Rise of the crypto-currency “smart ponzi”

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From a new academic paper:

The advent of Bitcoin [3, 12] has given birth to a new way to exchange currency, allowing secure and (almost) anonymous transfers of money without the intermediation of trusted authorities. This has been possible by suitably combining several techniques, among which digital signature schemes, moderately hard “proof-of-work” puzzles, and the idea of blockchain, an immutable public ledger which records all the money transactions, and is maintained by a peer-to-peer network through a distributed consensus protocol.

Soon after Bitcoin has become widespread, it has started arousing the interest of criminals, eager to find new ways to transfer currency without being tracked by investigators and surveillance authorities [9].

Recently, Ponzi schemes [1] — a classic fraud originated in the offline world at least 150 years ago — have approached the digital world, first on the Web [10], and more recently also on Bitcoin [16]. Ponzi schemes1 are often disguised as “high-yield” investment programs. Users enter the scheme by investing some money. The actual conditions which allow to gain money depend on the specific rules of the scheme, but all Ponzi schemes have in common that, to redeem their investment, one has to make new users enter the scheme. A more authoritative definition of Ponzi schemes comes from the U.S. Securities and Exchange Commission (SEC):2

“A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. With little or no legitimate earnings, Ponzi schemes require a constant flow of money from new investors to continue. Ponzi schemes inevitably collapse, most often when it becomes difficult to recruit new investors or when a large number of investors ask for their funds to be returned. ”

Often, the investment mechanism of Ponzi schemes creates a pyramid-shape topology of users, having at the top level the initiator of the scheme, and at level ℓ + 1 the users who compensate the investment of those at level ℓ. The scheme will eventually collapse because at some point it will no longer be possible to find new investors, as their number grows exponentially in the number of levels of this pyramid. Therefore, users at the top levels of the pyramid will gain money, while those at the bottom layers will lose their investment.

Despite many investors are perfectly conscious of the fraudulent nature of these schemes, and of the fact that they are illegal in many countries, Ponzi schemes continue to attract remarkable amounts of money. A recent study [16] estimates that Ponzi schemes operated through Bitcoin have gathered more than 7 millions USD in the period from September 2013 to September 20143 . We expect that, since the total capitalization of Bitcoin has grown substantially since then4 , also the impact of Ponzi schemes has increased proportionally.

“Smart” Ponzi schemes. The spread of smart contracts, i.e., computer programs whose correct execution is automatically enforced without relying on a trusted authority [15], creates new opportunities for fraudsters. Indeed, implementing Ponzi schemes as smart contracts would have several attractive features:

1. The initiator of a Ponzi scheme could stay anonymous, since creating the contract and withdrawing money from it do not require to reveal his identity;

2. Since smart contracts are “unmodifiable” and “unstoppable”, no central authority (in particular, no court of law) would be able to terminate the execution of the scheme, or revert its effects in order to refund the victims. This is particularly true for smart contracts running on permissionless blockchains, which are controlled by a peer-to-peer network of miners.

3. Investors may gain a false sense of trustworthiness from the fact that the code of smart contracts is public and immutable, and their execution is automatically enforced. This may lead investors to believe that the owner cannot take advantage of their money, that the scheme would run forever, and that they have a fair probability of gaining the declared interests.

All these features are made possible by a combination of factors, among which the growth of platforms for smart contracts [13], which advertise anonymity and contract persistence as main selling points, and the fact that these technologies are very recent, and still live in a gray area of legal systems [7, 11].

Understanding the behaviour and impact of “smart” Ponzi schemes would be crucial to devise suitable intervention policies. To this purpose, one has to analyse various aspects of the fraud, answering to several questions: how many victims are involved? How much money is invested? What are the temporal evolution and the lifetime of a fraud? What kind of users fall in these frauds? Can we recognize fingerprints of Ponzi schemes during their execution, or possibly even before they are started? Investigating on these issues would help to disrupt this kind of frauds.

You don’t say. Full ponzicoin smash here.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.