The Dangers of Crypto Fraud

Caveat emptor!

"Brooklyn Bridge - NYC" by Marcela McGreal is licensed under CC BY 2.0

In January, an explosive essay dropped on Medium. The anonymous author, who claimed to be an entrepreneur, said that startups involve illiquid markets, which means it takes founders and investors years to cash out of the businesses they are building.

“Crooks don’t like illiquid markets. Crooks like being able to cash out fast: the longer they stay in one place, the higher the chance they’ll be caught and arrested, because they are crooks.

“Since illiquid markets repel crooks, the illiquid startup ecosystem turns out to be largely (though not completely!) free from crooks. That’s part of what makes it such a pleasure to work in, but it also means that the community has never developed a great collective radar for fraud: it hasn’t needed one.”

People in the startup world tend to be very good at spotting opportunities that start small, grow fast, challenge the status quo and are generally misundersood, the author said. These are the features of successful startups - but also of frauds.

“Unlike startups, crypto is a highly liquid market — exactly the kind that attracts crooks, and crooks like to do fraud. And that means that many things in crypto that look like promising startups, are actually frauds.”

Modern con artists are unlikely to try to sell the Brooklyn Bridge to you. Instead, they will tell you about get-rich quick scams that don’t involve any work whatsoever on your part. You will be so interested in the big prize that you might not notice the relatively small commission you pay to get involved.

Of course, being a hedgehog (one big idea) can lead us astray. Just because some crypto involves fraud doesn’t mean that all crypto is dubious. People who understand these things tell me that bitcoin is based on truly elegant maths. Buying a few bitcoins in its early years would have been a very good bet, even if it should be seen as a new asset class similar to gold instead of a new currency.

However, Crypto Anonymous - the anonymous entrepreneur who wrote the Medium essay - warns us that crypto fraud can carry risks for genuine crypto investments, at least in the short term. The essay warned readers about tether, a so-called stablecoin, which has its value tied to the US dollar. People convert their dollars into tethers and then their tethers into bitcoin. However, what was backing tether? The entrepreneur was concerned that it was to all purposes unbacked by reserves and pulled out of crypto entirely.

The tether story has continued to develop since January. The company had always claimed to be fully backed. A few months after the Medium essay, though, Tether disclosed that its currency is 74% backed by cash and cash equivalents. In May, it said the stablecoin was 49% backed by unspecified commercial paper. This raised a lot of eyebrows!

In June, former Commodity Futures Trading Commission (CFTC) Chairman Timothy Massad warned that if tether loses its link with the dollar, it would cause a ripple effect throughout the crypto markets. In July, Bloomberg recently reported that Tether executives are being investigated for bank fraud (link behind paywall).

The situation is still developing and it is of course perfectly possible that Tether’s executives will be cleared of all accusations. Meanwhile, I’m not regulated to give you investment advice. However, as a general principal, if anyone tells you to put your life savings into crypto, please do much more research and seek the advice of investment professionals. Is it a fraud? If it was, how would you tell? If it isn’t a fraud, is it vulnerable to frauds elsewhere in the crypto ecosystem?

If investing into crypto carries more risks than you thought, what should you do instead? We have a very exciting guest column on the magic of compound interest next week. See you on Saturday!

Sharpen Your Axe is a project to develop a community who want to think critically about the media, conspiracy theories and current affairs without getting conned by gurus selling fringe views. Please subscribe to get this content in your inbox every week. Shares on social media are appreciated! If this is the first post you have seen, I recommend starting with the critical-thinking rabbit hole.

[Updated on 10 March 2022] Opinions expressed on Substack and Twitter are those of Rupert Cocke as an individual and do not reflect the opinions or views of the organization where he works or its subsidiaries.