If you don’t believe markets should be regulated then, if you trade or invest in crypto for a year or two, you soon will. While the financial press has always been flooded with histories of dodgy dealings in finance, many of the old scams have long since been driven out of the mainstream system. They are however alive and well in crypto.
When you see any schemes that might look like these then you need to steer clear. If it looks like a duck, walks like a duck and quacks like a duck, it’s unlikely to be a swan.
The premier classic scam is: The Ponzi Scheme
Charles Ponzi was an Italian scammer. The scam is simple. Promise tremendous profits to investors, then run off with the invested cash. This basic con refuses to die with the likes of Bernie Madoff racking up billions in losses for investors only a few years back and lesser scammers getting thrown into jail every year for small scale Ponzis.
If you see a crypto “project” offering returns of 10% a year or more, let alone 10% a month, put it down as a Ponzi. A Ponzi works by paying old investors the capital invested by new investors and needs an ever growing pool of investors to remain spinning.
The profits don’t come from anything as messy as a business, they come straight from the wallets of the most recent people getting scammed. As soon as the scheme runs out of new money it collapses, though most often it collapses when the criminal behind the scheme starts to feel the net closing in on them and chooses to vanish.
If the scheme encourages old investors to find new investors, that’s another red flag, but the acid test is simple. If the scheme offers significantly higher returns or profits than you could get on Main Street from a trusted brand, it’s a scam and more likely or not the scam will be a basic Ponzi scheme.
What to do: Don’t invest in crypto schemes that promise high returns. Ever!
The Exit Scam
This has been a pestilence in the crypto sphere, especially among small exchanges, but it has been rife in initial coin offerings (ICOs). The simplest form is to promote a scheme, get money, be it an ICO or exchange, take the money and run. Exchanges have taken this to a new level of sophistication. They take coins and allow trading with them. They sell the coins elsewhere and let customers think they are trading coins but are in fact simply playing the exchange’s accounting system. The balances do not reflect coins in the exchange’s cold wallets which are, in fact, gone. When deposit requests for withdrawals get too close to the limits of their denuded wallets, they shut up shop.
Now the exchange’s wallets might have been hacked, or they might have lost the coins through a bug or sold the coins to pay wages, but the outcome is the same, the crypto is gone and the exchange goes Kapoooof! A quick error page goes up and it’s goodbye to you and your crypto. A new wrinkle to this basic model is to demand know your customer (KYC) from customers, refuse the KYC result to big customers, then close, in the hope that the exit scam can be camouflaged by KYC issues and other such misdirections.
What to do?
Do not keep large crypto balances on exchanges. Take your coins out regularly and put them on-blockchain in an off-exchange wallet. Dump any exchange that doesn’t pay out fast and/or cant be communicated with.
Basically never trust any exchange, ever, because they are just like banks. It doesn’t matter how respected they are, how regulated they are, how much money they have, how big their offices, how full of it their execs, most banks go bust. Exchanges are basically banks because they operate with only a fraction of coins that trade actually moving around the blockchain. When you trade bitcoin (BTC) for litecoin (LTC) all that happens is an accounting system tells you how many you had then, and how many you have now. The coins if they exist at all are held mainly in a cold wallet with no actual connection to the accounting system. When you ask to take your BTC or other crypto out, that operation is likely to be completely unconnected with the exchange’s operation apart from a new account entry that you took BTC out and your balance is lower.
An exchange is like a casino. You give a guy cash, he gives you chips, you play with the chips, if you have any left you go back to the guy, who takes cash out of a drawer and takes your chips. This disconnect between the actual coins and the numbers you play with when you trade, leads to the ability of the exchange to act like a fractional reserve bank, for example, to have nowhere near enough cash to pay out all depositors if they all came knocking at once.
An exchange can short coins to infinity and it will only get into trouble when crypto turns around and bites it in the butt as it rallies. As long as crypto is falling an exchange that has shorted a load of coins is in happy land, but as soon as the market zooms, they are toast. So watch out for rising crypto prices and slow payments out from exchanges. If you see that, flee! Keep moving those coins around so you can catch an exchange starting to stutter its payments as it gets into trouble and starts gearing up to do a moonlight flit.
The Stop Drive
Well, it’s the middle of the night and you are asleep. Bitcoin seems to have fallen $2,000 in two minutes and that killed your stop and you lost that trade to the tune of $1,000. Funnily the market jumped straight up a lot after. Darn!
That is a stop drive and it can come from any quarter. It can come from an exchange that knows where your stops are, can crash the price with fake moves and sweep up the profits. It can do it by actually selling real coins in the knowledge that it will make more on the stops than it will lose selling enough coins to crash the price in one minute and then having to buy them back.
The good thing about driving a stop by selling is you get your coins back from the stop covering. It’s a license to print money and across history broker-types have been unable to resist the temptation. Big rich coin holders do not puke their coins into the market in a minute. Why would they when they can slip them out over hours? Traders play the stop drive game too but it is generally the ‘house’ that plays this game the most because they have all the information to time this crime perfectly. The illegality of this doesn’t stop it happening even in stocks and commodities today but these days it’s a rarer menace than it was. In bitcoin it appears to be rife.
What is a trader to do?
Don’t have stop losses registered with the platform. Better still don’t be levered so highly you can’t hodl through these fat moves. Leverage is death even without stops, but with platform visible stops, you are going to lose your shirt. It is best to trade without leverage and without stops but leverage is seductive and the novice is drawn to it like a cliché to a flame. The platforms do not provide leverage and stops because it is in your interest, it is because it is in theirs and reflect that trading is not a caring sharing environment. If you are going to trade with stops, make them mental, if you are going to use leverage, make sure it’s low and if it’s high, realize you have to watch that position every tick.
Better still, buy and hold, buy the dips… but sadly no one ever wanted to do that, which is why there are so few old rich traders.