in San Francisco and ripped through the rest of the U.S. in 1978. Here's how it worked:

In brief, I'd buy a copy of the Circle of Gold letter from you for $50 cash, and then mail $50 to the name at the top of the list, for a total outlay of $100. I'd then make two copies (removing the name at the top of the list an inserting my own at the bottom) and sell each for $50 to friends/family, for a total of $100, thus breaking even. The buyers in turn made copies and sold them on, the chain continuing. At some point my name would arrive at the top of the list and the money would begin to arrive in my mailbox.

Law enforcement declared the Circle of Gold letter to be illegal. But there was little they could actually do to stop it.

Chain letters like Circle of Gold may be difficult to eradicate, but they suffer from two big problems. I'll explain each of these problems, and also show how they were eventually fixed.

If decentralization is a chain letter's greatest strength, it is also the root cause of its main weakness. A buyer of a Circle of Gold letter had an incentive to break the rules by sneaking their name to the top of the list. Without a centralized administrator, there is no one who can prevent players from cheating.

This is the first weakness of chain letters. We'll call it the dishonesty problem. The dishonesty problem undermines a chain letter's credibility. If everyone knows that cheating will be rampant, they won't bother getting involved at all. Thus the odds of a letter widely propagating is going to be quite low.

To help make a chain letter more transmissible, what is needed is some sort of procedure that solves the dishonesty problem while preserving decentralization.

Enter Mega$Nets.

Mega$Nets was an ingenious 1990s-era chain letter that relied on software to prevent cheating. Here's how it worked:

I buy a $20 Mega$Nets disk $20 from you
After booting up the software I'd be asked to input my name and address, which was now locked into the program
Before I could make copies of the disk, I had to mail $20 in cash to five others above me on the list. Once the $20 was received, these people would mail a code back to me.
Only after I had entered the codes into the software could I duplicate the disk and sell it for $20. If the chain grew and my name worked up the list, I'd eventually start receiving a stream of $20 payments in the mail.

Mega$Nets software prevented names and addresses from being erased, thus preserving the list order. Importantly, it solved the dishonesty problem without compromising the decentralized nature of a chain letter. After all, Mega$Nets software ran independently on each individual machine, not from a central server.

Source: Donald Watrous's chain letter links

If Mega$Nets solved the dishonesty problem of chain letters, it didn't stay around very long. Eventually a programmer hacked Mega$Nets and figured out how to cheat the system. To undermine trust in the chain letter, he published his crack to the internet so that others could download it.

Now let's get to the second major weakness of traditional chain letters. Even if a chain letter manages to solve the dishonesty problem, it still suffers from another big weakness: lack of fungibility.

Fungibility is the idea that all members of a population are perfectly interchangeable with each other. Rice is fungible because one grain of rice is pretty much identical to another. My Tesla shares are fungible with yours. Dollar bills are fungible.

But positions in a chain letter like Mega$Nets are not fungible. A spot at the top of a chain is more valuable than a spot further down. And a spot on branch A of the Mega$Nets chain may have a different value than a spot at an equivalent height on branch B of Mega$Nets.

This lack of fungibility impinges on a players' ability to sell their spot in the chain letter to someone else. With every position in a chain letter being radically different, it's a huge chore for potential buyers to evaluate the market value of any single spot. And so a healthy resale market for chain letter spots can never develop.

Why would we want to be able to sell out of a chain letter? One of the big attractions of buying stocks, ETFs, bonds, gold, or currency is that we can resell these instruments, maybe two minutes later, maybe two decades later. If we are locked into an investment forever, we probably wouldn't want to invest very much in the first place. Likewise with chain letters. If a spot in a chain letter can be easily resold at a later time, then making an initial investment in the chain letter becomes a much more attractive proposition.

But is it possible to design a fungible chain letter? And if so, can we also solve the honesty problem while preserving decentralization? It sounds impossible.

Enter bitcoin, the world's first honest & fungible chain letter.

The novelty with bitcoin is that there is a fixed number of spots in the list.* New players can only join by purchasing a pre-existing position in the chain.** 

This approach is different from a more traditional chain letter like Mega$Nets or Circle of Gold. With Mega$Nets, the list is dynamic, not static. The number of spots in the list starts out small and expands organically as people join up, append their name, and generate a new spot in line. No need to buy someone's position out. Just add your own. New spots, however, are subservient to old spots

But Bitcoin software creates all spots on the list ahead of time, so no spot is superior or inferior to the others unlike . All bitcoin positions are fungible from the get-go.

As with every other chain letter, players "win" at Bitcoin by being early. The difference is that with bitcoin, winning is achieved by being one of the first to buy up a spot in a fixed non-hierarchical list. With a traditional chain letter like Mega$Nets, winning is achieved by creating one of the first entries in a hierarchical list that lengthens over time. Either way, the earlier one arrives, and the more latecomers who join up down the road, the richer one gets.

Because every single spot on the bitcoin list is fungible, buyers can easily appraise the worth of any single bitcoin (i.e. chain letter spot). And so a robust secondary market for bitcoins has developed where early bitcoin players fluidly auction off their positions to newer players. This marketability is one of the things that has turned bitcoin into such an incredibly contagious chain letter.

Bitcoin doesn't just solve the fungibility problem. It also fixes the dishonesty problem. Bitcoin software ensures that it is impossible for anyone to conjure up a new spot on the bitcoin list, or re-arrange the distribution of existing spots. (Some people describe this as solving the double-spending problem of electronic cash, but in this blog post it is the honesty problem of chain letters that is being fixed).

Finally, bitcoin achieves all this while being just as decentralized as its chain letter predecessors. 

Bitcoin is decentralized because individual participants can buy and sell bitcoin (i.e. spots in the list) in bilateral pairwise meetings. No need to rely on a central planner to distribute funds from late entrants to early birds. Secondly, much like Mega$Nets software, bitcoin software is deployed on thousands of computers all over the world. No central server. So like its traditional chain letter predecessors, bitcoin is very difficult for the authorities to attack.

In conclusion...

At first blush bitcoin seems like an entirely novel financial technology. But as I suggested in my post, it's just a meaner & badder version of chain letters like Circle of Gold and Mega$nets. 

What is revolutionary about bitcoin is how it has modified the chain letter model in order to solve the dishonesty and fungibility problems. Until bitcoin arrived in 2009, we had never seen the full capabilities of chain letters. Sure, chain letters regularly popped up, but they never lasted for more than a year or two. They were niche financial games played by odd people. Upstanding folks didn't touch them.

By solving the two problems of chain letters, bitcoin has radically dialed up the contagion factor for chain letter technology to a degree never experienced before. Bitcoin has become the first chain letter to go mainstream. It is the first chain letter to go global. Your sister is playing, your cousins are in, and so is your neighbour. Old-fashioned chain letters were for folks on the fringe. But playing bitcoin is something that regular people do. The abnormal ones are those who haven't yet secured a spot in line.


*Bitcoin has a 21 million cap. These 21 million coins were not created at inception. However, the protocol sets out the rules for their creation ahead of time.

** Players can also join by "mining" bitcoins. Mining is one of the processes that updates & secures the chain letter. Computers that engage in mining are rewarded with new bitcoins and/or a small fee out of the existing stock of bitcoins.


  1. All true, except that bitcoin is not JUST "a meaner & badder version of chain letters."

    It is also the first transferrable digital token of value, able to be used independently of government and government-regulated banks. This gives it great value, regardless of the chain aspect.

    1. Sure, bitcoin has tertiary functionality as a sort of digital cash. But most people adopt it to enjoy its core functionality as a chain letter. Bitcoin's thrilling volatility and potential for lottery like winnings have helped it go viral. But these very same features are what militate against it ever functioning as ecash.

    2. Especially if you want to be paid for extrotion, hacking, drug smuggling, or terrorism.

    3. Because bitcoin's core lottery function interferes with its ability to perform as cash, only motivated people will ever use it for the latter purpose. Unfortunately, "motivated" often means bad actors. But not always. It also means hobbyists. It also can be useful to those who buy & sell controversial but legal products, i.e. white supremacist literature.

    4. Bitcoin doesn't have to be used as cash to be valuable, people don't use gold as cash.
      Store of Value for fucks sake. But also many people will accept bitcoin as cash because they agree with the speculative premise that relative to other assets it's likely to appreciate in value because of it's scarcity. Why is this so hard for you to grok? Your chain letter idea is a Ponzi - just read one wikipedia article and you would know the difference. Please for my sanity, just do some basic critical thinking and reading.

  2. Hi JP,

    I think there's a few core misunderstandings in this essay. The Circle of Gold and Mega$nets were both predicated on future cash flows from buying in, derived from additional people buying in to continue it. Classic ponzi, albeit decentralized (with subsequent beneficiaries perpetuating it instead of a single boss running the show).

    Bitcoin is simply a fixed-supply token which people over time have chosen to value in an open market. There is no 'place in line' and getting in 'early' doesn't guarantee any sort of future return. The price is currently near all-time-highs, which means anyone before last month was 'early' but the price may easily drop 50% or more at any time. Is Tesla stock or any equity just a ponzi scheme where early buyers hope to dump on future buyers? I would say no, it's an asset class which is in price discovery mode, and it may end up being worth $0 in which case early buyers will have lost just as later buyers have.

    Mega$nets and circle of gold depend on the scam lasting just enough longer for you to get more than your investment back, at which point you've made your money and are sitting pretty. Short term speculators may do the same with Bitcoin, meaning Bitcoin can be used by some in that way, but that does not mean that's the entirety of it.

    Your comment of "If we are locked into an investment forever, we probably wouldn't want to invest very much in the first place" reminds me of buying real estate. Some may buy it to speculate and limit their downside, but many use houses as their single largest asset, hope it will appreciate over time, and in fact spend an enormous amount of money on it up front. Bitcoin is similar for some. Like real estate, you can borrow against Bitcoin collateral. You can even rent your Bitcoin out for cash flows similar to real estate. I'm guessing nobody securitized their circle-of-gold or Mega$nets positions, borrowed against them, etc...

    Finally to your reply to Mr. Lott, I disagree that the speculative use of Bitcoin prevents it from being used as ecash. Sure you can speculate on it, in which case your 'use case' is speculation. However anybody can also use the Bitcoin network as an ecash to conduct business, donate to charity, temporarily store some wealth, etc. Nobody takes Tesla stock in exchange for goods, but an internet-native ecash will increasingly be useful in transactions, no speculation needed. Buy some Bitcoin via an exchange, and send it to the person you're transacting with. Perhaps this is an American under the age of 10 with no bank account. Perhaps it's someone abroad with a smartphone. Perhaps it's a piece of software which will send you files when you send it Bitcoin, like a digital vending machine. Perhaps it's WikiLeaks or another 'dissident' organization who has had their traditional payment rails cut for political purposes. No Mega$nets ponzi will help you transact freely with anyone with a smartphone.

    Thank you for writing this piece, it was a good read about a piece of financial history despite my disagreements. Happy to flesh out any of this further!

    1. "I'm guessing nobody securitized their circle-of-gold or Mega$nets positions, borrowed against them, etc..."

      They didn't. That's because these early chain letters hadn't figured out fungibility yet. Once every spot in a chain letter's list has been made equal, it's easier to appraise the value of owning a spot in that chain letter, and this lets players use their chain letter spot as collateral. Mega$nets didn't figure this out, bitcoin did.

    2. You say "The novelty with bitcoin is that all the spots in the list are created at inception." this is a complete misunderstanding of bitcoin. First of all the coins are minted continuously, even today 900 are minted a day. Secondly, your 'spots' analogy makes no sense, people buy the coin at a market price and then sell it at a market price just like a commodity.

      I could go on and on about how dumb this is, but I just don't have the time to argue with a retard on the internet.

  3. Interesting article - I really enjoyed it and it did offer a fresh perspective. However, as someone who uses crypto to buy marijuana, it is invaluable to me. I mean this in terms of my health - and there should be no price for someone's health. I have severe endo - opiate painkillers are not an option for me because they're far too addictive. Weed, on the other hand, has literally saved my career (as I had to take a lot of time off work due to burst cysts and ovarian torsion). Especially since in my country it isn't legal yet. I only need a small amount twice a week to stave off the incredible pain I live with on the daily. Without crypto, I wouldn't be able to buy weed anonymously, there would always be the danger that I could be caught up in a sting. BTC is seen as the next global reserve currency - and it will be. It is only a matter of time. I couldn't ease my pain with a chain letter, let's put it that way! Loved your article, all the same though. Thanks for bringing a fascinating perspective to a subject that is misunderstood.

  4. Novogratz agrees - "I do believe Bitcoin is going to be digital gold. That means it’s the only one of the coins out there that gets to be a legal pyramid scheme. Just like gold is."