How not to fall for a cryptocurrency scam

It is natural for people to dream of getting rich quickly. Even more so when they see the ‘crypto bros’ around them who have moved to Dubai, drinking coffee with sheikhs, driving a lambo or even buying their own castle. However, trying to replicate other people’s way of getting rich runs into a few practical problems, which is why most people who try to make such a quick buck find themselves sitting in a chair at the police station, filing a criminal report, at a law firm, or becoming clients of a pharmaceutical company producing a benzodiazepine cure for failed investors. How to avoid this fate, but not close our eyes and minds to the good opportunities, is precisely the difficult question that is important.

In this chapter, I will try to identify a few red lights that we should pay attention to.

A better cryptocurrency

In the previous chapter I explained why it is not enough that a project is better at something. Bitcoin, but greener, faster, with lower fees? Ethereum, but with the throughput of the Visa network? It all sounds like good technological features, but maybe it won’t help – even in the rare case when the authors of these projects turn the dream described in the whitepaper into reality.

The unspoken part of the “Bitcoin, but…” story is the dream that a new project could replace Bitcoin because that “but” is so valuable to enough people that they will sell their Bitcoins and buy this new token. However, this is extremely unlikely. People are lazy, most of them have never heard of your new pet project, and they behave herd-like.

Trying to identify which project might trigger this herd effect is precisely the result of the desire to get rich. Buying something for ten cents a piece with the vision that it will someday be worth 1 BTC is a nice vision. What’s rather more annoying is that such a wanna-be investor often finds examples from the past when a similar was successful – “after all, this project also made 10000x in a few months, if I had only bought it for $100, I could be a millionaire today”. The problem is that we are choosing from thousands of possible projects that could have done it, but did not. On the contrary, you give your hundred dollars to those who created the token or bought it in a closed round that you didn’t have access to. Identifying one project out of a thousand that you could make money on – and not sticking to it when it eventually falls – is extremely difficult.

It is therefore good to look at negative examples – people who lost a significant portion of their savings because they bought Luna or any other project that, while it did 1000x, lost all of its value in a day.

Of course, warning that a project has poorly set incentives (as I did before Luna’s fall and warned people against its downfall) and can’t work long term is not exactly a popular strategy with people with visions of even more profit and false validation over time (“after all, it’s already done 100x what are you talking about!?”). 

Therefore, I recommend not thinking about whether a cryptocurrency can do 1000x, but what if it does 0.00001x. This principle is nicely illustrated by Taleb’s turkey, which is regularly fed by humans, its size and enjoyment of life grows until Thanksgiving comes, when the turkey finds itself nicely arranged on a plate and not only its enjoyment of life, but even its life itself comes to an end.

The guru fallacy – even your favourite crypto guru can go crazy

It is said that if you have a million chimpanzees and you let them press the “buy” and “sell” buttons as they see fit, over time you will find among them a few brilliant investors who have made thousands of times their initial capital. This fallacy is called “survivorship bias” – someone survives the cruel filter of the profit and loss statement. Of course, crypto gurus are probably a little better than chimpanzees and have their decisions backed up by some decision-making strategy. Still, past successes don’t necessarily mean future returns. Maybe it’s just the “chimp” that is going to drop out in the next round and others still remain.

Examples of crypto gurus who had an interesting investment thesis and got lured into a project that turned out to be a failure are abundant. So if you feel the need to be inspired by people who film themselves talking in their villa in Costa Rica about what the secret to success is, I suggest you talk to the guy who got the Luna logo tattooed on his thigh instead. By the way, he was a successful investor before that too. I hope he names his dog that so he doesn’t have to be embarrassed his whole life by this poor bet. But it’s very valuable for us to learn from other people who have made mistakes.

Nassim Nicholas Taleb writes in his books that you shouldn’t take investment advice from people who have to work for a living. But the converse is not true – people who don’t have to work anymore rarely know anything more. In 2022, the well-known Three Arrows Capital fund fell apart. Although founders Su Zhu and Kyle Davies promised risk-adjusted returns, the fund went under, gradually taking with it the big cryptocurrency projects and startups that had entrusted them with money to manage. Even well-known big funds and superstar investors get it wrong.

The first rule of investing is not to lose money. Only bet so much that it doesn’t ruin you (e.g. Kelly’s criterion). You’ve already paid the YouTube guru by watching the video that is monetized through ads, you’ve shared his videos with your friends, maybe you’ve bought a paid program from him. He can’t lose money anymore, he’s richer because of you. He doesn’t care if he makes you poorer – he might feel caring, but his wallet does not feel it. And even if he does care, even sincere interest doesn’t automatically mean he’s capable of delivering good information to you. The worst thing is if someone is the successful “chimp” from the example above, but has come to believe in himself – that he is successful because of his abilities, that he has figured out some magic recipe for wealth. Such people are very quickly “cleaned out” by the market if they use the magic recipe for wealth for themselves. If someone has found a magical recipe for riches and is sharing it with paying customers, he has indeed found a magical recipe for riches, but it is not the one he’s selling to you – his magic recipe is selling magic recipes. 

Where is your unfair advantage (edge)?

Investors who make good long-term decisions make money in the long-term. They invest in the right company that pays dividends, builds on a parallel financial system that is growing in importance, and so on. But long-term decisions are not very sexy. Who wants to wait a long time when they can be rich tomorrow?

In the short and medium term, people who have an “unfair advantage”, the so-called edge, win. And someone will be happy to sell you that edge. The secret 1,000-participant Telegram group (which you pay to join) is one of many 1,000-participant groups where traders like to share their unfair advantage.

And there is a sense of closeness and belonging. You are discussing with other people. You do business together and share successes. It’s a similar effect that fans of influencers on Instagram experience. You feel like you’re following your favorite model every day. What she’s bought, where she’s currently shooting, what it looks like in the first class on Emirates flight, whether the water in Fiji is nice, clean and blue. You get to know the person day by day when you see their instagram feed and you feel like you’re kind of buddies. The model or influencer has twenty million of buddies just like you and when you actually talk to her, you realise you don’t know her at all. The photos are prepared and published regularly by her PR team. The stories shows a slice of the reality she wants to present, and it doesn’t help when she takes a picture in the morning without makeup in an attempt at authenticity – you’re still one of the twenty million.

It’s no different with belonging to the exotic club of traders on the Telegram. There may not be 20 million of you, but only a hundred or a thousand, but do you know how many such groups there are? I personally knew a great many traders whose advice was worth following until the advice stopped working. If someone has a true unfair advantage (edge), they can very likely monetize it on their own or with a few investors. An unfair advantage only works if not many people know about it. By the time it becomes information that thousands of people know about (there may be a hundred of you in a telegram group, but you’ll share it with your friends, too, right?), it’s long since priced in – if it ever existed at all.

Trading signals – pump and dump

Various trading signals gurus and groups are also related to this topic. These work in different ways, but the most primitive form is the pump and dump group, where people coordinate to buy something together to make it feel like the price of something is skyrocketing so they can quickly sell the token at a higher price. It doesn’t help that such groups are often short-lived, but there is often someone behind them who will buy the pumped token before they organize the whole scheme and dump it before everyone else. The problem is also that pumping doesn’t always work. Other people will see through what you’re trying to do and you can easily find yourself at the buying side of the dump – no one will buy the token from you again.

There are other trading signals – based on crowd psychology (technical analysis and indicators) that work similarly, although not in a completely primitive way. The winners of these games are usually the ones with the most capital and experience – and you can’t even get those by being a member of a Telegram group for a year.

Heuristics for good projects

So now you’ve read how nothing can be done and it is all a scam. Is it true that there is actually nothing worth investing in and we should just give up? Probably most projects are not worth investing in. But if something passes through the sieve of heuristics that you can develop (in advance), it might be worth a long and careful deliberation. My criteria are as follows:

1.  Is it a working project or just a dream? There’s nothing wrong with supporting dreams, but it’s important to know if the team can turn the dream into reality. A nice metaverse project with a wonderful vision and interesting investors? Cool, get back to me when I can install and test it. If the first version is already better than the competition, I’ll be happy to support it. If it’s just a dream written on a forty-page pretty PDF, containing dreams about having hundreds of thousands of users the next year, I expect those early investors to fund the development of the first version. Then I will verify that someone can turn the dream into reality and someone believes in the team enough to fund that development. Obviously, if everybody thinks like that, nothing will ever get built, but the other side of that coin is that the world is full of dreams, but there’s a bit of a lack of people who can make them happen.

2.    Is this consistent with my worldview? For example, this is how I bought the cryptocurrency Monero. It wasn’t a successful investment at all, but privacy and cypherpunk values are important to me personally, so I’m happy with this investment even though I didn’t make any money on it. A project that I want regardless of the cost, because it improves the world and moves it where I want it to go, is a good investment for me.

3.    Would I buy it even if I didn’t make money on it? There are some projects that I just want to have in my portfolio because they are doing a good thing. A company that develops a nice electric car that I like, a project that solves a fundamental problem in this world, or something like that is something I want to have regardless of whether I buy it for $14.80 and a year from now it’s going to cost $10.40 or $18.90. It’s also information for me about whether I’m making good decisions and whether the project I’ve chosen can really deliver the kind of improvement in lives that I want, and whether there’s any interest in that kind of development in the world at all.

4.   Will the project work even if no one else (with money) comes after me? This is one way to identify ponzi schemes.

5.    Who will pay for the product or service and why? If a project solves a problem, someone should be willing to pay for the solution. Are there people who need what the project delivers? If they are willing to pay for it, that means they are willing to give up other scarce resources to pay for the solution to the problem.

Heuristics on traders

I don’t do trading personally at all, but the reason is that no project has passed my heuristics for trading yet. Why my heuristics? If nothing else, they largely avoid the turkey on a plate problem.

1.    How is your left tail covered? A tail event is an unlikely high-impact event. A left tail indicates that this impact is negative (i.e. a loss). Trading in most markets is a fat tailed domain (i.e. there are many of these events and they continue “far left” – for a more detailed description I recommend the book Antifragile by Taleb). The problem is that it is these tail events that determine the long-term outcome of trading. Anyone can make use of luck (improbable upside, the right tail), but how a trader deals with the turkey problem is what determines whether he or she will be successful in the long run. If a trader doesn’t know what a left tail is, doesn’t have it covered, or at least doesn’t warn the client that he needs to cover it himself, I know he has no idea what he’s talking about and so far he’s a chimp who has survived because the tail event hasn’t occurred yet. But it will occur.

2.    How did you survive the bear market? What did you do? If this is a new trader who hasn’t traded in a bear market before, I’m hoping for the best of luck for him, but he’s certainly not going to try his luck with my money.

3.    Earned more Bitcoins in the bull market? In a bull market when everything is going up, even a less smart chimp makes dollars. Make no mistake, those dollars disappear when the turkey finds itself on the dinner table. And you never know when it’s time for thanksgiving in trading – you might not be able to get out in time, especially in crypto. In a bull market, a trader needs to be able to make better decisions than a simple strategy – buy bitcoin and hold.

4.   Do you have a list of all your predictions and decisions somewhere? I hear a lot of predictions about what the expected bottom or top of the current market cycle is. Reflections on how traders have been right or wrong before are quite useful.

5.    Do you know what you will do if you are catastrophically wrong in your prediction?

6.   Does the opposing side have skin in the game? Skin in the game as Taleb describes it in his book is a symmetry of risk exposure. Many investment advisors only make money when you make money (fees come out of the money they make you). But the real question is – do they lose money when you lose money? That’s why it pays them to take bigger risks that the customer is comfortable with – if the risk pays off and they make you money, they get a fee. If the risk does not pay off, only you lose money, they just don’t get any fee. Unless the counterparty loses significant money when you lose significant money, you need to be very careful.

Staking, liquidity mining, farming, mining

Under these names are hidden various yield creating schemes, mostly in the form of percentage interest. Not all of them are scams, which makes this area all the more complex. Bitcoins are mined too, after all, so if I’m mining something that earns a certain percentage of my deposit each month, it should be OK, right?

Here again, we need to be aware of where the money is coming from and why somebody is paying it. Bitcoin mining has huge costs – the price of mining machines, power, datacenters and the like makes this a highly competitive and low-margin industry in most countries. But where does the value created that miners receive come from? Part of it is from transaction fees – the ones people pay to have their transaction processed by the network. And another part is the issuance of new Bitcoins, which reduces the price of existing Bitcoins. It’s a way of fairly distributing Bitcoins as a reward for the security of the network.

There are a few things to watch out for with percentage returns:

1. What currency is my investment in and how is the return paid? In 2017, in a big way, people were running master-nodes to “mine” proof-of-stake currencies. These were various coins like PIVX, Dash and many others that paid guaranteed returns. In order to receive this yield, you had to lock in a fairly high value in that cryptocurrency and operate a node. I’ll use PIVX as an example. If you wanted a fairly interesting monthly return, you had to lock up 10,000 PIVX tokens. At the end of 2017, not even fully in peak, you could buy them for $50,000 for example. Today, you could sell them for $1,300. Was that worth a few months of nice yield? Most people are in red numbers, they never recovered their initial investment.

2.    How long do I need to lock tokens for? Do I understand that their value can drop? Do I have an exit plan? Most people, when counting on such an investment, mainly consider the upfront costs. But the exit costs are perhaps even more significant. Many people think that they just need to place a stop-loss order on the exchange and everything is going to be fine. One of the key points here is liquidity – are there enough people to buy it? After all, a stop-loss is not a magical transformation of a falling token into something stable – there has to be a buyer on the other side of every trade on the exchange. Does anyone want to buy something that is currently failing? Does he or she want to buy as much as you are selling? With some tokens, you can hedge against such a crash, but most people just assume that the music won’t stop playing.

3.    Who pays the yield? If the yield is paid using inflation, is it assumed that demand will rise faster than inflation? For example, many crypto projects in liquidity pools promised tens of percent dollar yield, but this was paid in tokens for which the only demand was to enter the liquidity pool. When that demand dropped, the yield fell to zero, and with it the value of the locked tokens.

A positive example is money markets, which provide stablecoin loans. There is a real use for this market – many people want to borrow fiat for consumption, collateralized with cryptocurrencies they want to hold. If there is a saver on one side who wants some yield on their stablecoins and a borrower on the other side who is willing to pay money for this service, it can be a good return. But forget about 20% p.a. Even former “superstar investors” and larger investment banks did not make a good decision here. Now they are filing for bankruptcy.

What also confuses people about such income projects is that they know someone who got into such a project, made a return on their investment from the interest, and is now “just making money”. While that’s nice, it doesn’t mean that the entire market won’t crash just as you’re trying to do the same thing. The chart looks exactly the same as the turkey’s weight and happiness above. It looks nice until it’s over.

How to watch out for theft and scams

1. We hold cryptocurrencies in our hardware wallet. No, no one can “look after” our portfolio. The keys to cryptocurrencies are held by us and only us, and in a hardware wallet. We don’t have the cryptocurrencies “with the exchange” – that sentence is properly phrased “the exchange has our cryptocurrencies”. Bitcoin is a technology whose fundamental characteristic is sovereignty over one’s own assets. If we give up sovereignty, we deprive ourselves of the fundamental advantage of cryptocurrencies. We don’t have bitcoin at an institution, an exchange, with a friend, … We either have it with us in a hardware wallet or we don’t own it at all.

2.    If something promises too high a return, it is probably a scam. A YouTube video of Elon Musk promising that if you send 1 ETH somewhere, he’ll send you 2 ETH is a scam. You don’t even need to think deeper – close the browser window or report the scam to the platform where you discovered it. There is no such thing as easy earnings without risk.

3.    Never give anyone a seed (12 or more English words that constitute the backup of our wallet). We only write the seed in a hardware wallet, never in the computer and never ever give it to a third party. If you are not typing it into your own hardware wallet while you are initializing it, something is wrong – stop and don’t do it. There is no situation where we have to type seed in any way on the keyboard or mouse on the computer. No “restore”, “upgrade”, “verify” – if someone claims you need to give them your seed, they want to steal your crypto.

4.   If we confirm (sign) the transaction on the hardware wallet, it is irreversible. Let’s check well what we are doing.

5.    We use the hardware wallet for everything. Yes, even NFTs with Metamask can be kept in a hardware wallet. Most tokens can be held in a hardware wallet.

6.   If we don’t know exactly what we are doing and how it works, let’s not do it. There is no shortcut from educating ourselves. Learn.

7.    Beware of fraudulent sites. Check independently that you are on the right site. The address may look similar. Never go to crypto websites by googling and clicking on the ads – sadly, Google ad system often promotes scammers’ websites.

8.   If someone emails you saying something needs to be done, it’s probably a scam. In cryptocurrencies, we don’t have to give anyone an email. So if someone writes it to us, it’s either a marketing newsletter or an outright scam. If you’re unsure, then never click on links in an email. For example, if an exchange writes to you, delete the email and log in to the exchange’s website, which you know the address of.

9.   If you have to send money somewhere to cover “tax”, “processing costs” or something similar to get crypto you own, it’s probably a scam. The exchange may take money for fees from the money you have deposited with it. It never asks you to deposit any more money in order to withdraw.

10. If someone wants you to do something quickly, it’s probably a scam. In cryptocurrencies, things do move fast, but not so fast that you can’t take a slow breath or sleep on it. There is no “if you don’t verify your account within 24 hours, you’ll lose money”, it’s a known coercion technique. If something is only two hours on sale, you need to realize that you are being pressured by the other party and possibly will be making bad decisions under duress. 

What can I do if I have been the victim of fraud?

This is where the sad news begins. The flip side of sovereignty is responsibility. If you sign a cryptocurrency transaction and send it to the network, the cryptocurrencies have effectively changed hands. While you may be within your rights under the law, such a law is very difficult to enforce. Even a court ruling is not a guide for a decentralized network; it records transactions according to the signature of the private key and cares very little for court decisions. Actually, it does not care at all.

So in most cases, asking the police for help will not lead to recovery of your lost funds. The only option is if you can clearly identify the other party. If you had money on an exchange that was hacked, you can contact the police and it is possible that there will be some  settlement using whatever money was not stolen. In late February 2014, the Mt.Gox exchange was hacked. At the time of writing, it is eight years after the incident and the people who had money on the exchange still do not have recovered it, although a settlement process is underway. And we’re talking about a relatively efficient state – the Mt.Gox exchange operated out of Japan.

If you think you have an identified counterparty because you have some company name on the contract, it’s quite possible that the entire contract is made up or the company is owned by a nominee shareholder and you will never learn the true beneficiaries of the company. There’s no one to sue. This was especially the case with firms that offered “automatized trading by a (ro)bot”. People who wanted to save time, didn’t want to educate themselves about how cryptocurrencies work, just wanted to make a quick buck later found out that there was no robot, they just paid someone money – which they will never see again.

Do everything you can not to get into such a situation. Most of these situations don’t have a satisfactory solution for you, and even the ones that do have a possible payoff are not worth it in my opinion in most cases.

Are all the opportunities to get rich gone?

I don’t think so. What most people perceive as a huge success are mostly “chimps” rather than genius investors who have the edge. But I think even established projects have their best days ahead of them. I’m not saying Bitcoin will still do 1000x, although I wouldn’t rule out that possibility either, but if I’m going to pick something that has potential, I’d rather invest in Bitcoin with a possible return of 3x (but beware, even Bitcoin can crash!) than gamble on one of the many projects that are likely to go quickly to zero in hopes of making 1000x.

More importantly, however, it is important to realize something else – Bitcoin and cryptocurrencies are not about getting rich. Even most early Bitcoiners didn’t keep all of their Bitcoins. We used them, gave them away, bought something with them, and when they doubled in value, many of us sold them. A lot of people were doing test transactions with a hundred Bitcoins that had no value yet, but they don’t have them anymore because they sometimes sold them for $800 when Bitcoin jumped from $2 to $8.

Bitcoin is the foundation of a parallel financial system. It gives us sovereignty over our own money, it is a completely different paradigm in the financial world. It is a backup memory of the good deeds of society. It is money as it should be. I’m not saying don’t invest in cryptocurrencies, but if you have a few thousand dollars to make an initial investment, invest some of it in a hardware wallet, most of it in education, and very little of it in Bitcoin itself. Don’t buy “shitcoins” you don’t understand. And don’t think you understand them unless you have invested months in understanding the field and went through several bear markets. If you’re looking for something where you sign twice on a contract, send the money somewhere via wire transfer, and expect it to appreciate in value, then you haven’t really understood what cryptocurrencies are for in the first place, and you’re very likely to be disappointed.

But if you learn how hard money works, why it’s good to have “honest money”, what’s wrong with the fiat system, make cryptocurrency purchases without KYC, into your own wallet, try out sending and all the other possibilities that they offer, and then start exploring how to implement volatile cryptocurrencies into your life, you’re in for a life full of adventure and breathtaking experiences. Not all of them will be positive, but the result will be your growth, based on experience. If you want to hand your money over to someone to ensure the growth of your portfolio, you will only have one experience. At the dinner table – like a turkey.