Cryptocurrencies like Bitcoin are big names today - and big money. In fact, Bitcoin's rise in value caused one Computing editor to throw his glasses across the room in frustration last week at his lack of investment foresight. Entry into the market is not easy, though, and neither is it simple: as with any growing online industry, scammers are present to take advantage of those who don't understand the concept.
In April, technology developer Gnosis launched its in-house currency, selling $12.5 million worth of ‘GNO' in 12 minutes. One day before, in Mumbai, a sales pitch for digital currency OneCoin was interrupted by law officers, who arrested 18 company representatives and seized more than $2 million in investor funds. Even before the arrests were made, OneCoin had been described as a Ponzi scheme.
Despite the two projects claiming (important word) to be doing essentially the same thing, they could not be more different. Gnosis had experienced staff; an operational version of its software; and endorsements from known experts. For comparison, OneCoin's own CEO, ‘Dr Ruja Ignatova', made multiple unsubstantiated claims about her education and career, and two other prominent figures - Sebastian Greenwood and Nigel Allan - have both been accused of involvement in scam operations in the past (respectively: pyramid scheme Unaico; and digital currencies Crypto88 and Brilliant Carbon). In reality, the entire concept had similarities to a multi-level marketing scam (watch the video, it's worth it):
Cryptocurrencies are everywhere: more than 20 companies have been launched in the last two months using the same blockchain technology on which Bitcoin is built. They launch what are known as Initial Coin Offerings (ICOs) to raise capital, much like a traditional IPO (more than $270 million had been raised by ICOs at the end of last year).
Unlike IPOs, ICOs are not formally regulated; thus, they are a key target for scammers. OneCoin scammed investors by providing the appearance of respectability (if you consider this respectable) and claiming that it used blockchain technology; in reality, says an actual blockchain engineer, all that it had was "a[n] MS SQL server where they have scripted coin creation."
Despite the huge amount of negative publicity, OneCoin attracted more investors than Gnosis: hundreds of millions of dollars more. It is a classic example of a ‘get rich quick' cashgrab for the 21st century.
What are the facts?
OneCoin could trick people because there is a serious lack of knowledge about how cryptocurrencies work - specifically, blockchain. Blockchain is a technology first mentioned in the original Bitcoin whitepaper from 2008, and is the basis for many of today's digital currencies. It is a type of decentralised database that tracks digital transactions (avoiding the double spending problem, wherein a unit of value could be spent more than once).
When a digital transaction is carried out, it is grouped together in an encrypted ‘block' of other transactions that have taken place recently and sent out to the entire network. Miners (those in the network with a high level of computing power) solve the coded problems in the block, validate it and receive a reward - such as Bitcoins. The validated block is then timestamped and added to a chain in a chronological order. The chain tracks every transaction made in the history of that blockchain, and is continually updated so that every ledger in the network is the same. Because it is a form of distributed ledger, a hacker would need to compromise many machines to fake a transaction.
Because of its security and innate resistant to tampering, blockchain isn't only being used for currencies. It is thought that the technology could eventually be used to store sensitive, high-value data like health records: it has even been referred to as ‘Cloud Computing 3.0'.
Controlling the market
The next big battle for cryptocurrencies will be regulation. Most groups launching ICOs today iterate (and reiterate. And reiterate. And…) that they are selling part of a platform (the blockchain), rather than a stake in a company. By doing so, they are - technically - not subject to oversight by bodies like the US Securities and Exchange Commission. However, the way that investors treat them - tracking their value across marketplaces - makes them look a lot like speculative investments.
Buyer expectations are more important to regulators than fine definitions. Take the case of SEC vs W.J. Howey Co., in 1946. Howey was a Florida orange-growing operation that paid its investors (‘landowners') based on the success of the harvest. It argued that it was selling real estate and services, not a security; the Supreme Court disagreed and established the Howey test: if you give someone else money in the hope of their activities generating a profit for you, then you have purchased a security.
Regulation is probably inevitable, although most of the money being used in cryptocurrencies today is ‘smart' - it comes from educated parties who can do their own due diligence. When the market becomes more mainstream, though, greater numbers of people will be at risk - and that will bring the regulators.
Careful regulation could, in fact, be helpful to the market in the long run. Several sources have pointed to the dot com bubble of the late ‘90s: the crash ultimately slowed investment in the market for years afterwards, and the result could have been even worse if there had been no regulation.
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