In today’s highly speculative investing environment, arguably the asset class that has received the most attention is cryptocurrencies. Broadly, cryptocurrencies are digital currencies written into a computer language with built-in mechanisms for issuance, transactions, verification, and other controls. Currently, the most popular cryptocurrency is Bitcoin. At the time of writing, a single Bitcoin is worth approximately $57,087.30. By market capitalization, Bitcoin is the third largest currency in the world. Bitcoin was invented in 2008 by an unknown person or group using the name of Satoshi Nakamoto. Whoever, he, she, or they were, Satoshi was beyond brilliant. Since the creation of Bitcoin, thousands of different cryptocurrencies have been invented. As of May 2021, there were over 10,000 types of cryptocurrencies listed on CoinMarketCap.com.
In a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System, Nakamoto laid out the thesis for the decentralization of currency through the use of blockchain technology. A blockchain is essentially a type of database or ledger technology that allows for extremely secure transactions (compared to those that allow for human error) because the transaction data is stored in blocks chained together in chronological order. In Bitcoin’s case, these chronologically ordered data blocks are publicly available for download by anyone. Because the data is contained in millions of connected computers all over the world and the blocks are chained in chronological order, the transaction history of every single Bitcoin is verifiable, as well as virtually unchangeable and irreversible.
If cryptocurrencies and blockchain technology sound complicated, that is because they are. Understanding the uses, benefits, and risks of cryptocurrencies and blockchain technology requires a knowledge of coding and technology that is beyond the knowledge of this author and the scope of this blog. Unfortunately, as in other speculation and investment areas that are new, bad actors may try to take advantage of the complexity of cryptocurrencies to defraud unwary investors. Rather, far from technological or investment advice, this blog will focus on some of the dangers of buying into Bitcoin without a baseline knowledge of cryptocurrencies and how they are presented as investment vehicles.
Although they are highly popular vehicles for speculation or investment, few protections exist against Bitcoin and cryptocurrency-based fraud, in part because blockchain technology permanently records transactions. One issue facing regulators is how to characterize Bitcoin and other virtual currencies. In Texas, the Texas State Securities Board regulates the registration of certain cryptocurrency harvesting investments as securities. They require the registration of dealers and agents offering cryptocurrencies and cryptocurrency harvesting investment products, as well as the disclosure of material facts to investors. The Texas State Securities Board was the first state securities regulator to enter an enforcement order against a cryptocurrency firm. To date, the Texas State Securities Commissioner has entered 26 administrative orders involving 79 individuals and entities.
Cryptocurrency scams begin in similar ways to other scams—online ads, social media, public solicitations, and personal, family, or group connections—along with a complete failure to disclose the true nature of the operation or the risks of the particular investment. For example, in 2018, the Texas State Securities Board entered an Order against Investors of Crypto, LLC, an Austin-based cryptocurrency harvesting operation, who was found to be offering unregistered cryptocurrency investments via an online financial services forum for Austin residents, and through Facebook and YouTube. Crypto, LLC, agreed to halt sales of its investment products until it registered with the Securities Commission.
Some operations are more nefarious. For example, also in 2018, the Texas State Securities Board entered an order against Coins Miner Investment, LTD. The State Securities Board found that Coins Miner was an issuer of investments in cryptocurrency harvesting operations that publicly claimed to be operating in the United Kingdom. In fact, Coins Miner was operating from Russia. Coins Miner’s operations were complex. It spoofed email addresses of domestic cryptocurrency wallets and trading services to make it appear as if a domestic entity was endorsing the foreign Coins Miner. It also used fake videos and photos of its operations and offices to appear legitimate. It even enticed potential investors by claiming it would be giving away an automobile to a person who invested in its cryptocurrency program. Unsurprisingly, it did not actually own the automobile it claimed it would give away. Coins Miner’s website described four incredibly lucrative investment vehicles. For example, investors who invested between $100,001.00 and $1,000,000.00 in the “platinum plan” would receive 800% commission and seven days of compounding. As the adage says, if it sounds too good to be true, it probably is. The State Securities Board ordered Coins Miner to halt the sale of its investment products under the threat of a criminal offense.
Legitimate cryptocurrency investment operations are few and far between and often reserved for accredited investors. Generally, the Securities and Exchange Commission uses the term accredited investor to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include high net worth individuals, banks, insurance companies, brokers, and trusts. Legitimate cryptocurrency operations offering investments to the general public must comply with stringent disclosure and registration requirements. For starters, the operation must accurately disclose the location of the operations, the identity of its principals, the business qualifications and repute of its principals, the operation’s assets, liabilities, capitalization, and other financial information necessary to ascertain the operation’s ability to pay the promised return to investors. In addition, representations touting the profitability of an investment in cryptocurrency harvesting programs may be materially misleading or otherwise likely to deceive the public if they do not disclose the risks associated with cryptocurrencies, such as the negative impact of government action and legislation, system failure, technical failure or deficient source code, and the threat of competition with other cryptocurrencies. Moreover, legitimate cryptocurrency investment operations must disclose the risks associated with cryptocurrency harvesting, such as the cost of electricity used to power and cool cryptocurrency mining hardware, whether the difficulty of mining may increase over time, whether a system or technical failure may impact the efficiency of a cryptocurrency harvesting platform, as well as the threats posed by hacking incidents or other malicious attacks on the entities’ operations. If you receive an advertisement for the sale of cryptocurrency and cryptocurrency harvesting products as investments, and you are not allowed to view this type of information, chances are high that the operation is not legitimate.
The last order entered by the Texas State Securities Board was in 2019. However, the interest in Bitcoin and other cryptocurrencies, such as Ethereum, Litecoin, and Dogecoin (which started off as a joke), has only heightened since then. As the public increasingly looks to cryptocurrencies as investment and speculation vehicles, the number and complexity of bad actors seeking to defraud the public grows with it. Paired with the limited resources and general reluctance of the Securities and Exchange Commission and the Texas State Securities Board to regulate in the area of cryptocurrencies, investors should be increasingly aware of the benefits and risks of cryptocurrencies.
