Cryptocurrency is all the hype today. In every nook and corner, you hear someone talking about cryptocurrency. But inadvertently, it stands as something too good to be true. The mystery surrounding it makes it natural to consider it a Ponzi scheme or an MLM scam. But the truth is neither the same nor the opposite of this. To understand cryptocurrency and whether or not it is a scam, we need to dive deeper.
Understanding the Scams
While all these terms seem the same and are often used interchangeably when talking about financial frauds, they are actually quite different from each other. Let’s first understand what each of these terms stands for:
• Ponzi Schemes:
Named after Charles Ponzi and in existence since the 1920s, Ponzi scheme is perhaps one of the oldest forms of financial frauds. The reason why Ponzi scheme took off so well was the simplistic genius behind it. It works simply by taking money from one and paying to another. This is done to maintain the illusion of grand returns on investment made by the victims. Obviously, this chain cannot go for too long and would eventually fail. However, the scammer has expanded his web far enough by that point, and simply disappears with all the investments made by the current clientele.
• Multi-Level Marketing:
Quite surprisingly, MLM is not always a fraud. Though a dubious scheme, it is not considered illegal in many cases. The reason lies behind the promises made initially.
MLM is a networking scheme that works by recruiting people into the sales network in exchange of a fee. These people would have to recruit other people into the network, in exchange for a commission and a share from whatever sales the new recruits make. The whole idea is to have free marketing in exchange of profits. But in truth, the scheme is profitable only till 2 or 3 levels. Beyond that, people are in perpetual loss, while the company benefits from the joining fee.
• Pyramid Scheme:
Pyramid Scheme is often considered a subset of MLM, but there is an important distinction. In case of MLM, there is always a real product and the primary goal is always to sell that product while fooling people into becoming sellers is only the secondary objective. However, in case of Pyramid scheme, there is often no real product. The primary objective is to recruit maximum people into the network in exchange for a fee, and then make away with that money.
The existence of Pyramid scheme is the reason why MLM is now considered a fraud by experts.
Some Famous Fraud Cases
There have been many big and famous fraud cases as a result of pyramids and ponzi schemes. Let’s have a look at some of them.
1. Bernie Madoff:
Bernard “Bernie” Madoff may not have the fraud named after him, but he proved himself to be the king of Ponzi scheme. Madoff is attributed to the largest and longest Ponzi scheme in the history. Starting in the 1970s, Madoff had been fooling people for over 30 years. His clients usually belonged to the elite section of the society, as he charged $20 million just for the initial investment. By 2008, when he was finally apprehended, Madoff was sitting on top of a scam worth $50 billion, making it the largest scam pulled off by a single person in modern history.
If you were a teenager in the USA when the 21st century started, you would have probably heard about this scam. BurnLounge was a music marketing company that sold music and music-related merchandise. In addition to this, it also sold membership programs. Apart from buying the stuff offered by the company, the customers also had the option to become Independent Retailer and earn commission from direct sales. Another program existed to become a “Mogul”, which allowed customers to both earn from direct sales and sell the membership program to other customers.
However, after its operation in 2005-2007, it was finally caught by the Federal Trade Commission. Subsequent investigation revealed that out of the $28 million BurnLounge made in the 2 years, $26 million came from the membership plans alone. Out of all the customers that joined the membership program, 90% never made any profits. BurnLounge was a classic example of a pyramid scheme where the product was just a sham; a veil to hide the true fraud.
Before we begin exploring the possibility of it being a scam, we need to first understand what cryptocurrencies are.
Essentially, cryptocurrency is just another form of currency. Cryptocurrency originated after the apparent failure of digital cash, because of the flaws of the third-party arrangement. Thus, cryptocurrency provided an alternate model where the entire structure was decentralized. Everyone and no one had control.
Since the central authority was ticked off, there was no fear of someone taking over or hijacking the transactions. A public ledger called Blockchain exists to keep a record of every transaction that occurs within the network. The actual process is even more complicated, so let’s just leave it that.
There are two ways to get a cryptocurrency coin (or token), the most basic unit of a cryptocurrency. The first is by solving the cryptographic problems and get the tokens as a reward. The second is by simply buying it from coin exchanges, which is what most people do.
The following are the crypto applications that are used when dealing in cryptocurrencies:
In a decade, cryptocurrency has transformed from the science experiment to a legitimate currency. And the testimony of this would be the vast array of merchants that now accept cryptocurrency for payment purposes.
Even though it has not yet found a mass appeal, you can still go a long way with crypto shopping. App Store by Apple currently supports 10 cryptocurrencies for payment. From grocery payment to booking hotels, it is finding a use everywhere.
The primary reason why most people are buying cryptocurrency today is investment purposes. Just a decade ago, Bitcoin was literally worthless. During its peak last year, it had crossed $18,000. Most other cryptocurrencies saw a similar growth curve and their value was multiplied many hundred times over within a span of 24 months. Naturally, people considered it a great investment opportunity. Despite the huge drop during the beginning of 2018, cryptocurrency still remains one of the best places to put your money in.
Miners are the people who maintain the blockchain network, enabling the record of every crypto transaction. They give computation power to solve a cryptographic problem and get tokens in return. Mining is uncommon due to the hardware and efforts it requires, but a much safer investment option than trading.
Issues with Cryptocurrency
Ever since the time cryptocurrency started grabbing attention, speculations of it being some kind of fraud have floated around. The rapidly growing market cap of the asset does give such an impression. However, let’s make one thing clear: cryptocurrency is not a fraud or a Ponzi scheme.
The reason behind the high growth value of cryptocurrency is, as you might have heard, the “bubble”. A bubble is a term in trading that means that the value of the asset has become detached from the market value. In such a case, the market value of the asset keeps increasing, if though the actual asset might not be worth that much. But it would still be considered a risk and not fraud, so the Bitcoin bubble is perfectly legal as long as it stays afloat.
However, that doesn’t mean the cryptocurrency is free from any dangers of scamming. We are talking about an entity that is free from any central control and is not understood by even its investors. Many aspects of cryptocurrency stand vulnerable to frauds, like:
• The decentralized nature is obviously vulnerable when it comes to scammers. Due to the lack of any central authority, there are limited options to verify credibility.
• There is no qualification needed to be a crypto investor. It also means that people who barely understand cryptocurrency can be manipulated into investing in it.
• The soars and dips of the crypto market make it appear like a more advanced version of the stock market. Success stories of bitcoin and Ethereum (among many others) are enough to bamboozle amateur investors.
• Since most of the governments are neither willing to legalize cryptocurrency nor able to completely ban it, the entire crypto market is highly unregulated. There are no regulations regarding who can or can’t join. In such a chaos, it is very easy to fool novice investors.
• Lastly, there is a strong trend, especially among the tech-savvy urban youth, to invest in crypto. Even though these investors are not quite interested in neither crypto technology nor trading, they simply join due to peer pressure. Naturally, these people are the most susceptible to getting scammed.
However, one still cannot blame cryptocurrency for being the platform for frauds. It would be akin to saying that banks are fraudulent because of banking frauds. Furthermore, the risks associated with cryptocurrency are no secret. Various governments crossed the world and have reiterated them time and again as an excuse for not legalizing cryptocurrency. As cryptocurrency became a common topic in the entertainment world, the dangers of it also became an argument. Even comedians like John Oliver and talk show hosts like Jimmy Kimmel often talk about it. Additionally, every cryptocurrency comes with the clear message of “the risk is yours alone”. After all this, you can hardly blame the technology or the company behind it for misleading you.
Distinguishing Fraud from the Real
Now that there are so many schemes and investment options available, there is a big risk of getting into pyramids and ponzi schemes. Here are a few things to know and understand in order to distinguish fraud from the real.
1) Searching for the Source of Profit:
Like we discussed above, referral programs are prominent indicators of a pyramid scheme. Referrals are extremely common and almost every new (and sometimes established) company uses it to get more customers. But the question is: does it form the primary source of income for the company? In any legitimate company, the primary source would the product itself, and referrals would be responsible only for a small portion of the profits. The same applies for the cryptocurrency. If that is not the case, then maybe you are walking into a trap.
2) Understanding the Profit:
The only real reason for investing in something is profit. Thus, anyone selling you their investment product would promise profitability. But how strong do these claims sound? Almost everyone project returns that is hardly ever met. It is perfectly legal for a company to pitch its highest-ever figure, even if it never again achieved the same results. Also, it is legal to add certain secrecy towards how the investment grows and achieves the results.
However, if the cryptocurrency is claiming to give you guaranteed and multi-fold return on investment, then it is an instant red flag. Market rules either allow for guaranteed-but-small profits or huge-but risky ones. Cryptocurrency generally falls in the second category, which means that high returns are possible but the associated risk persists and might even result in huge losses. So, anyone guaranteeing high returns on crypto investments is most likely trapping you in a Ponzi scheme.
3) Dependency on New Investment:
As we saw in both Ponzi scheme and Pyramid scheme, there is a need for constant new investment for the scam to keep working. If the new investment stops even for a small duration, the entire house of cards would fall. This is what you check against the crypto investment in question.
To be honest, every company needs constant funds in order to supply. But while legitimate companies use those funds to convert into business process and finished products, sham companies simply use them as a fuel to keep fooling the investors. As we saw in the case of various scammers like Ponzi and Madoff, the funds from the new investors were used to pay the old ones, which was essential to keep the fraud alive. If you don’t want to fall into the same trap, you need to understand how much the cryptocurrency company depends upon new funds. Among the three things we discussed, this is the hardest to speculate, but it is the final step that would establish whether or not the crypto asset is legitimate or not.
Despite the apparent indication, cryptocurrency is no Ponzi scheme or scam of any other kind. However, it has every possibility to be used as bait by other scammers. It falls upon the customer to be wary and take the right decision before moving forward.