When demand surges in a potentially profitable sector, so do hackers and scammers rear their heads to profit from such opportunities. We are referring to DeFi Ponzi schemes, and we have seen many of them making rounds (perhaps a bit too many). In this blog post, we will discuss what a crypto and Defi Ponzi scheme is, how such schemes work, and how to avoid them.
What is a Crypto Ponzi Scheme?
A crypto Ponzi scheme is a fraudulent investment scheme where investors are promised high returns with little to no risk. The promoters of the scheme will use new investors' money to pay existing investors, giving the appearance of profitability and sustainable growth. However, eventually, the scheme will collapse when there is not enough new money coming in to support the payouts.
As the US Securities and Exchange Commission (SEC) notes, Ponzi scheme organizers "often use the latest innovation, technology, product or growth industry to entice investors and give their scheme the promise of high returns." Since such technology would be relatively novel, investors would not know whether they are being played or not. This results in people taking a risk out of fear of missing out on an (apparent) unmissable opportunity to make decent returns.
The most infamous Ponzi scheme known to date is OneCoin, where people were defrauded of around $4 billion. In August 2022, the SEC also charged 11 people in an alleged $300 million crypto Ponzi scheme. Make no mistake, these schemes are still alive.
How Crypto Ponzi Schemes Work
Crypto Ponzi schemes tend to operate in a very similar way to traditional Ponzi schemes. The promoters of the scheme will have a certain goal and investment strategy, but, instead of making real investments, they use newly deposited funds from investors to pay existing investors who are trying to cash out.
This creates an illusion of growth and sustainability, as more money is being made than lost. However, as the inflow of new money slows down or stops, the scheme starts to collapse. This is why usually during a bear market, companies start to collapse as they would not have prepared well enough for such scenarios due to mismanagement of funds.
How to Avoid Cryptocurrency Ponzi Schemes
There are a few red flags that you should be aware of that may indicate that an investment is a Ponzi scheme. These include:
- Promises of unsustainable high returns: Be wary of any investment that promises guaranteed or high returns with little to no risk. Some Centralised Exchanges (CEXs) offer too high a yield for them to be true or sustainable. In fact, these are dubbed as High Yield Investment Programs (HYIP) and tend to use influencers to promote their products.
- Unregistered investments: Investments that are not registered with the appropriate financial regulatory bodies should be avoided. In the United States, these would be the SEC (Securities and Exchange Commission) for stocks and securities, and CFTC (Commodity Futures Trading Commission) for commodities. For cryptocurrency investments, you should look for exchanges that are registered with FINRA (Financial Industry Regulatory Authority).
- Secretive or complex strategies: If an investment strategy is secretive or overly complex, it may be hiding something. A good rule of thumb is that if you don't understand how an investment works, you shouldn't put your money into it.
It is important to make sure that the technology and the yields being promised actually make sense. If you are not too tech and blockchain savvy, ask someone who understands better how these systems work and whether such an investment makes sense.
What to Do if You Have Been Scammed
If you think you have been scammed, the first thing you should do is contact your local law enforcement. For US investors, you should also contact the SEC's Office of Investor Education and Advocacy or file a complaint online. From there, they will be able to help you determine what steps to take next.
Cryptocurrency and DeFi investments can offer great opportunities for investors; however, there are also a number of scams targeting investors in these markets. It is important to be aware of these scams and how to avoid them. If you think you have been scammed, contact your local law enforcement so they can assist you in taking appropriate actions.