Cryptocurrency Frauds or: How I Learned to Stop Worrying and Invest Smarter

November 12, 2015

The illiterate of the 21st century will not be those who cannot read and write, but those who cannot learn, unlearn, and relearn. Alvin Toffler, American writer and futurist.

Cryptocurrency frauds constitute a very sensitive issue. Though sensitive and unpleasant, we cannot evade it and act as if it does not exist. The Alpha and the Omega for fighting the frauds are knowledge and capability for reasonable thinking.

Cryptocurrencies stay out of the legislation of any country. Their very essence protests against interference and control executed by the government. Therefore, the options offered by the cryptocurrencies for the development of the business also open possibilities for development of fraudulent projects.

Negligible involvement of the states in the life of cryptocurrencies means only one thing: the quad has become a bicycle. In order to balance, we have to be responsible, reasonable and learned.

Why cryptocurrencies are the best tool for the fraudsters?

New ideas always have their first evangelists. These people develop and spread them. However, there is a vulnerable point in the life-cycle of each idea, when it is quite popular yet not clear for the majority. The fraudsters can get impressive power at this point and use the popularity of the idea for their own needs.

This stage should not frighten you, however. A strong idea manifests its strength by overcoming this stage and keep going along the path to mass adoption. We have discussed the history of the money in the article 'Cryptocurrency: A New Branch in The Evolution of Payment Systems'. The financial history, naturally, contains a number of frauds as well. However, all of them are united by one simple fact: they are outdated.

When an idea is mass adopted, it is very hard to use it for cheating people. Mass produced cars prevent the idea of super-fuel, mass credit cards prevent the idea of a device allowing to pump money to the card. What would a person think if you propose to add to his card $100 using a special device, "$10, special offer, sir"? If you do want to try this out (manifesting pure scientific interest, of course), please be sure that the person is not armed.

Idea: Banknotes as the main payment method

The history of the banknotes in Europe starts as long ago as the 13th century. The idea that universal mean of exchange might not be made of precious metal came from China with Marco Polo, a great traveller.

The notes were a lot more convenient than the metal ones. They allowed to keep the precious metal coins in the safe storages and exchange receipts with other merchants. The receipts, naturally, allowed the latter to get the metal coins, if they wanted.

Still, replacing the metal with the paper was still very far ahead. The first experiment of this kind was performed by a Scottish economist John Law who was the Controller General of Finances of France in the beginning of the 18th century. By that time, the notes were already introduced to the French, yet they were always backed by gold and silver.

The economic expansion caused by the exploration of America eventually became a recession, when the people realized that tales of enormous wealth of the new lands were exaggerated. Law was the founder and one of the main shareholders of the Mississippi Company, which was managing the trade with America. He was not interested in the drop of the shares' value.

Continuous manipulations that Law conducted with the Mississippi Company shares and exchange rates led to the reduction in the company trust. People refused to use the banknotes and requested their gold instead. In order to prevent the panic and breakdown, Law declared banknotes the only legal tender.

Unfortunately, this forceful way proved to be even more disastrous for the notes, as people lost what little trust they had towards them. Still, the idea to use banknotes instead of precious metals was a strong one. It survived all errors and schemes and, as a result, reinforced the Europe economy.

Following the first experiments, the people learned how to manage the paper money and control the emission. With luck, this understanding will help us to prevent the crises like the Great Depression.

Digital Law

Creation and promotion of the idea of the cryptocurrencies has become a new Klondike for the fraudsters. The cryptocurrencies satisfy two very important requirements that allow to use them for devious beneficiation:

On the one hand, the cryptocurrencies are already quite popular. Most people have already heard or have an idea what Bitcoin is. On the other hand, cryptocurrencies are not popular enough for people to understand the principles of their operation. Using the appeal of the cryptocurrencies and knowing how they work, a fraudster can deceive people and profit from their greed, telling them nice tales about "collaboration" or vague words of "free economy".

Anyway, the mass cheating schemes are based on the Ponzi Scheme. Such schemes might create an illusion that their activities have some financial value, but it is not necessary. The beautiful tale about some advanced idea standing behind them increases involvement of the people. Therefore, modern scheming use a trigger that allows common people to believe that this particular scheme will make them rich.

For example, in summer of 2015, a Ponzi Scheme worked in China. It offered people to take part in the cloud-mining of Litecoin with high profit. The trigger here was the idea of cloud-mining, which implied that there is a way to get extra profit from cryptocurrency mining.

Unfortunately, the cost of access to the pool was 500 LTC. This amount could be considered reasonable compared to the profits promised by the masterminds. Extra profit from the mining was based on these 500 LTC brought by the new users. At some point, like in any financial pyramid, the creators were not able to pay the promised reward to the miners. The scheme fell down and brought the exchange rate of Litecoin with it.

This kind of schemes is not viable. In essence, they only re-distribute the existing money among the participants. Founders and those who came at the very beginning get enormous profits, those who came later get some money, and those poor souls who came the last get nothing from this scam. They only give 500 LTC each and get nothing. The pyramid collapses.

Another example of such scheme is used by a Russian investment fraudster Sergei Mavrodi. In the 1990s, he created a financial pyramid called MMM on the territory of Russia. After the pyramid collapsed, he was sentenced to 4.5 years in prison.

Sergei Mavrodi is now busy with introducing MMM in South Africa. MMM website claims that its purpose is "providing each other financial help on the principle of gratuitousness, reciprocity and benevolence. We use BITCOIN infrastructure in our transactions".

He offers interest from 20 to 100% per month. In order to make people invest into his fund, he uses the trigger "collaboration". This trigger is meant to maintain an illusion that something important and beneficial to the society is going on behind the scenes, in the same manner as the one used for the Chinese pool. This illusion implies that the fund is really able to provide such big reward for the investors.

How to defend?

We are coming to the point in time, when the cryptocurrencies become too popular. A neighbor heard something about Bitcoin. Her husband said that he heard Alan Greenspan stating that cryptocurrencies have potential, and colleague in an elevator topped that with the idea that we can get rich in a moment, when the cryptocurrencies are not mass adopted. "I need to ride the wave", says our potential investor.

In case you, or someone close to you, do get such ideas, we, the Bytecoin Team, offer our advice and experience.

The ignorant always pay the learned. If your knowledge of cryptocurrencies can be fit to one A4 page, you know nothing about them. In this case, you must not invest there.

If you do not educate yourself in this field while investing into some crypto-investment fund, your money would stay with the guy whose knowledge of cryptocurrencies can comprise a Moby-Dick sized book.

Below you will find a list of the most important points that should guide you in case you want to invest into some cryptocurrency project. If you want to save your friends and family from hasty and ill-judged decisions, send them this list:

  • If someone proposes that you invest your own money into some cryptocurrency or cryptocurrency-related projects, find out the exact mechanism of its work and how exactly this project is going to get profitable. Always ask details. If the person you are talking to cannot provide you with a clear answer and does not understand the principles of operation, do not invest.

  • Find out, who is behind the project and how long it exists. Try to get as much information about the project as you can, from different sources. If the project is relatively new, investing is risky. If the project is new and offers excess profits in case you invest right away, you must not invest. Always keep in mind that at least 2 weeks should pass from the moment you hear about a possibility for good investment to the moment you actually get your card ready. If someone tells you that you should do it immediately, see point 2.

  • Study the data about cryptocurrencies and regulations for the cryptocurrency organizations in your country in these two weeks. This will help you to evaluate the credibility of the scheme and make well-reasoned decision.

  • Always ask the following question: "What are the valuable activities of this project?" If there are none, or its value is described in broad terms, do not invest.

  • Always ask the following question: "Why is the interest rate so high?" 20% per month is almost 800% per year. This rate of efficiency can only be achieved by air-powered car or an ultimate medicine. The final recommendation is a general one, it belongs to Robert Cialdini. If you think that everything is wonderful and nice, but there is some subtle worry, do not let go of your money. Remember, you can always refuse to do something simply because you do not want to do it.

Is it really that bad?

Not at all. Everything is wonderful. We have already seen, thanks to John Law, that ingenious and useful ideas pass certain stage when the fraudsters try to help themselves to your money. It is quite normal.

Fortunately, this is not a problem. In order to fight the fraud in an organized way, there is the Government. Anyway, honesty wins in the long run.

The cryptocurrencies and business that overcome the flood of the fraudsters, that continue being honest and open, that counter criminal activities will lead the way to the new horizons opened by the cryptocurrencies.

To sum everything up, if you know that there is a strong idea behind some cryptocurrency, and the development team proves to be able to achieve the set goals, you can invest there. Still, remember that these are venture investments. Act reasonably.

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