Ponzi Schemes Using Virtual Currencies (2014) [pdf] | Hacker News Reader

Ponzi Schemes Using Virtual Currencies (2014) [pdf]

sec.gov

112 pointsfludlight57 comments

"No minimum investor qualifications. Most legitimate private investment opportunities require you to be an accredited investor. You should be highly skeptical of investment opportunities that do not ask about your salary or net worth."

This is a ridiculous regulation that prohibits class mobility as software eats the world. Apparently being middle class means you are too stupid to realize you are being scammed, but if you are rich you get first pick.

To further elaborate - a young student putting in $1000 in facebook seed round would now be a millionaire. Not unthinkable for someone like a young Warren Buffet. The government has successfully regulated the future to the top 1%, while claiming it's for the public good.

Title IV (Regulation A+) of the JOBS Act

OK sure, but it assumes that young student would be able to discriminate a money-making investment from a money-losing one-- something the best VC's in the business, who vet tech deals all day every day, struggle to do.

Imagine you repeal all accredited investment regs overnight. Which of these seems likely:

- everyone in america invests $1000 in a future facebook, ten years later we're a nation of millionaires.

- 10% of the middle class (a huge number of people) wholly or partially cashes out retirement funds to put too much money into speculative early stage startups chasing fantastic returns. They lose it. Kids lose college funds, adults lose retirement funds, and we / society / government has to pick up the tab when such people get too old to work.

The point is, it's easy to attack these regulations as a barrier to opportunity and an unfair impediment to your right to do whatever you want with your own money. That's fair as far as it goes, but you also have to grapple with the real consequences of changing the policy. I have a hard time with your analysis that accredited investment rules have no "public good."

Phrased differently,the view on the ground in middle America is this: lots of middle-class people buy lottery tickets. Why do you suppose they do that?

Young Warren Buffet could.

I can go to Vegas and lose all my money on dice. There aren't laws to prevent this. Why are there laws to prevent my ability to invest?

The regulation makes more sense as a way to keep the opportunities exclusive to the powerful, while regulators get to claim a moral high ground.

In many places in the United States, there actually are laws to prevent gambling.

That’s clearly a straw man argument.

A) The federal government doesn’t ban gambling.

B) As far as I’m aware there isn’t a single place in this country where gambling is/isn’t allowed for those with specific net worths.

It's not a strawman. The parent is suggesting that we as a people have no problem with allowing low-income or low-net-worth people to gamble (pointing to the acceptance of Las Vegas as evidence). Then an equivalence is drawn between gambling and securities investing. By pointing out that, in fact, 31 states make commercial casinos illegal[1], I am refuting the suggestion that gambling is considered acceptable, which weakens the argument that securities investing should be acceptable as well.

[1] https://en.wikipedia.org/wiki/Gambling_in_the_United_States

Meanwhile 44 states run lotteries. Apparently gambling is acceptable in principle, just not competition with the states' games.

https://en.wikipedia.org/wiki/Lotteries_in_the_United_States

I'm not sure it's that simple. There's a wide spectrum of types of gambling, and equal variation in the laws regulating those types. Going to Vegas and losing your money on dice sounds like commercial casinos, which is why I chose to highlight it. Most states do have lotteries, as you point out, and gambling where the proceeds go to charity is also legal in most states (see previous sources in this thread). Once you start shifting the type of gambling, though, you also get further from the analogy at hand. One way to look at it is that providing revenue for education or charities could be seen as a public good that outweighs the undesirability of gambling.

To take it back to the original argument, the question is then to decide where investing sits on that spectrum. I am not sure, but I do think there are enough reasonable differences between investing in securities, commercial casino gambling, and lotteries to expect that they may have different regulations.

You already have the opportunity to bankrupt yourself with lottery tickets and casinos, yet most people don't.

Casinos offer better odds than early stage startups you have no connection with or control over, and aren't allowed to market themselves as investment opportunities either

Perhaps then it makes more sense to regulate those seeking money instead of those investing?

The regulation does regulate those seeking money.

Non-accredited investors are still perfectly entitled to invest their money in their friends and family's startups and/or more heavily-regulated IPOs, but startups aren't allowed to solicit the investments from the public, and have limitations on how much they can take from how many non-accredited investors.

I have seen enough "super-smart" investors pretending to be dumb, unsophisticated and to have never been told of the risks when an investment goes bad not to have some sympathy for these investor sophistication thresholds.

On April 5, 2012, President Obama signed a landmark piece of bi-partisan legislation called The JOBS Act into law. The JOBS Act greatly expanded entrepreneurs’ access to capital, allowing them to go to the crowd and publicly advertise their capital raises.

Initially, private companies could only crowdfund from accredited investors, the wealthiest 2% of Americans. On June 19, 2015, three years after the JOBS Act was initially signed into law, Title IV (Regulation A+) of the JOBS Act went into effect. For the first time, Title IV allows private growth-stage companies to raise money from all Americans.

https://www.seedinvest.com/blog/jobs-act/raising-capital-reg...

I'm aware of the JOBS act. It's still a different system than the rich get to use.

Edit: not sure why I'm downvoted. Middle class can't invest in filecoin, for instance, even though the top tier can.

I don't see this any different than advertising laws. Given the nature of capitalism, people will always try to bamboozle each other and if the benefit of bamboozling someone is high enough, we get really smart bamboozlers. I think it's natural to plan ahead and prevent this.

If you're middle class, being hurt by a stupid investment could mean losing your house & retirement savings and yes, the state globally won't benefit from that.

Besides, historic numbers [1] show that passive ETFs outperform actively managed funds as a trend, so the original idea behind accredited investors was "if you want to play the high-risk game, at least don't put your last chip on the table".

[1] http://www.investopedia.com/articles/investing/030916/buffet...

The rich can be destroyed by investing more than they can afford as well.

Index funds beating managed hedge funds has nothing to do with inability to invest disposable income in startups.

> The rich can be destroyed by investing more than they can afford as well.

They have shell companies that protect them from this.

Shell companies are used to optimize taxes and cap liabilities (note the recent legislation on passive foreign investment companies), they don't have much to do with protecting against investment risks.

Yes and no. You are right it limits positive mobility. But there are really two kinds of people here. One kind expects to be handed success to them without them doing any work. It is correct to protect these people as much as possible. They'll probably still end up losing their money, though.

The second group of people know that they need to work, learn and plan to succeed. These are the people that may be slowed down by the regulation. But they are able to overcome any given set of static rules anyways, so it's only a slowdown at best.

In the end any kind of rules are not just there to protect the stupid, but also to establish the people currently at the top. It's selfish, but when you end up at the top, would you do it otherwise? I probably wouldn't.

Ponzi aside, let's say it's the greatest cryptocurrency idea. The SEC has right to use their Howey Test to determine whether it's a security. Based on 1,2,4 below, is this not ICO's?

Under the Howey Test, a transaction is a security (or investment contract) if:

1. It is an investment of money

2. There is an expectation of profits from the investment

3. The investment of money is in a common enterprise

4. Any profit comes from the efforts of a promoter or third party

Based on their recent cyber division being announced, there is seemingly a strong possibility of review/conviction if launching an ICO as a US citizen, no? Soliciting an unregistered security carries 20yr prison term. Are dev's factoring this as possible risk?

How many of the Howey test questions must be "yes"? All? Any? More than x number of them?

They all seem to BE "yes "IMHO. So does it matter that much?

All.

As a crypto-developer working in the blockchain space, my primary company has opted to do an ICO as part of its operations. The company has existing VC backing of between 4-10 million, and the project would benefit from blockchain - for one aspect. By no means is a new token necessary, but that fact seems to have been side-stepped. The product exists, and perceivably the token could be usable upon issuance...

I enjoy working on the crypto for the project, but I concern myself with the eventual legalities of the ICO and how it might change the companies incentives internally.

I have bills to pay, leaving on principle alone isn't viable for me, but, if it could impact on my family, I will.

I am not a lawyer, and the answers don't appear to be black and white.

Same. A quick chat with an attorney who is an SEC specialist basically said "if it breathes" i.e. involves money that ICO is seen as a security. The SEC putting together the digital division which covers cryptocurrency tokens is part of what led to him saying this. Basically fish in a barrel.

It is in my opinion that any US-based ICO is now in a lottery as to whether they get the SEC visit.

Not legal advice at all, just sharing an excerpt from a coffee chat.

What was your decision? Did you stay or leave?

Pass.

Not sure why this isn't discuss more, but Erik Vorhees was fined for not registering as a security back in 2014: https://www.sec.gov/news/press-release/2014-111

Although it was just fines, not worth the exposure just for merely operating an above-board business. With SEC now having Cyber Unit, in theory their regulating now increases.

Can you ask him how a virtual currency can also be a security? Tulips could be a security, OK; but, didn't the Securities Exchange Act of 1934 exempt currencies from being considered a security?

Found this interesting, and relatable:

https://www.sec.gov/news/press-release/2014-111

I’d suggest reading The Colony blog for an idea of what lawyers are saying.

Is "common enterprise" the only distinction between gambling and a security?

Not an answer to your particular question, but semantics seems to be the only difference between insurance and gambling.

If a bookmaker offers you a $500 bet that your house won't catch on fire this year, what is the difference in both intent and outcome?

The law is a fickle beast.

It seems that in practice, yes, most people who are buying into ICOs have an expectation of profits based on the actions/development/promotion of a third party team running the project. Matt Levine talked about some of the nuances of this back when the SEC released a report about the DAO[1].

A couple days ago, I stumbled across a blog post of the Colony.IO project[2], who are creating a token and blockchain platform for distributed organizational management (coincidentally similar in concept to the DAO). They go into detail about their plans for having an ICO only once they have a product actively functional. The hopes are that with a working product, people buying the tokens will do so with the expectation that it is a sale of services, rather than an investment security. Now, their perspective is that of the team and their lawyers, and not necessarily that of the SEC. But if there is hope that ICOs won't all be securities, I think that is the pathway.

[1] https://www.bloomberg.com/view/articles/2017-07-26/tokens-va...

[2] https://blog.colony.io/the-colony-token-sale-7ac14c845bc0

So wouldn't that be more of a pyramid scheme rather than a ponzi scheme?

I'm not sure exactly what you are asking about. I was focusing on the distinction on whether a coin would be considered a security or not. As far as I understand it, one could operate in a fraudulent manner (or not) regardless of that distinction. In order to not run afoul of securities law, companies have to either ensure that they are following said laws or avoid dealing in securities.

If you're referring specifically to Colony.io, then I have no idea. I just read their blog post.

Under this "Howey Test" Bitcoin would be considered a SEC registered security.

Bitcoins aren't issued, they're created by mining and they are used to participate in the blockchain. In particular, there's no third party trying to valorize my BTC.

However if I created a coin the possession of which entitles you to a cut of my bitcoin mining operation, yes that would be a security.

Bitcoin mining is like buying a lottery ticket, you exchange electricity cost for the chance of wining Bitcoins.

You could make the case that Bitcoin main valuation is from the network efect, so other people buying and using Bitcoin increases the value of your Bitcoin.

I'm not a lawyer but from what I've read, the Howey Test is more specific than 4 would suggest.

An unqualified read of 4 would count digital pokemons as securities. The effort has to be in the active management of the enterprise, and most of the profit has to come from this management - as you'd see in someone running a business - for the investment to be deemed a securities transaction.

In the case of Pokemon, or cryptocurrency, most of the value comes from the activity of the users.

1. is not money, but any money-like value, I believe.

And if 4ths is big enough in your plan so you can't even argue it doesn't play a role, then you probably have a shitty business plan, I'd argue. The profit of course should come from selling some service or product.

It happened in Brazil recently, where one company created a fake cryptocurrency and used it on its Ponzi scheme.

source: https://translate.google.com/translate?hl=en&sl=pt&tl=en&u=h...

It specifically says that it was a multilevel marketing/pyramid scheme, not a Ponzi scheme.

Although I don't know the specifics of the scheme, it seemed like a pyramid scheme while it was running, but turned out to be a ponzi scheme when it went down. I would bet the people reporting don't know the difference between the two. I didn't until now.

this is just the latest instalment in a never-ending series of mechanistically declaring illegal anything the kids like.

renting out your flat to tourists for profit? upsets the neighbours, doesn't comply with arbitrary laws written centuries ago -- illegal. using cabs that you order through an app? threatens our cronies with something they are not prepared to handle -- competition -- so must be illegal. buying and selling magic internet money for fun and profit? could be interpreted as a security, hence must comply with arbitrary rules that didn't prevent the biggest financial crisis in history, but are otherwise supposed to be good for you -- ILLEGAL.

at least one can take pleasure in the knowledge that the same people who enable and support these kinds of policies cry themselves to sleep with a (paper) issue of the WSJ every night, wondering why there is no growth, no inflation, 'millennialls' not buying diamonds, or cars, or houses, not having kids, and most of all, not sufficiently paying into the ponzi scheme that is their retirement plan, as well as any number of other issues more or less related to, or caused by, their own stupidity and boundless self-interest.

Seems that most of there are examples of fraud instead of a Ponzi specifically. They list a single example of using Bitcoins as part of a Ponzi scheme, but no examples of ICOs being Ponzi schemes. Based on OP's submission immediately prior I believe this is what they were trying to suggest.

Well they say: "We are concerned that the rising use of virtual currencies in the global marketplace may entice fraudsters to lure investors into Ponzi and other schemes in which these currencies are used to facilitate fraudulent, or simply fabricated, investments or transactions."

Which reasonably straight forward.

Would be interesting if they would give examples of ICOs or other crypto related investments which turned out to be Ponzi schemes or fraud.

Investor Alert: Public Companies Making ICO-Related Claims [1]

SEC Exposes Two Initial Coin Offerings Purportedly Backed by Real Estate and Diamonds [2] [3]

SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities [4] [5]

SEC v. Trendon T. Shavers and Bitcoin Savings and Trust [6]

SEC v. Garza, GAW Miners, and ZenMiner [7]

[1] https://www.sec.gov/oiea/investor-alerts-and-bulletins/ia_ic...

[2] https://www.sec.gov/news/press-release/2017-185-0

[3] https://www.sec.gov/litigation/complaints/2017/comp-pr2017-1...

[4] https://www.sec.gov/news/press-release/2017-131

[5] https://www.sec.gov/litigation/investreport/34-81207.pdf