A Theory of the Scam

Concerning a conference I’m attending in two weeks, a huge controversy has broken out about one of the 50 or so speakers. Many people think he is a scam artist, a guy who came up with a new cryptocoin as part of a ponzi-like pump-and-dump scheme. The idea is that you hype a new innovation, promise massive returns with hopped up language, pay off early investors with proceeds from future investors, drive up the price, and then bail suddenly and send your regrets.

I have no idea about the particulars of this case, but if the accusations turn out to be true, it wouldn’t surprise me. I’ve developed the feeling over the last year that there are many such characters in the Bitcoin space.

To be sure, all entrepreneurship requires marketing and sales. And every new business is a speculation. You have to go out pretty far on the ledge to make a new project work. I get that. For this reason, it can be difficult to tell the real thing from the scams.

And the accusation alone, or even the evidence of high leverage, is not enough to establish that something is a scam. I recall when Amazon itself faced such accusations in its first years of business. The stock price was screamingly high, completely out of proportion to its underlying value. When the price crashed along with everything else in 1999, the people who had called the company names felt pretty great about themselves — until two years later when the price recovered and the company went on to fundamentally change retail sales.

That said, scams are not all made up. They are very real. I have no doubt that the Bitcoin space is riddled with them. It was true in the early years of the Internet too. The high-flying stock prices for nothing attracted legions of people who figured it was enough to buy a domain and hype a service in order to attract investor attention. This is true in the Bitcoin and cryptocurrency world too.

Quite often at conferences, I get pulled aside by a start-up entrepreneur who gives me a sales pitch. Most often I can hardly follow what they are saying, and there’s no time to really get into details. So I leave the investing to others.

Meanwhile, the Bitcoin community has become super interested in policing itself. An attitude of extreme scrupulosity seems to have taken over the space. Some people go so far as to claim that every “altcoin” should be suspect, and every service too that claims to improve on the core Bitcoin infrastructure should be avoided.

The reddit community has become a den of accusations and counter-accusations. Hardly a day goes by when new accusations and defenses are not offered. This is surely a good thing. People are concerned that scamsters will discredit the sector in the same way that the Mt. Gox caper seriously harmed the reputation of Bitcoin.

But let’s ask a deeper question: why are scam artists so attracted to Bitcoin?

The answer is actually flattering. Scam artists are the evil cousins of genuine entrepreneurs. They are alert to new opportunities. They are attracted to ventures that are popular among the smart set. They are profoundly aware of what people imagine to be the next big thing. Where there is opportunity and the prospect of high profits, there are scammers. Their interest in Bitcoin, then, is actually a bullish sign. I would be more worried about this market if scam artists were not interested in it.

Think back to the early days when physical books first came to be viable as home-owned goods. There were no corner bookstores, but there were plenty of services that offered subscription services to large sets of books you could buy through the mail. At first it was just great books. Then it was great speeches. Then it was presidential notes. Then it was great men of history, then women of history, and so on. Then came the great “Who’s Who” scam where you had been chosen to be listed and you will surely want that book on your shelves.

You can wander through used book stores today and see these volumes. Most are terrible quality and completely worthless — really, they are no more than piles of paper with blather on them, volume after volume. People bought them. They were scams or near-scams. But the scammers knew: people wanted to own books. The scammers knew that in the future, every home would have a mini-library. They wanted to be first to fill those shelves. In this sense, the difference between legitimate entrepreneurship and outright scammery can become pretty gray.

But take note: the presence of scam artists did indeed indicate a future of success of that industry. Scamsters are nothing if not prescient. If you follow what they do, you will find the technologies and economic trends of the future.

Another example is railroads. Between 1870 and 1900, as the industry was booming and changing the way we travel and live, there were countless cases of stock fraud, pump-and-dump, ponzi operations, public-private corruption, and outright fraud that ended in tragedy. The cases filled the headlines day after day. It attracted massive public attention and condemnation.

It was the case here too: the scamsters knew a good thing when they saw it. They swirled everywhere in this sector to the point that even close observers couldn’t tell the difference between the fake and the real thing. And if the investors couldn’t tell, neither could the politicians and regulators. When the federal government got involved with the purpose of rooting out the scams, the fraud, graft, and corruption became worse, not better.

But as we look back, it is not the scams that were the truly lasting part of the innovation of railroads. It was how railroads changed our lives and vastly increased the standard of living for everyone. The railroads ended up ushering in the modern world as we know it.

In the end, the only way to keep scammers at bay is due diligence. This is exactly what the Bitcoin community is doing today. Investors beware. But never think that the presence of rackets in an industry discredits that industry. If anything, it is the opposite: scammers have exceptional talent at knowing a good opportunity when it comes along. That they abuse that opportunity changes nothing about the reality of a great technology. If anything, it flatters that technology.