How to spot a scam

In the wake of this morning’s Bit-Trader.biz announcement, I thought it was time to finally write an article about spotting scams. I’ve been “doing” Bitcoin fo-re-ver. You haven’t heard of me because, for the most part, I’m a lurker – and I like it that way. But recently, I’ve come out of the closet a bit more loudly in public.

For a little background on me … I’m a marketer. I have handled large brands, small brands, and everything in between. Nowadays, I run my own home security company, Alarm Grid. I’m the director of marketing and an avid Bitcoiner. Those are probably the two activities that I spend the most time on these days. I occasionally jump into the limelight, like last week, when I spoke at Refresh Miami on mobile payments next to one of the co-founders of Square in an absurd outfit consisting of a suit, a bowtie and a hat that said “EA$Y” on it. Such a costume lends to me an air of credibility that suits the internet Monopoly® money we invented and are using.

I have seen every scam come and go: every Ponzi scheme, every so-called hack, and the plain old professional thieves like Neo & Bee. Every time people get scammed, the mantra is the same. The afflicted take to Reddit, cry foul, talk about how someone should have warned them. Then the commenters start saying things like, “serves a person who believes [insert something] right.” The thing is, in the aftermath of a scam, everyone whose hackles were raised when they first heard the scam’s pitch comes out in droves claiming that they knew from day one. Just like when Bitcoin went up, everyone and their mother came out of the woodwork saying things like, “I was just about to invest, but then I didn’t.”

These sorts of statements are antithetical to my personal investment philosophy. But they are also the kinds of statements that indicate a mindset that is ready to be scammed. Very simply, I do not believe one should investing in vehicles that they do not understand. There is a lot of information out there. Some of it is knowable, and some of it is unknowable. There is a spectrum of knowability in there, and somewhere on that magical spectrum as it is applied to public companies in the US is where insider trading begins. If someone is making money on knowable things, their returns will be predictable. If they are making money or even just predictions with regard to unknowable things (like, for example, the day and hour that Bear Stearns will collapse), then they are being fed information. But that’s just how I feel. I don’t believe in oracles.

So anyhow, if you’d like to further explore why I think what I think, feel free to ask any questions in the comment section below. I’ll be around to participate. That said, let me share with you some really simple principles that have kept me from getting scammed over the years.

“If It’s Too Good to be True…” What That Phrase Actually Means

You’ve heard this before. But what does it mean for something to be too good to be true? In the investment world, it’s pretty simple. You have a few baselines that you can measure against. One of the most important is the S&P 500. This has a highly consistent 10-ish/year rate of return over 30 years. It’s a bit volatile, however, and goes up and down with the markets. That said, its returns are consistent. There are plenty of criticisms of investing in the S&P, but as a benchmark, it’s pretty much the best we have.

So when someone tells you that they have an investment opportunity for you, how can you know it’s “too good to be true?”

It’s not a universal law, by any stretch of the imagination. But if it returns more than 10, or anywhere near 10 per year, that’s a big red flag. Professional money managers (in spite of what they say) have a hard time returning anything near or above the S&P over long periods of time.

If you’ve ever wondered what a Ponzi looks like, consider looking at one of the greatest Ponzis ever executed. Madoff’s returns were about 15/year. Many Bitcoin scams promise between 15 and 20 or more each month. People were screaming Ponzi for years when it came to Madoff. In the real world a 15 return is unheard of. Madoff’s return was unprecedented.

A very simple way to gut check this is to apply the very simple rule of 72. If you divide the percentage promised by 72, you can get a good approximation of how much money you will make in an investment. In the case of Madoff, 72/15 per year = doubling every 4.8 years. At between 15 and 20 per month, you’re talking either 72/15 or 72/20 per month = doubling every 4.8 months or 3.6 months. So consider, while real-world investors were suspicious of a doubling of their money every 4.8 years, many Bitcoiners put their money into products that promise to go through 22 doublings in that same time period. So Berney would have turned your $1,000 investment into $2,000 over a nearly 5 year time span. Over that same time period, Bitcoin-Trader.biz – the most recent scam to be uncovered – was claiming that they could turn your $1,000 investment into just under $2.1 billion over the same 5 year time period. I’m not going to cast aspersions, but sometimes if you just run the numbers, the scams are obvious. Just for comparison, if you bought $1,000 worth of Bitcoin at $.20 and sold it at $1,000, you would have made about $5 million. And I think we can all recognize that that is absurd growth (also a pretty good explanation for why financial institutions are pretty suspicious of BTC).

Does It Guarantee Returns?

No one can guarantee anything unless they are doing something that is riskless. There are a few examples of quasi-riskless investments out there, but they are either 1) exploiting inefficiencies that will be closed once a certain amount of money is thrown at them, or 2) returning at or just above inflation. Arbitrage, by the way, falls under number 1. And while a lot of Bitcoiners believe that they are engaging in arbitrage, most of the time, arbitrage is regarded as (almost) risk-free. Bitcoin’s markets have a high chance of failure, themselves, which means that even keeping one’s money in there exposes it to high levels of systemic risk. So even Bitcoin arbitrage isn’t arbitrage.

If someone tells you that you will, almost guaranteed, get some high rate of return on your money, it is probably a scam. What’s a high rate? Well, remember, a riskless investment will probably return about what US inflation returns (3-ish percent). An incredibly high-yield, risky investment might return 10-12. Understanding this with regard to legitimate investments will help you get a really fast understanding of your exposure to risk in any investment.

By the way, I see the debates about inflation being a false number coming. I can smell them. Even if you believe that, I don’t care. Take the debate elsewhere, this isn’t the forum.

Is Your Money Illiquid?

A lot of investment schemes tie your money up for a period of time. In Bitcoin, a lot of these are Ponzis. But there are a lot of products in the real world that do the same thing. Non-trade REITs, for example, are a great way to run what looks legitimate but acts a lot like a Ponzi scheme. Oftentimes, wealthy people invest in them because their financial advisor recommends the product and they promise big returns. You can’t pull your money out of the product because it requires that you stay invested for some defined term. Locking your money in is a great way to bide time. While some legitimate investments will lock up money, this is a pretty big red flag.

Are You The Sucker? Because Someone Is the Sucker…

I feel like it’s stage 3 of becoming a Bitcoiner. Everyone buys mining rigs. They spend a ton of money on some rig they read about on the internet that promises that bitcoins will shoot forth like one of those infinity-coin boxes in Super Mario Brothers. That’s not how things work.

I believe in the efficiency of markets. Remember what I said about knowable and unknowable information? Well, money is not made by information that everyone can know. Why are mining companies selling you their rigs if they could have made more money simply running the rig? And don’t get all high and mighty on me here. You’re buying the rig which is a validation of that point. You purchase the rig because you believe that mining companies are selling the rig at a price that is so low that you will be able to make money on the purchase.

When I first heard about mining companies selling rigs, the first thing that came out of my mouth was very simply, “those people won’t get their miners for about 8 months.” And I was right. How did I know? Well, I knew because the place where people make their money is in the unknowable information. Do you know how to make an ASIC? No? Well, then you won’t be able to compete with others who do. Just a fact.

In every transaction, there is a trade going on. Hopefully, that transaction intersects at the point where you get a certain amount of value from the purchase, and the seller gets an equivalent amount of value by taking payment for the product or service. In the case where the company is doing something because they are “good guys” who want to help “make others rich” you are on the wrong boat. They are going to be getting a lot of value from your payment, and you will not be getting a lot of value from their product.

Opportunities Are Created Not Happed Upon

Remember, I’m an entrepreneur. I’m a little biased here. But let me tell you about how I’ve turned my investment of a small amount into an investment of a slightly larger amount. I showed up to work every day, I worked 18 hours a day for two years, I lost friendships and other significant relationships, I lost a lot of contact with my family, I stopped watching television and playing video games. I sleep in my car sometimes just to catch up on sleep so that I can go back into the office and work. Some entrepreneurs have it a little bit easier, but, I think if you read about the good ones (not that I’m equating myself with them), most have very similar tales of woe. For those who don’t have the itch, being an entrepreneur is awful. It’s not fun.

So what if I told you you could bypass all that heartache and pain and get wealthy? There is something appealing to the idea that we can all make money or create opportunity without giving up anything. For value to be created, something has to be sacrificed. In the Bitcoin system, it’s energy. In some ways, while more metaphorical than it should be, that’s one of the big philosophical problems I have with Proof of Stake systems that are not acknowledged as centralized systems. In order for value to be created, someone has to sacrifice something.

If someone tells you that they are giving you an opportunity to earn untold wealth, and all you have to do is sit back and enjoy the ride, 99 times out of 100, it’s a scam. Those aren’t real odds. My guess is that the odds of it not being a scam are even far worse.

The Best Scammers are Often Scamming Themselves; Many of Them are Really, Genuinely Good People

The reason this article came into existence at all was because last week at Coins in the Kingdom I made some noise about the Bitcoin-Trader.biz people. I just let everyone know that it was a Ponzi, I made sure to say it every time I saw a person talking to their reps at the center table. I’d walk over and just kindly inform them that I believed this to be a very blatant Ponzi. What was my proof? Math doesn’t lie. The two representatives behind the counter were probably genuinely good people. Both of them said that they had lots of money in Bitcoin-Trader. So with today’s announcement, I’m guessing they are in a pretty bad place.

The truth is, anyone can be scammed. We are all susceptible. Many early Bitcoiners have been through the ringer – scammed multiple times. The two representatives at Coins in the Kingdom were pitching what appears on the surface to be an obvious scam. Why were they so brazenly opposed to acknowledging it? I wish I knew.

I see what I think are obvious scams in this community all the time. But for the most part, these people are not going around trying to scam people. Some of them are – Trendon Shavers AKA Pirate was running a straight-up, unapologetic Ponzi. But there are scams out there that genuinely good people don’t know they are running. I’d say a lot of crypto coins based on personality cults fall into this category. The point here is that just because you met someone who is nice or competent, it doesn’t mean they aren’t pitching a scam.

Always be vigilant. Always be skeptical. And don’t be nice to scammers. Call them out. Because, there are a lot of people who don’t know quite what they’re getting into when they come to Bitcoin. And while it’s a good opportunity to learn for most of us, wouldn’t it be better if we could just ferret out the scammers at the outset?