Crypto Chaos: Infinite Wealth, Digital Hype and Economic Realities

In the realm of digital finance, economics and behavior, a peculiar phenomenon has emerged — one that stirs emotions, challenges conventions, and sometimes leaves us questioning the sanity of it all. For far too long, it seems, emperors with no clothes have danced their deceptive jig before a diverse audience, from seasoned investors to hopeful novices.

The Hype

This peculiar circus found its breeding ground in a confluence of factors: zero-interest-rate policies (ZIRPs), the disruptive shock of COVID-19, the advent of remote work, the pervasive influence of social media, growing government resentment, and the democratization of finance. Suddenly, everyone could become rich overnight through day-trading. Amidst the fervor, mainstream media, celebrities and asset-managers eagerly sought a seat on the crypto bandwagon, while a disparate band of charlatans and self-styled “finfluencers” only exacerbated the chaos.

The Illusion

Picture a scenario where savvy investors pour increasing sums into a seemingly limitless void, and, as if by magic, wealth multiplies infinitely. Envision a company crafting an enticing narrative around a “box,” portraying it as a revolutionary financial paradigm. [1] However, the stark reality is that this box possesses no intrinsic value whatsoever. The very “asset” linked to this enigmatic box should, by all accounts, be utterly worthless, yet it inexplicably lures countless individuals.

A Ponzi scheme is a fictitious investment program with little to no underlying legitimate business operation to which the investment is connected, and returns are paid to earlier investors from new funds coming in from later investors. These fraudulent schemes invariably implode when the perpetrator loses the ability to lure in new investors to fund the fraud. [2]

Cryptocurrency trading resembles a Ponzi scheme but with a unique twist. In this scenario, the issuer distributes the asset for free and only extracts a small fee from each trade. Users engage in direct trades with one another, bypassing the need to go through the issuer. Essentially, when individuals download an app and participate in token-trading, they are effectively duping themselves. As Judge Caproni put it, “the central fraud takes a back seat,” and it is the conduct of other individuals “whose assistance [helps] the primary perpetrators of the [] fraud profit from the scheme.” [3] In a different yet somewhat similar cryptocurrency Ponzi case, the Eleventh Circuit raised a significant question about whether an individual can solicit a purchase, as defined by the Securities Act of 1933, through the promotion of a security in a mass communication. [4] In this case, the Eleventh Circuit found that “a person sells a security when he makes a ‘contract of sale’ for or disposes of a security for value. And a person offers a security ‘every’ time he makes an ‘offer to dispose of’ — or a ‘solicitation of an offer to buy’ — a security for value.” [5] As such, “[w]hen a person solicits the purchase of securities to serve his (or the security owner’s) financial interests, he is liable to a buyer who purchases those securities — whether that solicitation was made to one known person or to a million unknown ones.” [6]

The Uncertainties

This crypto paradox highlights the surreal nature of digital finance — a world where the value of assets often defies reason, and the lines between innovation, deception and speculation blur. The U.S. Securities and Exchange Commission cautions that investors who deposit funds or crypto assets with a crypto asset securities entity might cease to have legal ownership of those assets and might not be able to get those assets back when they want to. [7]

Over the past year, a number of crypto asset entities have faced severe financial difficulties, sometimes resulting in suspending customers’ ability to withdraw their assets. Some crypto asset entities have entered bankruptcy proceedings, and it is unclear how much of their holdings (if any) customers might be able to recover. [8]

It’s crucial not only to conduct due diligence on an issuer, but also to thoroughly assess the issuer’s counterparties. In In re Cred Inc., the debtor operated a cryptocurrency lending platform and paid another entity that operated a multi-asset exchange to direct investors to buy and sell on the debtor’s platform. [9] Plaintiffs were attempting to hold the debtors responsible “for the loss of hundreds of millions of dollars’ worth of cryptocurrency invested in the [debtors’] cryptocurrency lending platform,” but were unable to substantiate their allegations. [10] The key takeaway is that investors need to carefully navigate these uncharted waters, approach digital investments with a discerning eye, and separate the substantial from the smoke and mirrors.

Conclusion

The world of digital finance continues to confound and amaze, with stories of unfathomable gains and spectacular collapses. As we reflect on the antics of crypto circuses past, perhaps it’s time to reassess our understanding of value, purpose, and the true impact of our financial choices in this brave new digital world.