CryptoCurrency: When Things May Really Be Too Good to Be True

by Daniel S. Maland | July 2019
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Charles PonziThere’s no denying the allure of an investment that can provide compounding returns nearly overnight. There’s also no denying that vetted cryptocurrencies such as Bitcoin and Etherium have turned normal individuals into millionaires in the course of just several years. However, not all cryptocurrencies are made equal, and some are gateways for fraud. It pays to do some research to understand what you are converting your money into before jumping on the cryptocurrency bandwagon.

Foundationally, it is essential to understand that not all cryptocurrencies are on the blockchain. Distilled down to its basic essence, blockchain is a decentralized method of recordkeeping in which entries are recorded on a digital record book or ledger, cross verified, and encrypted. Bitcoin is the world’s first decentralized cryptocurrency stored on a blockchain. This means that Bitcoin records are not kept in any one specific place, but instead are maintained on a series of duplicate digital ledgers kept publicly around the world. In addition, Bitcoins are generated through the assistance of miners: third parties which run complex algorithms to produce new Bitcoins (that are then recorded on the blockchain). Miners are rewarded with Bitcoins for their services. This system of third-party coin production and record keeping provides both transparency and security as well as allows for Bitcoin to be exchanged in a verifiable and trustworthy fashion. These characteristics allow Bitcoin to maintain a globally recognized value as a cryptocurrency.

Digital currencies do not have to be maintained on a blockchain to be publicly traded or carry value. However, privately held or produced cryptocurrencies may be subject to manipulation and could be a vehicle for fraud. Think of an arcade that awards its own unique tickets that its customers can then exchange for prizes. Customers enter the arcade and pay to play games with a hope of receiving tickets that they can use to exchange for prizes. That arcade controls its own proprietary currency— prize tickets—and can manipulate the value of that currency to fit its needs. The arcade can run promotions where it floods the market with tickets to make its prizes more affordable and attainable, or it can increase the value of its prizes by restricting the amount of tickets its games will dispense with each win.

Privately held cryptocurrencies can be manipulated in a similar fashion. Although a privately held cryptocurrency may be obtainable on the public market, such as via a cryptocurrency exchange, there may be a single company or individual in the background that might be controlling the actual amount of captive cryptocurrencies that are maintained on private records may also be manipulatable like the arcade tickets discussed in the arcade analogy above. Thus, before buying into a cryptocurrency it is prudent to find out who is producing the digital coins you are about to buy and how the records of who owns those coins are kept. This information should be publicly available. If you see that a single company or individual can flood the market with that currency at a whim—just like an arcade can unload tickets at its discretion— watch out! That investment may be too good to be true, and there may be some dubious business lurking beneath that sales pitch.

Kozyak Tropin & Throckmorton

Daniel S. Maland
Daniel represents individuals, public and private companies in complex litigation, receivership matters, class actions and government investigations. A third generation Miamian, Daniel practiced for several of New York’s largest and oldest “white shoe” firms, and held a federal clerkship before to returning home to Miami and joining KTT. Daniel consults on cyber security, blockchain and cryptocurrency technology, is a member of Florida’s blockchain and cryptocurrency task force, is conversant in Spanish and German, and is a member of the Maritime Law Association of the United States.
dmaland@kttlaw.com

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