
It’s Not a Bubble, People; It’s a Pyramid Scheme  - cwan
http://www.pehub.com/96111/its-not-a-bubble-people-its-a-pyramid-scheme/
======
snewe
Mark Cuban's statement is only true if the VC financings are simply a buyout
of previous investors. Many of Facebook's recent financings were capital
injections + buyouts of founder and early VC shares. I don't believe this is
the norm. Simply, VCs at round t-1 typically participate in round s > t and if
they don't, future investors will not buy them out. If they did, it would
simply mean that none of the money going to firms like Twitter and Zynga is
used for investment.

~~~
SriniK
Lot of people including Mark Cuban predicted that Youtube is a sinking boat
and that Google made a horrible mistake in buying it. Look at the present
situation - youtube is raking in 1B per year.

Any market leader facebook/zynga/twitter with their user base can become a
cash cow with enough focus. No one else in the world get internet companies
like valley/US does. This is the single most reason every other country's .com
company gets traded in nasdaq.

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forgottenpaswrd
Agreed.

It seems human beings are really bad at mathematics, we could spot a quality,
but not the quantity.

In Spain people thought houses near the beach were always in demand by
Europeans because of the good weather(quality), but failed to understand there
is a limit to the money they will pay for it(quantity).

With facebook people could see the value it gives to the world witch is real
(quality) but overstates the amount facebook is going to give back.

facebook is a pyramid scheme designed to make uber-rich the current shares
holders(Zuck and employees hold near half the company stock), witch is great
for them, bad for those that payed the overprice.

~~~
niyazpk
There is some serious witch hunting to be done in this thread.

~~~
georgemcbay
Toss them in a river.

If they sink they are innocent.

If they float they are in a bubble.

~~~
vinutheraj
Or you could just weigh them against a duck !

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russell
One thing that the last boom showed is that the first well executed play in a
segment captures the segment and makes competition nearly impossible. Examples
Google, Amazon, and eBay. The investors are betting that Facebook, Groupon,
Zynga, and Twitter have captured their segments and further competition is
impossible. The gamble is whether those segments are now closed. They weren't
in the case of Alta Vista and Myspace.

~~~
jdp23
I agree that the investors are making that gamble. A better way to look at
Google though is as a company that made major breakthroughs in two segments
(search, advertising) and then executed brilliantly for years while
benefitting greatly from its rivals' (Yahoo and Micro) sustained incompetence.
Which of the new group has breakthroughs in two segements? Which is on track
for years of sustained brilliant execution? Which will be lucky enough to have
incompetent rivals?

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bambax
But aren't bubbles and pyramid schemes the same thing? The article should
really define bubbles if it wants to argue they're different from pyramid
schemes.

~~~
alecco
Bubbles are usually fueled by public manias (e.g. tulips or real estate).
Pyramid schemes are planned frauds.

~~~
bambax
Ok, but both rest on the "greater fool" theory...

~~~
alecco
Yes

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joe_the_user
I think he's making "a distinction without a difference".

Pyramid schemes, Bubbles and Ponzi schemes are all instances of what Hyman
Minsky called Ponzi Finance. They all "recycle" new "investment" money coming
in as their operating income.

[http://en.wikipedia.org/wiki/Hyman_Minsky#Minsky.27s_theorie...](http://en.wikipedia.org/wiki/Hyman_Minsky#Minsky.27s_theories_and_the_subprime_mortgage_crisis)

A "pyramid scheme" makes it more explicit that the earlier entries get more.
If you make that less explicit, what else do you have but a "bubble"?

The reason not to worry about these variations is that there aren't really
three distinct variations of this theme but three million, with one born every
minute - _along with the suckers_.

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DanI-S
I've been wondering recently - a phenomenal amount of money and investor
excitement is circling around these few big companies. If it turns out that
they _are_ overvalued and the 'bubble' does burst, does this mean there could
suddenly be a surplus of capital and investor attention that will spill over
into smaller, less well known businesses?

If everyone who is waiting to get their piece of Facebook or Groupon suddenly
thinks better of it, could they decide to redirect their money toward smaller
interests, increasing the availability of capital for 'the rest of us'?

~~~
ZachPruckowski
>could they decide to redirect their money toward smaller interests,
increasing the availability of capital for 'the rest of us'?

Probably not. That money is pretty much stuck there, as VC is an illiquid
investment. Money invested in Groupon isn't going to get paid back until they
have a "liquidity event", like being bought or IPOing, or until you can sell
it to another investor. However, it's possible a larger fraction of new VC
investments could be targeted at "the rest of us".

~~~
marchustvedt
Well it's definitely not a one-for-one distribution, but those Groupon dollars
do make it around. Our site has Groupon ads popping up almost constantly, and
actually tend to yield a higher clickthrough.

Massive injections of capital into Internet businesses do help overall economy
of web startups. The danger, like the Yahoo comment earlier, are the spotty
business models and expansion that are built on that frothiness. Cause when it
goes, it's those startups that crumble first.

The ones that figure out a business model that isn't tied to a flush VC
climate should be ok. eBay as I recall, did just fine after the first bubble.

------
maxxxxx
It will have gone full circle when Facebook, Groupon and Twitter will have an
IPO. VCs and other investors will get their money back and individual
investors will absorb the losses of the collapsing pyramid.

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nissimk
All bubbles are Pyramid schemes. That's the definition. See The Financial
Instability Hypothesis by Hyman Minsky:

<http://www.levyinstitute.org/pubs/wp74.pdf>

<http://en.wikipedia.org/wiki/Hyman_Minsky>

When the economy reaches the third phase of "Ponzi Finance," entities must
recruit additional investments to meet their interest payment obligations.
This is the classic pyramid scheme and also frequently called a bubble when
it's referring to a financial market.

Ponzi scheme, Pyramid scheme and bubble are all synonyms.

~~~
wisty
Not really. A bubble can be a self-organising Ponzi scheme - earnings from
Yahoo came from advertising which was paid for by capital going into the tech
bubble; and the pre-GFC US economy was arguably one giant bubble (with
earnings being paid by people who were willing to do overtime to keep their
million dollar houses out to the hock), but it's not quite the same thing.

They do have the same (or similar) dynamics though.

------
vessenes
I suppose Cuban's comments ring true if you think that Twitter and Facebook
are adding no value.

I am unsure how any rational technology-minded person could state that they
add no value; the idea that a technology which is one of the first Governments
try to ban when they are under fire -- that the technology must not be worth
anything -- is pretty staggering.

Facebook has a pretty clear path to socially connecting THE ENTIRE WORLD via
the Internet, and has proven it can do it in a cashflow-positive way.

I fundamentally don't understand the 'bubble' complaints right now: these
companies are the anti-boo.com's of our time: Wildly successful, working,
scaling businesses which millions of people rely on every minute to do their
work and socializing.

Focusing on valuation for smaller companies also seems silly to me: the YC
class that just got $150k per company will be able to punch out some
incredibly great and useful technology for that money. In 1999, that money
would have purchased 2-5 servers, and no co-location for them. Really. You can
worry about a bubble, but if these companies even produce 300k in value, then
the investors didn't invest in a bubble, they got their principal back plus a
little.

I do think it likely we'll swing back to a slightly less founder-friendly
funding regime at some point in the future, but it may also be that we're just
at a new plateau given what's currently possible in software. Another shift
might change funding dynamics again in our industry; but right now, a whole
lot of useful tool can be created for a couple hundred thousand dollars.

~~~
mtrn
"Facebook has a pretty clear path to socially connecting THE ENTIRE WORLD via
the Internet, and has proven it can do it in a cashflow-positive way."

Yes, I see that they can connect. And maybe tomorrows revolutions will use
facebook -- but the fact remains that I value my privacy and those of my
social relationships. That's just it.

~~~
rayiner
You might, but all the people using Facebook really don't. Especially the
whole 13-33 contingent raised with the internet - the convenience of being
able to keep in touch with your friends circle is worth more to them than
their privacy.

If you think privacy concerns are going to hinder Facebook's profitability
you're completely wrong.

------
alecco
This is unoriginal. And as someone else stated on FT, the last layer of the
pyramid scheme is probably aimed at dumb money. Unintelligent mutual funds
(mis) guided by S&P and Moody's ratings for inflated assets. Just like it
happened in 2006-2007. I believe more "AAAA++++ would buy again" ratings from
random people on auction sites than credit rating agencies. It's a scam with
many players. The agencies get their cut, too. And there's no downside for
them (mostly).

Edit: it happened with government bonds, too; in fact it seems they move on to
the next scam every year.

~~~
omh
S&P / Moodys are rating companies for debt, not equity. The investment
proposition for someone lending a company money as a secured creditor is very
different to someone investing equity, and I'm not sure that it directly
results in investors getting any profits.

~~~
alecco
Yes. I'm wrong. But the ratings of the debt of corporations are highly
correlated with their valuations.

Edit:

To be clear, I was talking about dumb money. Usually indexed funds and such.
_Enron was part of S &P 500 for years_.

------
mlinsey
I don't get it. It sometimes is the case that early-stage investors sell off
parts of their shares in later rounds, but this is not the norm. In which case
yes, there is pressure on later investors to give high late-stage valuations
for a company which had high early-stage valuations, but it's not the case
that angels and early-stage VC's can ignore the company's final outcome and
profit merely by bringing in later stage investors, which is the
distinguishing feature of a pyramid scheme.

------
thrill
Any money paid for private or public companies is entirely voluntary on the
part of the seller and the buyer. If you don't like what your investment
manager invests in, it's easy to move your money elsewhere, unless you weren't
smart enough to insure you had a way out of your investment promise. If you
want to be one of the early investors who gains the most reward, then be one
of the early investors who takes the most risk.

------
fleitz
How is this different than the economy as a whole? Look at seniorage and
Milton Friedman's take on what caused the Great Depression. As money
circulates in a fractional reserve banking system it multiplies. The last guy
holding the dollar is the guy who loses most. In times of exuberance that
multiple is greater than 1 and in times of pessimism that number is less than
1 which is why consumer confidence is essential to the functioning of the
modern economy.

Start thinking of money more as a piece of information reflecting scarcity of
supply/demand, and realize that the faster information moves the faster money
will cycle increasing it's rate of growth. It's called an information economy
for a reason, because the commodity from which we derive most of our value is
information. This is largely why it doesn't matter that China is taking "our"
manufacturing base. You can point to the importance of things like iPhones
being manufactured in China, but for the economy as a whole the AppStore is
far more important than the manufacture of the phone. As information bandwidth
increases globally so does money supply.

------
raintrees
"Either way, when the chain ultimately ends, few, including Cuban, will feel
terribly sorry for those left holding empty envelopes."

Except that lately it is usually the general public that is brought in, to
help the investors no longer be the last in the chain. Maybe this will begin
to happen with VC financing?

Along the lines of the quote I have read from several sources "when my barber
and the shoe shine boy has a stock tip, it's time to get out."

~~~
maxxxxx
I agree. In the 90's bubble the public got let in earlier. Now VCs and
investment banks squeeze all the value out before the public finally can
invest.

------
toto
In economy, if you want to avoid bubbles/pyramid burst, you have to check who
is investing (as stated by Warren Buffet)?:

The three "I" actors: \- "I"nnovators: Time to invest \- "I"mitators: Time to
be careful \- "I"diots: Time to leave

The key to success is to spot when the ecosystem's actors are switching from
the 2nd to the 3rd category.

------
takinola
umm, hate to point this out but assuming Cuban's point is true (which is
obviously highly debatable), the people with the most to gain are the founders
(from being at the tip of the pyramid) aka most people on this thread hence
there is probably a strong bias towards not recognizing the issue

------
toto
Ponzi Scheme are everywhere: <http://www.youtube.com/watch?v=ITMEZImvNio>
(Slow/questionable start... because he is trapping the guy)

------
nickpp
But whose money is in those funds managed by the fund manager?

~~~
toadi
Probably your pension.

~~~
javanix
Not unless your pension manager has some really huge cajones.

~~~
noahc
That's not true. Pension managers are increasingly turning to fund of funds
hedge funds, etc. It would only take fundA investing in a private equity or a
social media financial product and then a pension manager investing in fundA
for whatever reason.

~~~
javanix
What would the draw of a highly volatile pension investment be?

I would think that pension managers would be encouraged to keep something that
would generally have a stable (but not necessarily particularly high) yield.

I don't doubt that this sort of thing happens for various reasons, but those
managers would, by definition, be taking somewhat unusual risks.

~~~
noahc
The risks are often masked. This is an extreme example, but imagine a fund of
ultra safe bonds and an investment in Zyanga, Facebook, Twitter, etc.
Depending on the make up of the fund that particular funds risk profile may
look similar to what might be called a moderate risk growth fund.

Now, a fund buys that fund and puts it with a bunch of other funds and now the
risk profile is under another level of obscurity.

Now a manager buys that fund of fund and puts it with other financial products
and that's your pension. Basically, the further you get away from the actual
investment the more diluted the risk profile becomes. What could potentially
happen is that a particular manager is buying products that somehow are invest
in a particular sector (perhaps too heavily, and it is masked via the
layering) and the sector pops and what he thought was diversity is actually
concentrated risk.

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jdp23
Agreed. <http://bit.ly/tcangelgate> is a good example of pyramid-scheme-like
behavior.

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cfontes
The guy has a very good point.

