Warren Buffett is famous for saying “Only when the tide goes out do you discover who’s been swimming naked.” If you invested in cybercoins, the news has not been good lately. Are you wearing your bathing suit? What to do? Is time to take your profits … or cut your losses?
The international investment community was shocked and saddened to learn of the utterly unexpected news that millions of investors worldwide were victims of a pyramid scheme involving cryptocurrency accounts controlled by “founders” in Tbilisi, Republic of Georgia, and Moscow. The SEC charged 11 people in the case in August.
No, wait. Nobody was shocked or surprised. This was the least surprising story of 2022. If you were playing “Password” and the first two clues were “Cryptocurrency” and “Moscow,” the only rational guesses would be “Pyramid” or “Ponzi.” Full credit for either answer.
Domestic actors have been at work as well. The founder of California’s Titanium Blockchain Infrastructure Services recently pleaded guilty to a cryptocurrency fraud scheme that raised $21 million.
The cryptocurrency world has been conjured out of thin air in the last decade or so. Across the globe, new crypto products have appeared, along with new uses for those products, and new markets for the exchange of these products. It includes crypto derivatives, synthetics, and electronic arbitrage trading systems run by bots. For better or worse, this is now a $10 trillion plus marketplace that is largely unregulated.
Most of the participants in that space are sincere entrepreneurs seeking to carve out a “first mover” advantage in a new and currently lightly regulated frontier. But a recent exposé by Bloomberg on the stablecoin business questions the backgrounds of some of the entrepreneurs that have introduced crypto products. And naturally, because some of the uses of cryptocurrency – money laundering comes immediately to mind – are highly attractive to persons who would prefer to remain clear of regulators, taxing authorities and criminal investigators, cryptocurrency has attracted its share of out and out criminals.
Even where criminal activity isn’t present, the “wild west” unregulated cryptocurrency world is fraught with more risk than the more conventional banking and investment world. Warren Buffett’s bridge partner Bill Gates has recently stated that cryptocurrencies are “100% based on greater fool theory,” that is, the idea that overvalued assets will go up in price when there are enough foolish investors willing to pay more for them.
The reckoning has begun. News reports note bankruptcies touching cryptocurrency entities on a daily basis. Robinhood, one of the biggest brokers of meme stocks and cryptocurrency has just laid off 23% of its staff.
So, what does this all mean for you? Each investor must weigh risks on a very personal level. Here is an outline that may help you decide whether to invest in cryptocurrency or not, and if so, how much to commit.
First, Make Sure You Have Your Financial Basics CoveredBefore you consider investing in cryptocurrency, ask yourself some questions about your finances:
Would you pass Finances 101? Meaning, are you maxing out your contribution to a retirement plan that has an employer match? Are you paying off consumer debt? Are you paying your monthly bills on time? Do you have an emergency fund? In other words, have you done all the boring conventional things you know you should have done since Andrew Tobias wrote The Only Investment Guide You’ll Ever Need in 1978?Do you have an FDIC insured bank account and a SIPC protected investment account with a securities broker for your principal financial assets and relationships?Next, Set Reasonable LimitsIf you are honestly satisfied with your answers to questions 1 and 2, and you absolutely want to invest in the cryptocurrency world, here is a possibility: Keep a separate account at a separate entity and put no more than 5% of your liquid assets in speculative investments.
Don’t be seduced into trading cyberassets on margin. This must be money you would otherwise spend on hockey tickets, red-soled Christian Louboutin shoes, Lotto, or a bet against the Yankees, and can afford to lose.
Finally, Don’t Take It Too SeriouslyIf you make a profit in your speculation account, perhaps you could slip this into a conversation as a “modest success.” This will make you sound like a careful student of the markets. If you lose some money in this account, you could tell a self-deprecating story with a smile, noting that the investment provided you an opportunity to learn and follow the developments in a new and exciting investment realm. If you are already invested in the cryptocurrency markets, you could evaluate your positions in a similar way.
These tentative-style investments may keep you from hitting a financial home run into the upper deck. That’s possible. On the other hand, when the tide goes out, your bathing suit won’t be down around your ankles.
Stephen P. Harbeck, Securities Investor Protection CorporationPresident and CEO (retired), Securities Investor Protection Corporation
Stephen Harbeck served as President and Chief Executive Officer of the Securities Investors Protection Corp., a nonprofit created by Congress to protect customers of failed brokerage firms, from 2003 to 2018. He guided SIPC through the insolvency of Lehman Brothers, the largest bankruptcy in history, the collapse of Bernard Madoff’s brokerage firm, the largest Ponzi Scheme in history, and other major insolvencies. Harbeck retired as President and CEO of SIPC in 2019. Since then he has acted as a consultant to the Shanghai Financial Court, and Shanghai Jiao Tong University, and is currently a consultant to the Japan Investor Protection Fund. SIPC, as a matter of policy, disclaims responsibility for any private publication by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of SIPC or the author’s colleagues on the staff of SIPC.
Thomas P. Vartanian, financial services lawyerExecutive Director, Financial Technology & Cybersecurity Center
Thomas P. Vartanian leads the Financial Technology & Cybersecurity Center, having previously chaired the financial institution’s practices at two international law firms, Dechert LLP and Fried Frank LLP. He also has served as General Counsel of the Federal Home Loan Bank Board and the FSLIC during the S&L crisis, and as Special Assistant to the Chief Counsel of the Office of the Comptroller of the Currency. Vartanian was the Chairman of the American Bar Association’s Cyberspace Law Committee and is a Fellow of the American College of Consumer Financial Services Lawyers. He has worked on technological advancements from the development of ATMs to the tokenization of financial instruments on blockchain networks and wrote 200 Years of American Financial Panics. For more, visit www.thomasvartanian.com.