There are stages in the life of any newfangled security or investment. Between the time it's created and the time (if ever) it goes mainstream, there is often a special point at which its glow of novelty and sophistication makes it the perfect tool for charlatans.
These shady types typically pump out jargon-filled pitches full of hazy promises of sky-high returns, then snap up money from investors with a surplus of optimism and a shortage of due diligence.
By this measure, bitcoin has reached an important milestone -- starring in what the U.S. Commodity Futures Trading Commission says was a Ponzi scheme. While the bitcoin wrinkle is fresh, everything else about the case is textbook.
The commission claims in a federal civil enforcement action filed in U.S. District Court in Manhattan in September that Nicholas Gelfman of Brooklyn and the company he ran, Gelfman Blueprint Inc., took custody of client assets, shrouded their alleged strategy in meaningless jargon and advertised impossible returns. The trifecta.
While Gelfman, representing himself, denied the government's accusations in an October court filing, understanding the allegations can help you protect yourself.
In January 2014, shortly after a late-2013 run gave bitcoin its first rush of popularity, Gelfman opened a bitcoin fund, the agency said. Not a vanilla ETF like the Winklevoss twins tried to get off the ground, but something fancier: a "high-frequency, algorithmic trading strategy" executed by a proprietary computer program named Jigsaw, according to the CFTC suit.
Better still, the fund advertised monthly returns of 7% to 9%, net of commissions, with zero downside risk because, as it said, "trading results are maximized during price drops," according to the CFTC. Sounds like a winner.
Only problem is, that is literally impossible to achieve. In fact, Jigsaw trading account records "reveal only infrequent and unprofitable trading," according to the regulator. In 2015, it had trades "on only 17 calendar days," the CFTC said.
Far from protecting against loss, the CFTC notes, those trades "incurred approximately 185 bitcoin in losses." By that August, Jigsaw's account was down to zero, but the fund continued providing false statements to investors while charging "fees in the form of large percentages of supposed bitcoin trading profits," the agency alleged.
But by October, the jig(saw) was up, and the accused told clients that hackers had stolen all their money, the agency said. According to the CFTC, there was no hack.
Most folks know, intuitively, that no investment on earth can achieve 9% monthly, every month, and never fall. (Or at least we hope they do.) But it's possible the presence of bitcoin made investors turn off all rational thought.
If true, it's the old "dazzle them with jargon" trick. It makes Bernie Madoff's pledge of steady returns with a supposedly simple split/strike strategy look like child's play.
"High-frequency, algorithmic trading strategy" plays on people's perception of computers as infallible traders that beat humans every time. If you can't beat 'em, join 'em.
But toss in some mumbo-jumbo about cryptocurrencies, blockchain and the technology of the future, and people can't resist. Have you ever tried talking to someone about the finer technological points of bitcoin?
Have you used "blockchain" or "cryptocurrency" in a sentence? Try it sometime and watch eyeballs glaze over. Techspeak makes people tune out almost as fast as Financespeak, and it has a similar effect: People don't want to admit ignorance or seem dumb, so they politely nod along, pretending to keep up.
Just utter the word "fintech" to somebody and see how fast their mind shuts down. They're sitting ducks, waiting to be Jedi mind-tricked into a Ponzi.
The lesson here is as old as the hills: Whenever you're considering any investment, make the broker/adviser/snake-oil salesman explain it in simple terms you can understand. Would people have been as willing to invest in a bitcoin product described like this?
So at the risk of way oversimplifying this, if you think of the Internet as a country, bitcoin is trying to be its money. People think it's the wave of the future, but it's really just some complex computer code playing dress-up. Some people do use it, but it's mostly for drug deals, ransom payments and human trafficking. You can also spend bitcoins at some legitimate stores, but the IRS just announced that it would consider that a transfer of property and probably subject to capital gains taxes, so I'm betting people won't use it much. The tech is cool, though.
Maybe that's still appealing? But probably not. BitSeduction requires something much more like this:
Bitcoin is the leading cryptocurrency, which means it's a digital currency that exists entirely in cyberspace and is stored in your digital wallet. This cryptocurrency is the next wave of all transactional transactioning and built on the bleeding-edge technology called blockchain -- a secure and unhackable digital database of all transactions that leaves out buyers' and sellers' names. Because the government isn't involved, it has no monetary policy or central bank. Programmers mine bitcoins at a preset rate using powerful computers running complex proprietary algorithms, so the government can't hyperinflate it. Libertarians love it because the government can't see who uses it, and soon it will take over the world, dethroning the dollar and all other currencies, so this is your chance to get in on the ground floor of blockchain. Blockchain is taking over the world, and if you own bitcoin, you own the blockchain.
Actually, we probably didn't use enough jargon there, but you get the drift.
Bitcoin's fringe status renders it even more ripe for misuse. While bitcoin has had a well-publicized run this year, perhaps making the Ponzi's advertised returns seem plausible, it wasn't faring so well from January 2014 through October 2015.
A 9% monthly return would have compounded to about 566% in that time, but real-life bitcoin was weathering a bear market, falling 57%.
It was possible to discover this, but interested parties would have had to do some work. After all, bitcoin isn't on the CNBC ticker tape or a regular feature in The Wall Street Journal's market wraps. To track it, you have to visit cryptocurrency sites like CoinMarketCap.com.
The other issue here is custody. It probably goes without saying that if your money is in a third-party brokerage account in your name, Shyster McCretin can't hoodwink you with a snazzy online "dashboard" displaying fake account values.
Bitcoin makes ploys like that even easier, as you kinda have to jump through hoops to own bitcoins -- by joining a bitcoin exchange or opening a digital wallet (and exposing yourself to hackers). "Having your own account with bitcoins is really hard, so just put your money in my fund and I'll do it for you" would probably be an easy sales pitch.
You'd think that after Madoff took Ponzis mainstream and unwittingly gave the world a self-defense playbook in the process, no one would ever fall for scams again.
But fraudsters will always try to hack into people's fear and greed, and unfortunately, on occasion it will work. Smooth talkers can make you forget that anything that sounds too good to be true probably isn't. But remembering the common threads in such schemes can help you avoid getting taken for a ride.
Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.
More of What's Trending on TheStreet:
- Is Hashgraph Technology Just Hype, Or Can It Dethrone Blockchain?
- 10 Most Worthless Pieces of Military Memorabilia
- Here Is How Millennials Can Get Rich From Exchange Traded Funds
- Should You Use Reddit for Retirement Advice?
Editors' pick: Originally published Nov. 8.