Schemes, Scams, Frauds, Waste, Abuse, Predators, and Prey: A Brief History of Cryptocurrency

Once thought to be an alternative to unwieldy fiat currency largely gatekept by the world's largest banks and corporations, crypto instead turned out to be a vehicle unethical and illegal practices.

(A bitcoin ATM machine, photo courtesy of britannica.com)

The Financial Environment Before Bitcoin

The invention of cryptocurrency was foretold in part by Neal Stephenson in his novel Cryptonomicon, published in 1999, nine years before the release of bitcoin to the world. Stephenson’s long, rambling book features a wide array of characters, and often deviates from its central theme of creating what the author called electronic currency. The main purpose of such currency would be to do what normal government-issued (fiat) currency could not.

Well before Stephenson’s novel, fiat currency had been subject to financial manipulation and abuse. When the money primarily consisted of gold coins, monarchs would sometimes shave down the coins when paying one another so that they could actually pay less than what they promised. When the money became paper- which was initially seen in the late 18th century as being worthless- it was subject to inflation, deflation, and hyperinflation.

Leading up to the Wall Street crash of 2008, and a more significant one in 1929, investment bankers had grown incredibly reckless with their customers’ money. Scam artists like Donald Trump had started borrowing multi-millions of dollars from banks only to default on his loans- even while his business projects, such as an Atlantic City casino , struggled.

In 2008, the libertarian movement, which had always been on the fringes of society due to its absurd ideologies and unserious political candidates, was beginning to have a moment. The American electorate, always hungry for a viable third-party choice, looked to Republican Ron Paul, who led the movement into prominence for the first time. (Previous presidential candidates such as Bob Barr had not done well.)

The libertarian movement also had the Free State Project (FSP), a group of scofflaws who selected a single state- New Hampshire- as its base from which to build a libertarian utopia by supplanting local and state representatives in government, ignoring the will of citizens who had lived in the state their whole lives, and incessantly talk about having the state secede from the union. The knee-jerk response any FSP member would have when discussing any social problem would be to blame the government for either creating it or providing sufficient incentives for it to exist.

Paranoia ran high in the group, some of whom saw the specter of hyperinflation, such as that experienced by Weimar Germany in the 1920’s, right around the corner. The government, as the story went, could at its own discretion print sufficient amounts of paper currency such that the currency would be devalued. In that situation, a million dollars wouldn’t buy a loaf of bread. The savings a person had accumulated their whole lives would be worthless. Gold bugs- those who bought and sold gold as a hobby- also spoke about using rare minerals as a store of financial value against inflation.

As a result, when bitcoin arrived in 2008, there was plenty of reason to believe it would provide an alternative to paper money in a way that nothing else could. Perhaps, just perhaps, it would be the world’s first international currency not regulated by any governing body.

Bitcoin was a libertarian fever dream made real; it allowed them to do what limited financial resources and financial regulations had prevented them from doing. Suddenly, with this new invention, they could scam the pants off people like never before.

(A bitcoin computational farm, photo courtesy of publish0x.com)

How Bitcoin Worked

Soon after its launch, bitcoin became the key piece in a negative-sum game, despite its continually rising price and the occasional person who was able to buy a house with it (they probably couldn’t pay property taxes with their bitcoin). A negative-sum game is one which makes losers of both sides. The person who bought bitcoin with money (or used computers and electricity to make bitcoin for themselves) found themselves with a type of currency that couldn’t easily be exchanged back into money.

As a result, every service imaginable sprung up trying to support bitcoin: bitcoin digital wallets in a phone app, bitcoin credit cards, bitcoin websites allowing users to buy products from Amazon, bitcoin ATMs- to name a few. An entirely new infrastructure had to be created for bitcoin to work correctly as intended. The only people who really profited were those with increasingly enormous computing power, called computational farms. These individuals soon proved themselves to be at the top of a scheme whose complexity revealed itself to be pyramid in shape. Even they lost out in ways that weren’t immediately apparent.

No one who got involved with crypto on a large scale won anything- except perhaps a Bulgarian-born German citizen named Ruja Ignatova who created an infamous billion-dollar ponzi scheme named One Coin. As of this writing, Ignatova has an FBI award of 5 million dollars for her capture. While she might have all the money at her disposal she could ever want, she is forced to live in hiding, if indeed she continues to live at all.

At first glance, just by looking at its white paper- a document that explains how bitcoin works and is intended to work- there doesn’t seem to be anything inherently fraudulent about bitcoin. Each coin, which is really a unit of digital measurement unrelated to any physical coins, is generated by a mathematical computation in a structure called a blockchain. The blockchain is a public ledger in which every transaction is always available for public view, at all times. The transactions, while being pseudonymous, can be traced from one person to another. This process was intended to create trust in bitcoin.

Instead, the award of a bitcoin going to the person with the most computational power led to an arms race in computer technology and electricity consumption. Bitcoin’s value, the most important thing about it, continued to rise over time, luring people into buying millions of dollars worth of equipment for bitcoin mining farms. Those who won the coins would be at the top of the pyramid. Those who did not win would have to use pay fees if they wished to transact their coins (or fractional increments thereof) between one large exchange and the next.

Understanding how this all worked in detail required a strong understanding of mathematics- or the ability to use a computer to do the math instead. New terminology sprang up around bitcoin, such as HODL, a slang for always holding on to bitcoin and never selling it. The phrases diamond hands and paper hands referred to not selling and selling, respectively.

Over time, bitcoin became known for its perceived value. Whether it was actually valuable, or whether it would become an antiquated mess surpassed by more efficient cyptocurrencies- or both- no one knew in the beginning. While bitcoin offered an alternative the traditional banking system, it soon became apparent that the average user was far more interested in value-watching and making themselves feel good about digital assets in a phone app than they were in esoteric concepts like financial justice.

(Photo courtesy of technodena.com)

The Children of Bitcoin

Bitcoin, which was intended to have a finite amount of individual coins in it, saw a select few begin to monopolize the process. The finite coin problem might eventually cause the blockchain ledger to become non-functional as users would no longer be willing to use their computer power and electricity to solve the necessary computations to reveal the next block, and award the next coin to one of the participants in the problem-solving process. Those who dreamed of getting rich quickly might not be able to do so- unless they invented an alternative currency of their own.

Alternative cyptos were born from this idea, if for no other reason than the creators of a particular coin could gift themselves a certain amount of crypto as the first transaction on their blockchain. Suddenly, the ability to get into the crypto market relied not only on money but smarts and know-how. A variety of different cryptos were created as well, some of which were intended to perform different functions. These were called altcoins.

Litecoin (LTE) served as a copy of bitcoin. It could, in the event of the finite coin problem coming to pass, serve as another outlet for miners to utilize their computational power. While bitcoin is the big one that everyone knows, litecoin can best be described as bitcoin’s little brother.

Xcoin, later renamed Dark, later renamed Dash, was intended to provide more privacy for its transactions than bitcoin. Initially seen as a good idea, the nature of crypto soon revealed this a less than desireable prospect for government regulators, many of whom continue to crack down on it. Dash is operated by a small subset of users, who call themselves masternodes. The masternodes, in the project’s conception, awarded themselves 1,000 Dash each.

Ripple, also called XRP, was originally intended to serve as a bridge between two more types of international currencies. Rather than going through a cumbersome, possibly expensive process, of exchanging dollars for yen or vice versa, users could exchange dollars for XRP and initiate payments that way. In principle, it could help third-world nations without access to American dollars, which is recognized as the world’s reserve currency. In reality, it became just another speculative asset on exchange markets through which those exchanges could shave off transaction fees, making money for doing nothing other than owning and operating a website or app.

Etherium, intended to be an upgrade of bitcoin, broke the market for crypto scams wide open. While an asset unto itself, Etherium allows users to do what no other crypto had done before: individuals could make their own cypto assets and their own blockchains within Etherium. This lead to a promulgation of cryptocurrencies, many of which served no other purpose but to enrich its creators.

Because cryptocurrency involves so much arcane knowledge and has so much potential for profitability, ponzi schemes such as OneCoin arose in which users were promised large returns on their investment, but most often got nothing as they funneled increasing amounts of money to those at the top.

NFTs, such as that which inspired Logan Paul’s failed video game project, CryptoZoo, worked the same way. A digital image, intrinsically worth nothing, was given a marker on a blockchain. People who purchased an NFT (from the creators of it) would have a digital asset they could later resell, even if the asset itself was a picture of disgruntled mammal looking for a place to sleep. The markers, not the images, were for sale. The images could be copied / pasted at any time, and, given fair use laws, would be difficult to monopolize through ownership rights.

The NFTs, though initially a fad inspired by confidence scams on discord forums in which scammers spent considerable time grooming their audience, soon fizzled out. The blockchain markers became worthless. The video games promised with NFTs either failed, were boring, or didn’t work as intended (par for the course for the normal video game industry). The creators and owners of NFTs did as little as possible to gain the maximum amount of profit they could.

This pattern of behavior typified every crypto scammer / investor who got into it looking to make a quick buck.

(Sam-Bankman Fried arrested, courtesy people.com)

Modern Problems for Crypto

Other than the finite equation problem, several problems exist within today’s crypto market that ought to make it difficult for average people to trust their money into a system that so consistently shows no regard for the security thereof.

Crypto exchanges, essentially a place where a user can acquire a variety of cryptocurrency wallets and move their assets around however they like, have been subject to scams themselves. Different techniques have been used to do so.

At times, hacking can take place from within the exchange- perpetuated by the people responsible for operating it. This happened when the exchange BitThumb lost 13 million dollars worth of crypto. At other times, phishing techniques were used. Smart contracts were exploited.

Once, the owner of an exchange called QuadrigaCX misappropriated 190 million dollars worth of crypto from his own users.

A famous example of hackers stealing crypto funds was Mt. Gox. Mt. Gox, in 2014, handled 70% of all bitcoin transactions, the year when they declared bankruptcy. Hackers repeatedly targeted the exchanged between 2011 and 2014, which caused thousands of bitcoins to go missing. As of this writing, when Mt. Gox officials begin repaying its customers who lost money, the value of the missing bitcoin has been estimated as high as nine billion dollars.

The history of large exchanges, except perhaps for an exchange called Kraken, has proven the only secure crypto wallet is one a person has control over themselves on their own hardware. The behavior of scammers, hackers, and bad owners towards most exchanges provides a glimpse of what might happen if today’s large banks were not sufficiently protected and/or regulated.

Most scammers would like to keep their activities quiet. This conflicts with a public blockchain in which activity from everyone using it can be viewed at any time. There are others for whom the phrase, “if you have nothing to fear, you have nothing to hide” doesn’t ring soundly. Some users continue experiencing paranoia of government intervention against their own transactions. Others, such as large corporations getting into crypto, use private blockchains, obscuring all transactions from public view.

For some individuals, privacy cryptos such as Monero or ZCash will satisfy their need; the problem in obtaining them is they either have to have a computational farm or find someone willing to sell their desired asset for the crypto they currently have. Most often, this would be bitcoin, Etherium, or another well-traded asset.

Given the reputation of cryptocurrency as being inherently fraudulent by default, government regulators have every reason to use the tools and power at their disposal to regulate a market that was intended to get around regulations. Users who expect one outcome with their experience may find another waiting for them.

The American Securities and Exchange Commission has been among those cracking down on crypto trading and spending. Continually rising prices over time suggest pump and dump schemes taking place; these are designed to artificially inflate the value of an asset so that its owners may benefit by an increase the price thereof.

In March 2023, financial regulators closed down Signature Bank, which was based in New York City but did much of its business in California’s silicon valley. Signature was one of two banks who worked with crypto exchanges. Before being taken into receivership by the Federal Trade Commission, it claimed revenue of over one billion dollars a year. The bank had 110 billion in assets and 88 billion in deposits.

Signature bank closed just after Silvergate Bank liquidated its assets and came under a federal enforcement action. The closure of Silvergate in March 2023 was directly related to the crypto exchange FTX, filing for bankruptcy in November 2022. FTX, then run by Sam Bankman-Fried, was one of Silvergate’s largest customers.

FTX had been involved with fraudulent and unethical practices with its sister company, Alameda Research. Its collapse came about when the owner of a rival exchange called Binance, Changpeng Zhao, announced on twitter his intention to sell all he had of FTX’s own crypto asset called FTT.

The resulting chaos brought down two large billion-dollar brick-and-mortar banks, threatening what federal regulators called “systemic risk.”

For years, crypto enthusiasts had difficulty liquidating their crypto assets into fiat currency when the need or desire arose to do so. After the closure of Silvergate and Signature Banks, with government regulators closing in from all sides, this problem appears to be only getting worse. Sometimes touted to benefit “unbanked” citizens of the world, such as those in developing African countries, it turns out the unbanked citizens are now those who use crypto themselves.

There are other issues cropping up as well, beyond nuts-and-bolts issues such as the double-spending problem. Wealthy owners and operators of exchanges have been centralizing ownership of crypto for some time. Initially designed to be a decentralized system, centralization for a crypto asset means unwieldy control and authority of the asset and/or blockchain itself. After all, not everyone can afford the million-dollar computational farms with all the latest computer chips and energetic air conditioning systems doing all they can to prevent hard drives from overheating.

As federal investigations continue, wealthy owners and operators will be better able to afford lawyers to stave off the investigations, if not stifle them completely. A rags-to-riches crypto millionaire likely would find it difficult to pay a laywer’s billable hours with the crypto asset they themselves invented, hoarded, or stole. This will eventually cause further concentration in crypto markets.

The brief moment when cryptocurrency enjoyed respect and curious interest is past. Rather than wearing no clothes, the Emperor is in ruffled casual clothes, wearing handcuffs, a goofy expression on his face, with a corrections officer on either side to make sure he doesn’t run away on his way to prison.

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