The Thin Line Between Cryptocurrencies and Ponzi Schemes

“I’m sure that many crypto offerings are simply Ponzi schemes.” These words from a cryptocurrency expert reverberated throughout a large meeting room at an alternative investment conference we attended recently. As lawyers who spent the last ten years zealously fighting to recover monies for victims of Ponzi schemes, this caught our attention. The comments from this crypto expert echoed sentiments that Warren Buffett expressed recently when he said: “Cryptocurrencies will come to a bad ending” largely because they “draw in a lot of charlatans.”

The crypto expert – who runs a wildly successful crypto hedge fund – met with us after his talk and we asked him what exactly he meant by his comments. His explanation was blunt – – some crypto offerings are fake. He is not alone in his assessment. The former CEO of PayPal and Intuit has declared that “Bitcoin is a scam” and attributes its success to the Greater Fool theory. Are cryptocurrencies, Initial Coin Offerings (ICOs) and crypto investments really just Ponzi schemes incarnate?

Named for the famed Boston fraudster Charles Ponzi, Ponzi schemes are nothing but expensive smoke and mirrors. A fraudster promises an investment with strong and clockwork-like returns. But in the end, the investment is merely a complex scam in which earlier investors get paid with later investors’ funds. Many cryptocurrency offerings or crypto investments may fit within what we’ve seen as intricate frauds or traps for the unwary.

Our crypto expert talked about well-publicized prosecutions, such as OneCoin, which were indeed Ponzi schemes, masquerading as cryptocurrencies. There, the promoter had no intention of ever creating a functioning cryptocurrency. The entire operation was a ruse to make off with investors’ cash. But this raises the question: how do you know if a cryptocurrency, is nothing more than a Ponzi scheme? The SEC, for its part, has issued guidance to the public about the potential dangers of crypto investments. According to the SEC “many online trading platforms appear to investors as SEC-registered and regulated marketplaces when they are not,” and that “investors should not assume the trading protocols meet the standards of an SEC-registered national securities exchange.” The SEC warns investors to be skeptical about the information on bid and ask pricing provided by many crypto trading platforms or exchanges.

Despite the SEC’s warnings, the case for crypto is not clear-cut. We’ve represented hundreds of victims of financial fraud, ensnared in both simple and elaborate schemes. These frauds share a common thread: in each, an investor thought they were putting money into a real asset, be it real estate, mining operations, or a drug development company. But the promoter instead used their money to line his own pockets. The fraudster routinely uses funds to pay earlier investors, which gives the scheme legitimacy and creates happy early investors who spread the word.  Often, the rest of the investors’ money goes towards things like private jets, luxury lifestyles, and Vegas jaunts. In the end, there are only so many investors a fraudster can lure before the scheme inevitably collapses.

Crypto skeptics liken Bitcoin and its competitors to Ponzi schemes, claiming that the concept itself is nothing more than a scam. But we see it differently. There is nothing inherently Ponzi-like about a crypto offering for one reason: legitimate cryptocurrencies have intrinsic value. Regardless of what you think about the utility of Bitcoin, it can be used for its intended purpose – to be exchanged for goods and services. The valuation of the investment might be up for debate, because Bitcoin prices have erratic booms and busts. But the investment is real. And, just like most other real-world offerings, there are lots of fraudulent knock-offs.

Certainly, a promoter using a fake crypto offering as “bait” to steal your money is akin to a Ponzi scheme. There are certainly fake cryptocurrencies that are created to lure investors to what invariably turn out to be worthless investments. And there are no doubt fake Initial Coin Offerings that invite investments of cryptocurrencies to fund an alluring startup, only for it to be revealed that the startup is nothing but a trap set by greedy and unscrupulous fraudsters. The growing list of ingenious crypto scams is just starting to come into focus. But, that is the case with virtually any new, edgy “alternative” investment.

Although some crypto offerings may indeed be fraudulent, legitimate coins and tokens do not fall within the definition of a Ponzi scheme. The ultimate question is whether the cryptocurrency or crypto investment is legitimate.

So, what’s an interested crypto investor to do? Pay attention. Do your homework. Watch out for red flags. All alternative investments are fraught with risk. Know what you are getting into. Check bona fides. If it sounds too good to be true – – it is. Apply sound principles to your investment decisions and learn more about how to avoid Ponzi’s, cons and other investment scams. When in doubt, seek professional guidance.

To learn more about how to avoid financial frauds and what to do if you have been victimized, please email us at [email protected]