Cryptocurrencies, such as bitcoin and ethereum, are intended to serve as a type of digital money that consumers can use in everyday commercial transactions. They may be traded on online exchanges for conventional currencies, including the U.S. dollar, or be used to purchase goods or services, usually online. But with one bitcoin recently trading at around $15,000, an increase of about 15-fold since last January 2016, cryptocurrency mania set in.
And like clockwork, fraudsters, quick buck artists, and wannabes gravitated to the hype, tempting unsuspecting investors to rush into a high-risk, and sometimes fraudulent, investment. At the time of this writing, bitcoin has sold-off since its peak, wiping out some $200 billion in investor value and prompting the public to ask whether cryptocurrencies are a bursting bubble, virtual riches, the future of money, or some combination of each.
Cryptocurrencies are highly complex and speculative products with a mercurial track-record. Apart from the investment risk, a North American Securities Administrators Association (NASAA) survey of state and provincial securities regulators shows 94 percent believe there is a high level of investor fraud, including Ponzi schemes, associated with these investments and transactions. Therefore, it is important to realize that only those who understand the risks and can tolerate this sort of roller-coaster ride should be investing in cryptocurrencies.
Investing in cryptocurrencies can take several forms. The simplest is to purchase a cryptocurrency on recognized exchanges, such as Coinbase. These exchanges also act both as a digital wallet where customers store their cryptocurrencies, and as a platform where merchants and consumers can buy and sell goods and services with cryptocurrencies. However, exchanges are not free from their own set of challenges. In 2017, when bitcoin split into two cryptocurrencies, bitcoin and bitcoin cash, in what the industry calls a fork, several exchanges, including Coinbase, declined to support bitcoin cash, leaving their customers without a means to access their bitcoin cash. Aggrieved customers soon discovered their customer agreement included mandatory arbitration provisions and prohibitions against bringing a claim as a class action.
Now, the initial coin offering, or ICO, seems to be the latest rage. These ICOs involve the opportunity for individual investors to exchange currency such as U.S. dollars or cryptocurrencies in return for a digital asset labeled as a coin or token, some of which are yet to be developed. The ICO can also represent other investments such as real estate, diamonds, and emerging businesses, such as digital bitcoin mining operations.
The promoters offer these ICOs through a general solicitation posted on the Internet for viewing by the general public. These ICO schemes often promise high returns for getting in on the ground floor of a growing Internet phenomenon. The promoters of these offerings emphasize the secondary market trading potential of these tokens. A large number of prospective investors are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the expertise of others.
One of the more controversial products is known as the contract for differences, or a CFD. CFDs are complex financial instruments that enable an investor to speculate on the price of an underlying asset and can be highly leveraged, which multiplies the impact of price changes on profits and losses. Cryptocurrency CFDs allow investors to speculate on price changes in cryptocurrencies. CFDs are marketed on Internet platforms and regulators caution that some of these platforms promote securities fraud.
Victims of the cryptocurrency mania may find recourse in the securities laws as well as the federal commodity exchange law.
Those who offer and sell securities in the United States must comply with the federal securities laws, including the requirement to register with the Commission or to qualify for an exemption from the registration requirements of the federal securities laws. The registration requirements are designed to provide investors with procedural protections and material information necessary to make informed investment decisions. Some of the investment products linked to the value of underlying digital assets, including bitcoin and other cryptocurrencies, may be structured as securities products subject to registration under the Securities Act of 1933. Under this law and similar state laws, a seller of these unregistered products is liable to the buyer for a full refund of the purchase price. The buyer has one year from the date of the violation to seek a refund.
The Commodity Futures Trading Commission, or CFTC, has designated bitcoin as a commodity. Fraud and manipulation involving bitcoin traded in interstate commerce are appropriately within the purview of the Commodity Exchange Act and the CFTC, as is the regulation of commodity futures tied directly to bitcoin. Victims of bitcoin investment fraud may bring a claim within two years after the fraud was committed.
Although these are powerful tools for investors, they are not foolproof against a hardened criminal element who strikes from the Internet and then vanishes into thin air. The best way to protect yourself is to be cautious when investing your hard earned money. Ask many questions and identify the “red flags” of a fraud. These include:
- Unlicensed sellers
- High investment returns with little or no risk
- Seller needs you to make a quick decision
- No minimum investor qualification
- Internet solicitations