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How to tell if a cryptocurrency project is a Ponzi scheme

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How to tell if a cryptocurrency project is a Ponzi scheme

The crypto world has seen an increase in Ponzi schemes since 2016 when the market rose to prominence. Many shady investment schemes are designed to take advantage of the hype behind cryptocurrency booms to woo impressionable investors.

Ponzi schemes have become commonplace in the industry, primarily due to the decentralized nature of blockchain technology which allows scammers to bypass centralized monetary authorities that would otherwise report or freeze suspicious transactions.

The immutable nature of blockchain systems that makes fund transfers irreversible also works in favor of scammers by making it harder for Ponzi victims to recover their money.

Speaking to Cointelegraph earlier this week, Johnny Lyu, CEO of crypto exchange KuCoin, said the industry is fertile ground for these types of schemes for one main reason:

“The industry is full of users eager to invest their money, and there are virtually no regulations that would prevent projects from hiding their malicious intentions.”

“Until clear and internationally approved financial regulation of the crypto industry is put in place, it will continue to witness the rise and fall of Ponzi schemes,” he said. added.

How Ponzi Schemes Work

The expression of the Ponzi scheme emerged in 1920 when a con man named Charles Ponzi marketed a high yield scheme to investors who were supposed to take advantage of postal reply coupons to make impressive income.

It promised investors returns of up to 50% within 45 days or 100% interest within 90 days. True to their word, the first group of investors earned the claimed returns, but unbeknownst to them, the money they received actually came from later investors. The ring was designed to attract new investors and resulted in the Ponzi scheme stealing over $20 million.

Although he was not the first to use such a scheme to scam people, he was the first to use it on such a scale. This is why the technique bears his name.

In a nutshell, a Ponzi scheme is a fake investment scheme that promises astronomical gains to clients but uses the money raised from new investors to pay off early investors. This helps the scammers behind such operations maintain a semblance of legitimacy and attract new investors.

That said, Ponzi schemes require a constant flow of cash to be sustainable. The ruse usually comes to an end when the number of new recruits dwindles or when investors choose to withdraw their money en masse.

How to Spot a Crypto Ponzi Scheme

There has been a sharp increase in the number of Ponzi schemes in recent years, alongside the bullish trend in the crypto market. As such, it is important to know how to spot a Ponzi scheme.

Here are some of the aspects to look out for to determine if a crypto project is a Ponzi scheme.

Ridiculously high yield promises

Many crypto Ponzi schemes claim to reward investors with high returns with little risk. This, however, contradicts how investing works in the real world. In reality, every investment involves some degree of risk.

Typical crypto investments fluctuate with prevailing market conditions, so these claims should be considered a red flag. In many cases, investors who join such networks never get their money back.

Khaleelulla Baig, the founder and CEO of KoinBasket – a crypto index trading platform – told Cointelegraph that transparency should be the most important factor to consider before investing money in a crypto project:

“What really matters is transparency on the details of the project. Most founders build their businesses on hope and optimistic projections. Check the past track record of the founding team’s delivery history against commitment.

He also advised investors to stay away from projects with obscure fundamentals based on external influences.

Unregistered investment projects

It is important to confirm whether a crypto company is registered with regulatory bodies such as the United States Securities and Exchange Commission before investing any money. Registered crypto companies are usually required to submit details regarding their revenue models to their respective regulators to avoid penalties. As such, they are unlikely to participate in Ponzi schemes.

Projects registered in jurisdictions with lax crypto regulations that additionally have Ponzi-like features should be avoided.

Some jurisdictions, such as the European Union, have already offered developing crypto regulations designed to protect crypto investors against this type of scams. According to a recent proposal adopted by the European Council, crypto companies will soon be obliged to comply with the rules of the Crypto Asset Markets (MiCA) and will need to have a license to operate in the region.

Placing crypto companies under MiCA will force them to reveal their revenue models, which will temper the rise of crypto firms relying on Ponzi-like schemes in the bloc.

Use of sophisticated investment strategies

Ponzi schemes usually allude to complex trading strategies as part of why they are able to achieve high returns with minimal risk. Many of their outlined growth strategies are generally difficult to understand, but this is usually done on purpose to avoid scrutiny.

The Bitconnect Ponzi scheme that was unveiled in 2016 is an example of a Ponzi scheme that used this tactic to deceive investors. Its operators encouraged investors to buy BCC coins and lock them onto the platform to allow its “sophisticated” lending software to exchange the funds. The platform claimed to provide monthly returns up to 120% per year.

Ethereum co-founder Vitalik Buterin was among the first notable figures to sound the alarm about the project. The scheme was busted by US and UK authorities, who branded it a Ponzi scheme. Its closure in 2018 triggered a drop in BCC prices that resulted in billions of dollars in losses.

High level of centralization

Ponzi schemes are usually run on centralized platforms. A crypto Ponzi based on a highly centralized network is the OneCoin Ponzi scheme. The pyramid scheme, which operated between 2014 and 2019, defrauded investors out of some $5 billion. The project relied on its own internal servers to run the scheme and lacked a blockchain system.

Thereafter, OneCoin could only be traded on the OneCoin Exchange, its native marketplace. Tokens could be exchanged for cash, with fund transfers being done over wire.

The OneCoin market also had daily withdrawal limits which prevented investors from withdrawing all of their funds at once.

The scheme was dropped in 2019 following the arrest of some key members of the operation. However, there is an outstanding federal arrest warrant for OneCoin founder Ruja Ignatova who remains at large.

Multi-level marketing

KuCoin’s Lyu noted that the worrying red flags haven’t changed much over the years and multi-level marketing is still at the heart of many Ponzi schemes:

“Complex payout schemes involving multiple tiers of users, referral programs, percentages, sliding scales and other tricks are all signs of a Ponzi scheme that feeds higher tiers using funds injected by the lower levels without doing any business.”

Multilevel marketing is a controversial marketing technique that requires participants to generate revenue by marketing certain products and services and recruiting others to join the network. Commissions earned by new recruits are shared with upline members.

GainBitcoin is a Ponzi scheme that has recently made headlines for using this hierarchical system. The pyramid scheme led by Amit Bhardwaj had seven main recruiters based in India and different continents around the world. Each of them was responsible for recruiting investors into the network.

The program guaranteed users 10% monthly returns on their Bitcoin (BTC) deposits for 18 months.

The scheme reportedly collected between 385,000 and 600,000 BTC from investors.

Ponzi schemes have been used by scammers for over a hundred years. However, they have been able to thrive in the crypto industry due to the lack of elaborate regulations governing the industry.

Since the crypto world is susceptible to these types of schemes, it is important to exercise caution before investing in any new venture.