Crypto is Full of Ponzi Schemes; 3 Ways to Spot Them

The world of cryptocurrency and its investors is filled with winners and losers. Fortunes have been won and lost on some projects that have shot up “to the moon” and others that have failed entirely. Of course, you won’t hear any complaints from those who have made incredible profits. Individuals who have lost substantial sums of money, however, have shared many concerns over cryptocurrency. One of the more legitimate and contentious concerns in cryptocurrency is the rise – and prominence – of scams.

In the wake of Terra’s dramatic failure, many are calling for increased regulation and investigation in cryptocurrency. The hope is that with enforced transparency and verification of some of the more hopeful claims, the end goal of greater truth and lesser embellishment will be achieved. Unfortunately, the reality is that scams are often difficult to differentiate from legitimately failed projects.

Whether or not regulation and oversight will help eradicate deceitful projects remains to be seen. Regardless, the crypto space is currently one in which scams are relatively free to emerge and dupe investors. Some of the less substantiated projects are identified and called out as scams by the crypto community more or less immediately. Others are more difficult to spot. Ponzi schemes, especially, are rampant in cryptocurrency today. This article will teach you how to spot them.

What is a Ponzi Scheme?

Ponzi schemes got their name from Charles Ponzi who ran a scam on his investors in the 1920s. Charles Ponzi enticed individuals to hand over their money by promising them large profits over short periods of time, claiming that his venture was an investment in “international mail coupons.”

Behind the scenes, however, the truth was that Ponzi’s proposed investment was not capable of creating any significant profits. In actuality, Charles Ponzi was merely paying his earlier investors with the money from new investors. This mechanism, by which profits are primarily generated by influx of money from new investors, became known as a Ponzi scheme.

In order to really pin down a simple and concrete understanding of Ponzi schemes, here are a few key elements that Ponzi schemes usually share:

  • Promise. The individuals that run Ponzi schemes almost always attract investors by promising them that they will be able to make huge returns on their initial investments.
  • The promise of returns must be justified by a money-making premise – an idea with which the scammer claims he/she can make large sums of money quickly. Inevitably, the premise turns out to be false.
  • Early “Success.” Recall that the scammer uses the money from new investors to pay the first investors. This results in a “honeymoon” period during which the investment seems genuine and profitable to outside observers. The lucky early investors profit and may even bring new investors through word of mouth.
  • Collapse. Ponzi schemes are inherently unsustainable because of the fact that they rely on money from new investors. As soon as investors stop putting new capital into the venture, the earlier investors cannot be paid and the entire thing falls apart.

Especially because Ponzi schemes can and do make money for their early investors, it’s relatively easy for immoral and persuasive individuals to run Ponzi schemes. Throughout history, we’ve seen dozens – if not hundreds – of notable cases that have seen perpetrators of Ponzi schemes run off with huge sums of their investors’ money. In many cases, the perpetrators have been caught and punished for their scams.

Examples of Ponzi Schemes

Ponzi schemes are neither rare nor difficult to pull off (for a while). Additionally, there is never a shortage of people with high levels of greed and low levels of morality. As a result, there have been countless Ponzi schemes throughout history. In fact, it would be impossible to even estimate how many have been pulled off.

There are, however, many notable examples that have been identified and reported on. Here are a few:

  • In 2010, Scott Rothstein was sentenced to 50 years in prison for stealing $1.2 billion by conning individuals to invest in fraudulent legal settlements.
  • Allen Stanford managed to rob his investors of over $7 billion over a period of 20 years before being caught and sentenced to 110 years in prison.
  • Perhaps the most infamous Ponzi scheme perpetrator of our time, Bernie Madoff, made off with over $20 billion prior to receiving his 150 year prison sentence.

How do Crypto Ponzi Schemes Work?

As we covered in our earlier explanation, Ponzi Schemes need plausible premises for making money. Whether they are legitimate or not, every new cryptocurrency project emerges with a premise: some sort of utility or mechanism by which it will add or create value.

Actually, cryptocurrency may provide the best breeding ground for Ponzi schemes the world has ever seen. It may be particularly easy to build false premises in emerging crypto projects because:

  • Crypto technology is notoriously complicated. Although every new investor has been told, “Do your own research,” the reality is that truly understanding an emerging crypto project may not be possible for anyone but extremely skilled coders. If a new project promises to offer a quicker, more secure blockchain, how many potential investors will be able to verify or discredit claims by going through the code?
  • FOMO in crypto is very, very high. Throughout crypto’s short history, we’ve seen countless projects emerge and skyrocket in value extremely quickly. Those who were bold, smart, or simply lucky enough to invest got rich. Those who didn’t missed out. Every time this happens, FOMO (fear of missing out) builds amongst the crypto community. FOMO makes us greedier and more careless.
  • Crypto provides a relatively safe haven for scammers. Although cryptocurrencies are becoming increasingly regulated, it’s still very easy for scammers to start new projects and receive money from people without exposing themselves. Everything takes place online and cryptocurrencies themselves allow anonymous transfers of capital.

Now that we understand how crypto makes it easy for scammers to run Ponzi schemes, let’s get practical: Here are the 3 ways to spot them.

1. “Promises” (Revisited)

Earlier, when we identified some of the common elements of Ponzi schemes, we recognized that Ponzi schemes attract investors by promising unusually large returns. If you’re on the lookout for promises like this in cryptocurrency, you’re likely to start finding them everywhere.

Although it isn’t an exciting concept to accept, the reality is that no money-making endeavor can legitimately promise sustainable and exceptional returns.

When we look back at the cryptocurrencies that have risen the most in value over the years, we do not see promises. We see utility, use cases, and innovation. The teams that created the crypto success stories did not tell their investors, “Buy in now and you’ll make 100% over the next 2 months,” or anything of that nature.

In fact, any time you see any sort of direct promise, identify it immediately as a bright red flag.

2. Lack of Accountability/Transparency

Whenever you’re considering investing in a new project and doing your independent research, you should be scouring the documents produced by the project’s team. Continuing with that notion, you should also be looking into the project’s team itself; an important part of researching an emerging project is familiarizing yourself with the individuals who are developing it.

Believe it or not, there are countless new cryptocurrencies that are attracting investors at this very moment who do not disclose the names of their team members. Should you happen to find one of these projects, you can read their entire website, go through every last page of their whitepaper, and even follow up on their contact links, but you will not find a single name of a real living, breathing human. Care to guess why?

The more anonymous a project is, the more difficult it will be to prosecute them for wrongdoings.

If you’re considering investing in a crypto project but you can’t find the names of the people who are building it, run!

3. Flimsy Premises

For most investors, the premise of a project is the main reason they decide to buy in. Blockchain technology and the cryptocurrencies they enable are exciting innovations that are creating new possibilities that had never even been conceptualized before. As a result, there are fascinating premises everywhere.

As we acknowledged earlier in the article, truly validating the inner workings of a project’s premise is probably too complicated for most people. Even if we are not skilled enough to scrutinize lines of a project’s code, however, we can use logic and common sense to deduce whether or not a project’s premise makes sense.

There is a whole category of projects emerging that promise returns but do not even make the effort to plausibly explain where those returns come from. Sniffing out those projects is your responsibility during the research phase. Again, this involves reading whitepapers as well as anything else you can find. Legitimate projects have nothing to hide and publish large amounts of data. Scams do not. Use this to your advantage.

  • If you can’t find much info on a project, avoid it.
  • If you can find a significant amount of info, review it carefully. Scams will make big claims but often, their literature will reveal glaring holes.

Err on the Side of Caution

Any time you are enticed by a shiny, new crypto project, do your research with these 3 ways to spot crypto Ponzi schemes in mind. Beware of lofty promises, identify any lack of transparency, and dig deep into premises.

It must be admitted, however, that you might do everything right and still be fooled. The truth is that crypto Ponzi schemes have managed to steal money from even extremely intelligent and experienced investors.

For this reason, we urge you to err on the side of caution. Do not let FOMO get the better of you. Do everything you can to feel secure and confident in your investments. And if you’re on the fence about anything, hold off and wait for better opportunities. There is no shortage of opportunities in the crypto space, after all.

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