My Overwhelming, Disappointing Foray Into Cryptocurrencies
By: Nicky Woolf
Tags: History, Bitcoin, Cryptocurrency, Technology

The Wild West

Cryptocurrency investing is a Wild West space, made more fearsome by the comparative lack of regulatory oversight, and if you don’t know what you’re doing, you can easily get bitten.

According to David Yermack, the Albert Fingerhut professor of finance and business transformation at New York University’s Stern School of Business, the market for cryptocurrencies currently “resembles the ‘era of free banking’ in the 19th century, prior to the existence of the central bank, when most currency was issued privately by banks and there were very few rules.”

“Back then, banks issued money privately, and the government had no central bank or official currency,” Yermack tells me. “Banks were subject to very little regulation and held whatever reserves they chose. Money rose and fell in value based on the reputation of individual banks — like bitcoin and Litecoin today, for instance.”

This was, Yermack says, “a difficult period for the U.S. economy,” as it became subject to “repeated booms and busts,” and the movement of goods throughout the country was “encumbered by limits in the money supply and variations in the prices of individual banknotes.”

“The only real regulation of cryptocurrency in the U.S. is by the Internal Revenue Service for income tax purposes,” Yermack says. “The SEC is interested in regulating certain coin offerings under the securities laws, but it has brought enforcement actions against only a handful of them up to now. The area is still in flux and evolving.”

The market for cryptocurrencies may seem like a new ecosystem, and it certainly has its predators. Some are scammers, such as those behind fraudulent initial coin offerings (ICOs), where new coins are launched and then disappear, the creators vanishing with everyone’s money. These predators can be caught: In April, two men behind the launch of a cryptocurrency called Centra — which raised $32 million last year after being publicly endorsed by Floyd Mayweather and DJ Khaled — were arrested and charged with fraud.

Perhaps even more insidious are the “pump and dump” groups. “Imagine 15,000 people orchestrating a price pump of a stock, and then all of a sudden dumping it all when it goes up 20 percent,” said one cryptocurrency enthusiast we’ll call Robin, who has been a member of such a group in the past and spoke on condition of anonymity. Members are invited to pay extra to be on a higher tier of the group, which means they get the privilege of being among the first to receive the instruction of when to buy and when to sell a particular token in order to make the most profit.

“The pump groups are almost entirely beneficial to the people that create and manage them. As the managers are the ones who know which coin will be pumped, most of the users are exploited,” Robin said.

“It’s completely unethical and would be national news if it happened on Wall Street.”

Robin described watching as one pump-and-dump group’s actions increased the price of a cryptocurrency by 100 percent—doubling its value. When the group exited a currency, the price would collapse, and “those that didn’t sell in time either sell at a loss or are forced to hold.” There are, Robin estimates, “at least a few dozen” such groups.

“Where people’s hopes and expectations exceed reality, you will see people take advantage of that with pump-and-dump schemes where people manipulate the market” Charles Hayter, CEO and founder of cryptocurrency data analysis firm CryptoCompare, told me. “Obviously, there are rules against that in traditional markets. There are no rules here. It’s difficult to regulate; it’s a global phenomenon. So…naturally, you’re going to get people who are trying to pull a fast one.”

The global nature of cryptocurrencies, which operate on the distributed model of the blockchain, combined with the fact that scammers tend to organize via encrypted chat apps such as Telegram or Discord, means scammers are extremely difficult to catch or even predict.

“People are playing jurisdictional arbitrage,” Hayter says. “A rate changes in [mainland] China, they just move to Hong Kong, or Bermuda, or Malta. It’s basically whack-a-mole when you have companies that can just close up a laptop and move country.”

Faced with scant options, the U.S. Commodity Futures Trading Commission (CFTC) announced in February that it will try to tempt potential pump-and-dump whistleblowers with a cash bounty.

And yes — pump-and-dump also has an interesting history and actually dates back to the early 18th century, to a man named John Law.