​The Bitcoin Pyramid

Digital currencies are a profitable opportunity for investors and fraudsters, alike.

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​The U.S. Commodity Futures Trading Commission (CFTC) has filed a civil complaint alleging that a Bitcoin trading company CEO operated a Ponzi scheme that raised $600,000 from investors, CFO magazine reports. According to the complaint, Nicholas Gelfman, CEO of Gelfman Blueprint Inc. (GBI), promised investors a high monthly return on investment on Bitcoin trades, but paid profits to some investors using funds from new customers. Gelfman allegedly told investors the fund used a high-frequency computerized trading program to conduct trades. However, the CFTC says his company only executed trades on 17 calendar days between 2014 and 2016.

Lessons Learned

With a single Bitcoin recently valued at $6,000, this best known form of cryptocurrency is a tempting target for both fraudsters and investors. Individual Bitcoins are created by computer code, with a maximum number that can exist of just under 21 million (there are currently around 16 million in circulation). Like all currencies, the value of Bitcoin is determined by how much people are willing to exchange it for.

To create Bitcoins, a procedure called mining must take place, which involves a computer solving a difficult mathematical problem with a 64-digit solution. For each problem solved, one block of Bitcoin is processed. To compensate for the growing power of computer chips, the difficulty of the puzzles is adjusted to ensure a steady stream of new Bitcoins are produced each day. To receive a Bitcoin, a user must have a Bitcoin address — a string of 27-34 letters and numbers — which acts as a kind of virtual post box. Since there is no register of these addresses, people can use them to protect their anonymity when making a transaction. Internal auditors are likely to see increased use of Bitcoin by institutions and companies (Microsoft now accepts them), as well as in fraud schemes, even if the currency becomes regulated by governments.

Nonetheless, the kind of comprehensive fraud strategy perpetrated in this story is a much more traditional, if bold, manipulation of unsuspecting investors. GBI allegedly misrepresented that investors would see an average 7 percent to 9 percent monthly increase in their Bitcoin balances, when in fact they did not. The company allegedly falsified individualized performance and balance reports to investors. In addition, GBI allegedly told investors its assets and performance were audited by a certified public accountant (CPA), when in fact they were not. Even a computer hack that supposedly caused the loss of nearly all GBI customer funds was faked, the CFTC claims.

Despite the "wild west" environment of cryptocurrency investment, this fraud may have been preventable, if investors had sought answers to some basic questions before parting with their money:

  • How does the fund operate? Many acts of misrepresentation and falsification can be uncovered by asking questions and seeking information that investors should request with any investment activity. Perform reference checks of individuals and companies offering investment services, and check the credentials of any CPA or auditor. Take account statements to an independent advisor. Avoid long-term commitments to investment funds. Refer to regulatory sources about the risks and advisability of making investments.

    More particular to this story, it may be difficult to spot Bitcoin Ponzi scams that promise "double your bitcoin" overnight, or some similar outlandish claim. But the only way to double one's money is to first send it to them. These Ponzi schemes also typically have referral programs. For example, if an individual get others to sign up for the site by visiting an affiliate link, he or she may make a few cents. This is another red flag.
  • How does cryptocurrency work? Understanding the underlying technology that powers cryptocurrency can help investors avoid falling into traps with Bitcoin investments and trades. These basics include how digital currencies are mined via blockchain, how they are transferred from one party to another, and how currency exchanges and digital wallets function. There is a growing number of useful educational resources that can be used to gain a better understanding of cryptocurrency.
  • How is cryptocurrency regulated? In the face of increased examples of Bitcoin-related frauds, the Bitcoin industry is beginning to self-regulate, with rules around who can invest and how. For example, some Bitcoin exchanges put users through a vetting process with several layers of security checks to help weed out bad actors.
Art Stewart
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About the Author



Art StewartArt Stewart<p>​Art Stewart is an independent management consultant with more than 35 years of experience in internal audit, financial management, performance measurement, governance, and strategic policy planning.​​​</p>https://iaonline.theiia.org/authors/Pages/Art-Stewart.aspx


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