Many people seem to think that cryptocurrency is a legitimate response to the “evils” visited upon the world by banks, Wall Street and other intermediaries. They see the mainstream world of finance as corrupt and predatory. Many of these same people are confident that a decentralized system of cryptocurrency will be more transparent and therefore will reduce the bad acts and eliminate the bad actors.
The same old scams that these crypto enthusiasts hate are playing out in the crypto market every day. It is actually easier to scam people in the crypto market because both the players and the investors are remarkably naïve.
There has always been crime and criminals in the financial markets. Some of the same scams have played out over and over for more than 100 years. The perpetrators and the technology change but at their core many of the scams are the same. The scams succeed because the one fact that never changes is that investors can be both greedy and stupid. But that fact does not excuse anyone who lies to investors or takes advantage of investors’ stupidity.
Regulation came to the capital markets in the first decade of the last century in the form of “blue sky” laws that were passed by various states. They were called blue sky laws because they sought to put an end to “speculative schemes which have no more basis than so many feet of blue sky”. Or more succinctly “to stop the sale of stock in fly-by-night concerns, visionary oil wells, distant gold mines and other fraudulent exploitations.” Those laws still exist today and were enveloped in a series of federal anti-fraud laws in the 1930s.
I invite you to read the white papers for ten Initial Coin offerings (ICOs). Pick any ten at random. What you will find are the same “fly-by-night” companies that claim that they are going to disrupt this or that multibillion-dollar industry without so much as a bookkeeper on staff. Almost every white paper I read clearly violates both state and federal law because they do not make full and accurate disclosures. That is why US regulators are perpetually busy issuing injunctions to stop ICOs in their tracks.
In many cases the ICOs are trying to convince themselves that they are not offering securities so they do not have to make the required disclosures. In some of these cases it is because accurate disclosures would sink the offering. It is hard to find even simple disclosures like “there are other, larger and better financed companies in this market with whom we will have to compete”.
In other cases, the companies claim to be domiciled in other countries and are not subject to US laws. I get several e-mails a week soliciting my investment in an ICO domiciled in another country. Of course if you are soliciting investment from US citizens, then US law applies.
The ICO industry does not acknowledge that it needs to play by the rules. It calls the rules old fashioned and out of date for the modern global economy. But those rules still apply and failure to follow them is often criminal conduct.
An ICO is an off-shoot of equity crowdfunding or direct to investor financing that uses the internet rather than a brokerage firm to reach potential investors. Equity crowdfunding was billed as an inexpensive way for small companies to have access to investors.
In the mainstream markets a brokerage firm will conduct a due diligence investigation of the company seeking financing. The purpose of a due diligence investigation is to have a professional verify the information that is being given to potential investors. This protects investors from the most obvious scoundrels.
With a few exceptions the crowdfunding industry never bought into the idea of due diligence and many of the worst crowdfunding platforms and crowdfunding “advisors” make no serious attempt to verify whether any of the information given to investors is in fact true. The worst of the crowdfunding platforms and advisors have seamlessly moved into the ICO market.
The ICO community suggests that investors conduct their own due diligence investigations. How, exactly, does a small investor thinking about investing in an IC0 which claims to have a new complex technology and a management team spread over 5 countries “investigate” the offering? Did the management actually graduate from the schools they claim and work at the companies they list? Are the advisors that are listed actually participating? Does the tech violate someone else’s patent? Is the potential market really as big as they say it is? Who are the competitors and how are they positioned in the market?
The ICO market is a market where telling investors the truth is the exception rather than the rule. In my thinking, every person who sells tokens in an ICO without telling investors all the material facts is a criminal. And that describes the bulk of the ICO market and ICO advisors.
After the tech market collapsed in 2001 it was revealed that many of the research analysts at the large Wall Street firms had conflicts of interest. Keeping the large tech companies happy meant a lot of investment banking fees for the firms. That is just what the analysts did; they said nice things about the long term growth prospects of companies that were a step away from bankruptcy. This type of behavior is also clearly illegal.
It is absurdly easy to purchase a good rating for an ICO. Advisors on one of the largest ICO rating platforms, ICO Bench, sell good ratings to any ICO that wants to pay for one. A pay-for-play rating violates many laws. Many people in the ICO industry are aware of the practice and keep their mouths shut. In my mind, any rating by ICO Bench is a scam and ICOs that use an adviser affiliated with ICO Bench should be avoided at all costs.
I recently read an article by Jordan Belfort whose antics were portrayed as the Wolf of Wall Street. Belfort is no fan of cryptocurrency but he is an expert on pump and dump schemes. What he sees when he looks at an ICO is a lot of insiders and advisers getting a lot of cheap tokens before the public gets any. The insiders then loudly hype the company and dump their tokens on the unsuspecting public. It is exactly the same method that Belfort used and he landed in jail for doing it.
If you follow the Bitcoin trading market it is impossible to avoid repeated allegations of market manipulation. Crypto enthusiasts are always writing articles claiming that the price moved up or down because some “whale” took a large position or dumped one. No one knows for certain because the cryptocurrency world is anything but transparent. Many of these people write articles claiming that some large investor has “blessed” cryptocurrency or is making a sizable investment. They repeat every unsubstantiated positive rumor while ignoring the reality that the rumor they spread last month never came true.
That there is real crime in the crypto world is evidenced by theft and money laundering. More than $1 billion has apparently been stolen from electronic wallets and crypto exchanges. Banks spend a small fortune on technology to keep their accounts un-hackable. The crypto world which is based in technology cannot seem to get its act together.
Likewise, governments all over the world are constantly reporting that money laundering by drug cartels, human traffickers and the like are a significant problem. The FBI recently reported that they have 130 active investigations concerning money laundering and cryptocurrency. Governments in other countries have many more investigations under way.
In response, the crypto world always says that a lot more money is laundered through banks than with crypto. That logic is very similar to saying that you can get food poisoning at any restaurant, so why should we make our employees wash their hands. Again banks spend a lot of money on anti-money laundering protocols even if they are not perfect. Most of the crypto exchanges spend little or nothing.
Organized crime has been active on Wall Street for decades. The NY State Attorney General did a study back in the 1990s that concluded that organized crime was operating smaller brokerage firms that were foisting pump and dump schemes to unsuspecting investors.
A few weeks back someone sent me the prospectus for an ICO that had filed for registration as a Reg. A offering. The company is just a lawyer who is going to raise $50 million and then hire developers to create blockchain based projects for this industry or that.
It was a vanilla offering, more akin to a shell than a company; the kind of shell commonly used for pumps and dump schemes. The lawyer has actually represented small brokerage firms that have been accused of pump and dump schemes and also people associated with organized crime families. How do I know? I “googled” the lawyer’s name and that is what I found. So why would a lawyer who has ties to organized crime register a shell? If you do not know the obvious answer, you have no business calling yourself a crypto “expert”.
Everyone I speak with in the crypto world is confident that it will continue to expand and that more and more investors will be drawn to it. But that will remain a myth unless and until investors are always told the truth about ICOs and their secondary markets. It will remain a myth until the honest people in the industry are prepared to start publishing articles about advisers listed on ICO Bench and other ICO charlatans and stop inviting them to speak at conference after conference. It will remain a myth until the platforms spend what it takes to become as secure as banks, so that the tokens they hold for investors cannot be stolen and the trading platforms can identify and refuse to deal with the drug dealers and human traffickers.
Do I think any of this will happen? Not a chance. Within hours of the time I publish this article I will begin to get e-mails from people who will tell me that either 1) the regulations or protocols I seek will act to centralize a market that is supposed to be decentralized; or 2) decentralization and blockchain will fix all these problems; or 3) I am too old to understand modern technology or the “new” world of finance. In the meantime the crypto market will continue to be a cesspool of criminals and criminal acts; the very conduct its backers detest in the mainstream markets.
by Irwin G. Stein, Esq.