In my new book Don’t Fall for It: A Brief History of Financial Fraud (Does anyone get tired of talking about it?) I have compiled a list of 8 conditions that usually occur when financial fraud is flourishing.
They are (in no particular order):
(1) If there is an expert with a good story
(2) When capital goes blind
(3) When the banking industry gets involved
(4) When individuals start to focus on the crowd
(5) When the markets rock
(6) When the opportunity arises
(7) When people are involved
(8) When innovation is widespread
All fraud and scams don’t necessarily affect every one of them, but this is a decent framework based on my research.
The logical question that some people have asked me now is: Which areas of the markets or the financial area fit this calculation today?
With yields so low and so many people ill-prepared for retirement, there are likely to be many scams that involve guaranteed income payments with a high promised return.
However, the obvious answer is cryptocurrencies.
Let’s look at the list to see how many of these crypto hits:
(1) If there is an expert with a good story. The secret behind Satoshi, the anonymous founder or anonymous founders, along with the anti-establishment / tech-libertarian utopia dream, makes crypto the perfect story-based financial asset. Add keywords like cryptography, decentralization, cold store, blockchain, and digital wallets, and it’s easy to see how easy it would be to create confusion here.
(2) When capital goes blind. Walter Bagehot once described speculation as “blind capital”. There are many blindfolds in the crypto space as many believe it is their savior no matter what. It’s like a religion.
(3) When the banking industry gets involved. This is a case where Wall Street hasn’t really hit the accelerator, which may make the existence of space fraud easier. It is still the wild west in many ways.
(4) When individuals start to focus on the crowd. The surge in crypto prices after Thanksgiving weekend 2017, when everyone went home to talk to their families about it, was an unforgettable sight. The herd mentality works in both directions, but is omnipresent in this room.
(5) When the markets rock. Bitcoin gained 1300% in 2017. In 2018, it decreased by 74%. In 2019, it grew by more than 90%. This boom-bust pattern invites bad actors because increased volatility plays with investor emotions in both directions.
(6) When the opportunity arises. There are many doomsday hunters who, according to their predictions for the end of the world, have turned the crypto hard and acted against the Fed on the stock exchange. This space is ripe for financial predators who want to take advantage of the emotions of investors.
(7) When people are involved. Check.
(8) When innovation is widespread. This is probably the biggest factor in crypto history. It is new and exciting. It is innovative and difficult to understand. And when something is difficult to understand, it is easier for people to pull the wool over their eyes because they present themselves as knights in shiny armor who can find out how to make money with them.
Here is the Wall Street Journal about the ever growing fraud in crypto:
Cryptocrime is growing. Ponzi programs and other Bitcoin and cryptocurrency frauds attracted at least $ 4.3 billion from investors in 2019after chain analysis. That was a larger sum than the combined $ 3 billion in 2017 and 2018.
After a boom in dubious coin offerings in 2017 and a series of hacks in 2018, Ponzi programs are among the most popular means of fraud. The largest were productive: only six well-orchestrated scams accounted for about 90% of the money stolen last year, Chainalysis said.
I can’t believe that Ponzi programs still exist, but here we are. The number of fraud cases in 2019 was higher than in 2017 and 2018 combined:
As with most financial scams, there are stories that are incredible, yet true. Here is one that defeated a group of major league baseball players:
The U.S. intelligence agency arrested John Michael Caruso on January 30. Caruso is the founder of Zima Digital Assets, a blockchain and cryptocurrency investment company, and has described himself as “The Michael Secretus” “Michael Jordan from algorithmic cryptocurrency trading.” The authorities arrested Zachary Salter, an aspiring R&B singer who founded Zima with Caruso on the same day.
But he was the Michael Jordan of algorithmic cryptocurrency trading! Who could have seen that coming ?!
This Ponzi program was “only” $ 7.5 million, but it also included seniors who were impressed by claims that they could use algorithms and “proven” strategies to predict the future. The two scammers who managed to do this were basically broke before finding unsuspecting markets to give them money to fund lavish lifestyles:
Most of the money that Caruso and Salter took from their customers went not to investments, but to financing their opulent lifestyle, prosecutors say. They each lived in villas worth about $ 9 million. Caruso is the registered owner of a 2019 Lamborghini Urus and has spent at least $ 350,000 in the past two years renting a Rolls Royce, a Ferrari, and an Aston Martin, among others. Caruso, who has flown private jets to London, New York, Chicago, Los Angeles, Hawaii, Cabo San Lucas and Aruba in the past two years, has made about 30 trips to Las Vegas, where he spent more than $ 1.4 million lost while playing in a period of 13 months.
Here’s another one SEC that involved a number of doctors1:
The SEC claims that Michael W. Ackerman, together with two business partners, raised at least $ 33 million by claiming to investors that he had developed a proprietary algorithm that could help him make exceptional profits trading cryptocurrencies. The SEC’s complaint alleges that Ackerman misleading investors about the performance of their digital currency trading, its use of investor funds and the security of investor funds in the Q3 trading account. The complaint also alleges that Ackerman edited computer screenshots of the third quarter trading account to create the illusion that the third quarter was heavily invested in cryptocurrencies, was extremely profitable, and had assets of up to $ 310 million , In reality, the third-quarter trading account never claimed more than $ 6 million at any time, and Ackerman was He personally enriches himself by using $ 7.5 million in investor funds to buy and renovate a house, buy high-quality jewelry and multiple cars, and pay for personal security services.
Whenever someone tells you that they “cracked the code” or “uses a proprietary algorithm that generates extraordinary profits”, you should be extremely careful. This applies to crypto, stocks, bonds, real estate, baseball cars or any investment strategy that someone is pursuing.
As crypto becomes more popular and attracts public attention, this stuff is likely to only get worse. Many more people will lose money on false claims hoping to have found electronic gold.
The combination of a difficult-to-understand technological innovation with a good story will be too difficult to miss, both for those who want to commit fraud and for those looking for wealth overnight.
It’s a perfect mix of innovation, hype, emotions and hope.
I’m still not sure how the whole crypto thing will develop in the coming years. But I can guarantee that crypto fraud will continue to be a growth industry.
The man who tried to sell the Eiffel Tower (twice)
1Based on my research, doctors are one of the most vulnerable groups regarding financial fraud. Doctors are so intelligent that they often become too confident in their investment skills.
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