In April of 2021 Bernie Madoff passed away while serving a 150 year sentence at the Federal Medical Center, Butner, a special health needs federal prison for inmates near Butner, North Carolina. Madoff was the author of the largest and longest running Ponzi scheme ever in which as much as $65 billion (including fabricated gains) went missing. Mr. Madoff came to mind this morning when we heard that Sam Bankman-Fried of FTX fame was taken into custody by Federal Agents. The SEC has issued a statement in a parallel civil complaint saying that there was massive fraud for years. So, was FTX just another Madoff Ponzi scheme or simply a business mismanaged by its owner?
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What Constitutes Fraud in the World of Crypto?
A valid concern for crypto investors for years has been crypto fraud. Actually there are eight different kinds of cryptocurrency fraud.
Crypto Financial Crimes
Governments have been concerned about how the international reach of cryptocurrencies, their portability, and virtually instant transactions have given criminals new tools for money-laundering, avoiding taxes, bribery, and terrorism. This facet of crypto fraud is a major focus of crypto regulation.
Initial Crypto Token Offerings That Are Scams
The success of Bitcoin and several other major tokens like Ether has fueled huge growth of the crypto realm with thousands of new tokens. Unfortunately, gullible investors with little experience but lots of hope are too often taken advantage of. Some initial coin offerings are hoaxes. Bios are created for team members that do not exist and technical explanations of the workings of the system are simply copied from other legitimate crypto operations.
Cryptocurrency Pump and Dump Schemes
The pump and dump is an age old way to profit with investments like penny stocks. It is also used from time to time in the crypto world. We have written about Bitcoin wash trading in which bad actors try to give the appearance of high trading volume in order to drive prices up. Likewise, efforts like celebrity endorsements can fall into the same category. Crypto pump and dump schemes are perhaps most common with startups but seem to be happening even with Bitcoin, the biggest and oldest cryptocurrency.
Manipulation of Crypto Markets
This sort of manipulation takes place within the markets themselves and affect direct crypto trading and trading of crypto derivatives. Churning, front-running, and spoofing are terms for various types of crypto market manipulation.
Unscrupulous Crypto Promotion
This falls into the celebrity endorsement realm in which famous people are paid to read from a script about how great crypto is. What they do not disclose is that they have no special expertise to promote an investment and that they are being paid for their efforts.
Traditional Crypto Theft
Hackers fall into this category. They overcome crypto system defenses and simply steal the necessary code for a person’s crypto wallet. Fake wallets and fake crypto exchanges are part of this picture.
Crypto Pyramid Schemes
For years cynics have called crypto a Ponzi scheme. A more accurate term is a pyramid scheme. A Ponzi scheme has one perpetrator while a pyramid scheme has many. People who get in early get money from those who come later. It is instructive that a successful investor like Warren Buffett does not constantly promote stocks that he invests in but many who invested early in Bitcoin and the rest are avid and aggressive promoters.
Fraud by Dealers, Brokers, and Crypto Exchanges
This is where any fraud perpetrated by Bankman-Fried would lie. Investors purchased his tokens which are understood to be a store of value. Then, rather than safeguarding them, he lent them to allied companies and called them assets of that arm of his crypto empire. He lent them to himself for personal use all the while, never telling his investors that he was taking their assets for his personal use. The initial evidence coming out of the FTX bankruptcy hearings made us wonder if it was failed business or fraud that brought FTX down. Sadly, it would seem that fraud may be the case, putting the FTX collapse in the same category as the Bernie Madoff scheme where investors were continually defrauded from the very beginning.