The Great Crypto Grift May Be Unwinding

Last week, federal prosecutors arrested a fifty-year-old Long Island man and accused him of defrauding hundreds of investors by offering them gains of five per cent per week—yes, per week—from a fictional crypto-trading platform. “Eddy Alexandre allegedly induced his clients to invest over $59 million with promises of huge passive income returns,” Damian Williams, the…

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Last week, federal prosecutors arrested a fifty-year-old Long Island man and accused him of defrauding hundreds of investors by offering them gains of five per cent per week—yes, per week—from a fictional crypto-trading platform. “Eddy Alexandre allegedly induced his clients to invest over $59 million with promises of huge passive income returns,” Damian Williams, the U.S. Attorney for the Southern District of New York, said, in announcing the indictment. “In reality, no such technology existed, as Alexandre is alleged to have invested very little of their money—most of which he lost—and transferred most of it to his own personal accounts to pay for luxury items for himself.”

Alexandre is presumed innocent until proved otherwise, of course. In an initial court appearance, a judge freed him to home confinement on a bond of three million dollars. But the indictment came during what is increasingly looking like the unwinding of the great crypto “bezzle.” The term comes from John Kenneth Galbraith’s classic account of the 1929 stock-market crash, and it refers to the “inventory of undiscovered embezzlement” that builds up during speculative booms, when investors become ever more credulous and rising prices create the appearance that real wealth is being created. In this halcyon part of the cycle, Galbraith noted, “the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.” It is only after the inevitable crash occurs that many of the swindles, and alleged swindles, come to light.

The day before Alexandre’s arrest, Europol, the E.U.’s law-enforcement agency, placed Ruja Ignatova, the German inventor of the OneCoin cryptocurrency, on its most-wanted list, for “having induced investors all over the world to invest in this actually worthless ‘currency,’ ” which has produced a total loss that “probably amounts to several billion” dollars. Earlier this year, the F.B.I. arrested a New York couple and accused them of helping launder billions of dollars in stolen bitcoin.

Most crypto swindles, though, are on the smaller end of the spectrum. U.S. News & World Report recently ran an article about the “5 Top Crypto Scams to Watch in 2022.” The list includes some traditional tactics for illicitly relieving rubes of their money, such as pump-and-dump schemes and phishing for passwords. It also describes new, more novel schemes, including the “pig butchering” crypto scam, which often involves an attractive person approaching you online and offering you spectacularly lucrative crypto investments. The Department of Justice, in a sign of the breadth of the problem, has set up a new cryptocurrency-enforcement team, and the Securities and Exchange Commission announced earlier this month that it is doubling the size of its cyber division. In a press release, the agency said the new hires would investigate securities-laws violations related to “Crypto asset offerings; Crypto asset exchanges; Crypto asset lending and staking products; Decentralized finance (‘DeFi’) platforms; Non-fungible tokens (‘NFTs’); and Stablecoins.”

Despite the proliferation of scams, and the fact that drug dealers and extortionists have long been among the most enthusiastic adopters of Bitcoin, it would be unfair to dismiss the entire crypto phenomenon as a fraud. Some of the early enthusiasts, and perhaps even the original developer of Bitcoin, Satoshi Nakamoto—whoever she, he, or they are—seem to have genuinely believed in the vision of a peer-to-peer monetary system that would replace fiat money. The goal of disintermediating major financial institutions, and eliminating (or, at least, sharply reducing) some of their onerous fees, remains a worthy one. So does the idea of providing an alternative for people in countries that don’t have a stable currency. Moreover, it’s important to distinguish between scams and legitimate business ventures that seek to promote and exploit the growing public interest in crypto assets, such as Coinbase, MicroStrategy, and Silvergate Capital, all of which now trade on the stock market. There is no suggestion that they have broken any laws.

But, ever since big money got in on the crypto game—venture-capital firms, hedge funds, and, lately, some of the big Wall Street banks themselves—there has been a great deal of expensively produced puffery and flimflam surrounding the entire industry, encapsulated by the “Don’t Miss Out on Crypto” ad for the FTX trading platform, which featured Larry David and ran during the Super Bowl. The over-all aim was to make crypto investing seem mainstream and draw in gullible investors who feared they were being left on the sidelines.

Following gyrations last week of the TerraUSD stablecoin, and the evisceration of the Luna cryptocurrency that’s linked to it, investors’ willingness to swallow hot air appears to be diminishing. “Hyped and leveraged areas of crypto . . . are seeing mass liquidations, as it is becoming clearer that all the elevated prices were traded on speculation, with limited real user demand,” Morgan Stanley said, in a research report published late last week. N.F.T.s could be the next crypto asset to watch, the report added, noting that the only reason many investors bought these assets was because they thought prices were going higher.

That’s what happens in a speculative bubble: people follow the trend blindly. Only subsequently do they ask some of the questions they should have asked earlier, such as: What use does the object of speculation really serve? In a highly informative explainer that was published on Monday, Emily Stewart, a writer at Vox, points out that crypto enthusiasts have yet to answer this question persuasively.

If a cryptocurrency is money, it should fulfill three functions that money has always fulfilled: serving as a unit of account, a means of exchange, and a store of value. Like shells in Native American societies and cigarettes in prisons, cryptocurrencies can serve as units of account, but what about the other two uses? Stewart pointed out that transactional costs associated with spending crypto are frequently substantial. On Monday, the Financial Times published an interview with Sam Bankman-Fried, the founder of the FTX crypto-trading exchange, in which he said bitcoin doesn’t have a future as a means of payment because it is too complicated and environmentally costly. (Because of the extensive computations involved in digital mining for bitcoin, the cryptocurrency famously uses more energy than Argentina.) “Things that you’re doing millions of transactions a second with have to be extremely efficient and lightweight and lower energy cost,” Bankman-Fried said.

How about crypto as a reliable store of value? A year ago, the price of a bitcoin was $43,580. Last July, it fell below $30,000; in November, it hit $67,500; now it is back to about $30,000. The value of Ethereum, the second largest cryptocurrency, has gyrated as well. Some investors who got in years ago and held on have made fortunes, but anyone who bought cryptocurrencies within the past twelve months is likely sitting on substantial losses. And that’s not counting the folks who have fallen victim to outright swindles.

What happens next? After a market crashes, the trust and laxity that characterize the boom period get reversed, Galbraith wrote. “Money is watched with a narrow, suspicious eye. . . . Audits are penetrating and meticulous. . . . The bezzle shrinks.” For crypto promoters—the ones that operate on both sides of the law—there could be more tough times ahead.

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