Cryptocurrency Investment Scheme Primer

The cryptocurrency industry is plagued with problematic investment opportunities. But while the historical values of cryptocurrency have demonstrated volatility, investors continue to be drawn to these investments in hopes of capitalizing on increasing value. However, cryptocurrency investments have lately been associated with fraudulent investment schemes.

Blockchain, Cryptocurrency and Smart Contracts

A cryptocurrency, also referred to as a digital or virtual currency, is a digital asset that functions as a medium of exchange. Examples of cryptocurrency include Bitcoin (BTC), Litecoin (LTC) and Ethereum (ETH). Blockchain technology facilitates the life of cryptocurrency. The blockchain is a decentralized ledger that records each transaction in a peer-to-peer network that operates publicly or privately. Blockchains allow individuals to transact directly with each other in a highly secure manner. Anything can be tracked and traded on a blockchain, including both tangible and intangible assets.

Cryptography is a secure communication technique that allows only the sender of a message and the intended recipient to view the message contents. The accuracy of the blockchain is maintained by cryptography, which validates and stacks blocks of transactions on top of one another that are irreversible, making it practically impossible for a party to tamper with the ledger.

A cryptocurrency or digital currency is a digital asset that functions as a medium of exchange using cryptography to secure the transactions on the blockchain and to control the creation of additional units of the currency. For example, the cryptocurrency used by the Ethereum blockchain is Ether, or ETH. Smart contracts are programs, or a set of rules, stored on a blockchain that execute once predetermined conditions are met.

Ponzi and Pyramid Schemes

Ponzi schemes lure investors with promises of high rates of return. However, in a Ponzi scheme, the investment is a fiction and does not generate sufficient returns to pay the investors. In some instances, the investment or business does not even exist: Investors are paid with other investors’ money rather than profits from the scheme. For this reason, Ponzi schemes need a continuous flow of new investor money to survive.

A pyramid scheme is a form of investment where top-level participants recruit new participants and are paid returns from the ever-increasing base of new participants. Investors are also drawn to pyramid schemes by alleged high return rates. The SEC defines a pyramid scheme as “an investment fraud in which new participants’ fees are typically used to pay money to existing participants for recruiting new members. Pyramid scheme organizers may pitch the scheme as a business opportunity such as a multi-level marketing (MLM) program. Fraudsters frequently use social media, Internet advertising, company websites, group presentations, conference calls, and YouTube videos to promote a pyramid scheme.” [1]

Virtual Currency Schemes

Investment schemes associated with virtual currencies are becoming increasingly popular. Fraudsters may capitalize on the popularity of cryptocurrency and pitch an investment opportunity with tremendous growth potential. Typically, unusually high growth potential is a red flag for investors, yet it might not seem unusual in a cryptocurrency investment given their historical volatility. Investors are lured by the potential of a novel investment opportunity and want to get in on the “front end” of a growth industry.

Virtual currencies may also be attractive to fraudsters because there is less regulatory oversight than transactions with traditional currencies. Smart contracts can facilitate fraudulent investment schemes because they can instantly accept payments from anywhere in the world, provide anonymity to investors, and provide the investor with a sense of comfort due to the “transparent nature” of the smart contract.

Lately, there have been myriad recent fraud schemes associated with cryptocurrencies.

The Forsage Ponzi/Pyramid Scheme [2]

In August 2022, the Securities and Exchange Commission filed a complaint against 11 individuals for operating an online pyramid and Ponzi scheme. The schemers operated a website, Forsage.io, that allowed millions of investors to send money via smart contracts on the Ethereum, Tron and Binance blockchains in exchange for a payout when they recruited other investors to the scheme. Forsage was essentially promoted as a multi-level marketing scheme, even though there was no product or service associated with the investment. Forsage raised more than $300 million from investors.

The SEC alleged that Forsage “did not sell or purport to sell any actual consumable product to bona fide retail customers” and “had no apparent source of revenue other than funds received from investors,” a common trait in both pyramid and Ponzi schemes.

To participate in the scheme, investors created a crypto-asset wallet, then purchased slots in Forsage’s smart contracts. Investors could only make money by recruiting other investors into the scheme, which created “spillover profits.” The more slots an investor purchased, the greater the promised future payout, the source of which was money from new participants.

The schemers used social media sites, including YouTube, Facebook and Instagram, to market and educate investors about the Forsage investment opportunity. While investors were assured that Forsage was a legitimate business operation, in many instances the videos disclosed that Forsage was a “marketing plan” and did not actually sell a product. The YouTube videos also represented that some investors had become millionaires by participating in Forsage. The schemers told investors that 100% of the income earned from the cryptocurrency investments went directly and transparently to the members of the project with zero risk. Both the lack of an underlying business and representations of unrealistic investment returns with low risk are red flags of fraudulent investment schemes.

The SEC alleged that the investment contracts constituted securities and that investors made an investment of money, using Ethereum, Tron or Binance tokens, in a common enterprise from which they were led to expect profits solely from the efforts of the defendants or third parties.

Trade Coin Club [3]

In November 2022, the SEC filed a complaint against several individuals for their role in Trade Coin Club (TCC). TCC was a multi-level marketing program that operated from 2016-18 and raised more than 82,000 in bitcoin, valued at the time at around $295 million, from more than 100 investors worldwide. The SEC alleged that investors were lured to the scheme with false representations that a purported cryptocurrency “trading bot” made millions of microtransactions every second and that investors would receive large returns on their investments. However, the schemers siphoned investor funds for their own benefit, and withdrawals made by investors were only funded with funds from other investors.

IcomTech and Forcount [4]

In December 2022, the Justice Department charged nine individuals for founding and promoting an $8.4 million Ponzi scheme known as IcomTech and Forcount. IcomTech and Forcount were alleged cryptocurrency mining and trading companies that promised to pay investors profits for their purchase of cryptocurrency investment products. Investors were promised guaranteed rates of returns and were told that their investments would double within six months.

However, neither company engaged in cryptocurrency trading or mining. The individuals that conducted the scheme traveled throughout the U.S. and internationally and hosted lavish presentations to lure investors to the scheme. The schemers would arrive at events in luxury vehicles and wore luxury clothing to give the appearance of success.

Once an investor made an investment in IcomTech and Forcount, they were provided access to an online portal where they could track their investments and alleged profits. Yet while the online portal reflected profits, most investors could not make withdrawals and ultimately lost their entire investment.

The scam began in mid-2017, and by early August 2018, investors were no longer able to withdraw their investments. Although investors began lodging complaints, the other schemers continued to promote the scheme and offered investors “proprietary crypto-tokens” as a means of continuing to fuel the scheme. The schemers also used shell companies to launder the investor funds and to pay for personal expenses and extravagancies.

What Investors Should Watch For

The Securities and Exchange Commission published an “Investor Alert” regarding aspects investors should beware of when evaluating virtual currency investments, including the following: promises of unusually high/consistent rates of returns; unregistered/unregulated investment products; secretive and complex investment strategies; no minimum investor qualifications; and multi-level marketing business plans with no underlying business or product.

Conclusion

Schemers will continue to target cryptocurrency’s appeal as a new technology, as well as its reputation for potentially high returns, to lure investors to fraudulent investment schemes. Investors may be given a false sense of security that their cryptocurrency investments purchased through an exchange are secure or that all smart contracts are safe and transparent. Due diligence and education are the keys to vetting cryptocurrency investment opportunities.