Bitcoin Ponzi schemes, magical thinking, and the S(H)AFT

A dear friend once gave some good advice that I follow to this day. “Steve,” he said, “never get the pie at a place called Mom’s, pay extra for good shoes, and avoid people who promise you guaranteed returns of 300 percent in 3 weeks as result of trading off-exchange binary option contract on foreign currency and cryptocurrency pairs, among other things.” By religiously following this advice, I have avoided unnecessary reflux, my feet are generally comfy at the end of the day, and (so far, knock wood) I have not lost money in unregistered commodity pools shut down by the CFTC in emergency proceedings (though I did lose my first bonus as a lawyer in an ill-conceived investment in Enron, but that was before the advice).

If the allegations in a new lawsuit filed by the CFTC are to be believed, the same can’t be said by the victims of a scheme operated by an outfit called Circle Society, according to filings by the CFTC in Nevada federal court earlier this month in a case called Commodity Futures Trading Commission v. David Gilbert Saffron a/k/a David Gilbert and Circle Society, Corp.

In an emergency ex parte motion for a temporary restraining order filed on September 30, the CFTC describes a scheme where pool participants invested $11 million with defendants via a bitcoin wallet address:

From at least December 2017 through the present (the “Relevant Period”), Saffron has fraudulently solicited and accepted at least $11 million worth of Bitcoin (“BTC”) and United States Dollars (“USD”) (BTC, together with USD, “funds”) from no fewer than fourteen members of the public to participate in an unregistered commodity pool (the “Pool”). During the early stages of his activity, Saffron individually created a business entity, Circle Society Corp. (“Circle Society”), on or about September 6, 2018, and used this entity to perpetuate his fraud. Beginning on or about September 6, 2018 through the present, Saffron, individually and as principal and agent of Circle Society, has fraudulently solicited members of the public to participate in a commodity pool operated by Circle Society. Id. Through the use of in-person meetings, word-of-mouth, instant messaging services such as Telegram, podcasts, and websites operated by Saffron, Defendants solicited actual and prospective participants to pool their funds with that of other participants for the purported purpose of trading off-exchange binary option contracts on foreign currency (“forex”) and cryptocurrency pairs, among other things. Defendants guaranteed returns of up to 300% in three weeks.

The fact that people parted with 11 million dollars and believed that they stood a legitimate chance of a 300 percent return on investment in 3 weeks is just mind-boggling to me. According to the CFTC, the promise was bogus, and in fact, they alleged that this was a Ponzi scheme, “Defendants did not conduct trading on behalf of participants as promised and operated their unregistered pool in the nature of a ‘Ponzi’ scheme. Defendants also misappropriated some portions of participants’ funds by providing BTC to earlier-in-time participants using the BTC of later-in-time participants to perpetuate their fraud.” The CFTC also says that the defendants failed to register with them as a commodity pool operator (“CPO”).

Without judging the merits of this particular case (though it sounds laughably bad) another feature that you find in Ponzi schemes and other scams is absurd excuses when people try to get their money out. I don’t know about you, but as soon as someone tells me that solar flares are why I’m not getting paid, my next call is probably going to be to the feds. The CFTC says that was the case here: “Defendants attempted to perpetuate the fraud and conceal their misappropriation of participants’ funds by making false statements to participants. Saffron made and continues to make, individually and as the agent of Circle Society, numerous representations to participants as to why Defendants are not paying profits as promised, including but not limited to: (1) computer shutdowns due to ‘solar flares’; (2) withdrawal delays at various cryptocurrency exchanges; and (3) transactions being ‘jammed up’ or ‘frozen in cycle.’”

Anyway, if this all sounds bad to you it apparently sounded by to a federal judge, who issued an ex parte temporary restraining order and set the case for a hearing on a preliminary injunction, which is now scheduled for later this month. Ex parte means it was done without notice to the other side, which the CFTC said was necessary because they didn’t want the defendant to find out and destroy evidence or move/transfer assets.

You know who else got an ex parte TRO slapped against them recently? Telegram, at the urging of the SEC. Now, that is a completely and totally different case, and (to be clear) the SEC hasn’t made any allegation of fraud, or that Telegram is a Ponzi scheme. Nothing of the sort. (For more on Telegram, Frank Chapparo and I wrote the DEFINITIVE explanation about it here, so I am not going to re-belabor the details). Bottom line:  the SEC says that gram tokens, which Telegram offered as part of its SAFT fund-raising, are actually investment contracts and unregistered securities.

Let be clear again so that nobody gets upset — I am not saying that the SAFT is or was anything like the (alleged) Ponzi scheme in this CFTC case. But there is an element of magical or wishful thinking that the entire thing was premised on. The notion is that you can raise capital using an investment contract for a centralized entity and that promised future tokens will (wink wink) somehow upon delivery be transmogrified into non-investment contract bits of software that have functional non-speculative utility and can be used to do … things.

While I suppose, in theory, these things can be Hinmanized into sufficiently decentralized assets, the magical thinking part is that anyone would actually make an investment that promised these things if the purpose — let’s be honest now folks — wasn’t to dump them on retail for 10x what you paid for ’em. Magical thinking is not the same thing as criminal Ponzi scamming, but it may leave you with an unregistered security that you can’t actually dump on retail.  Or as one wag observed on Twitter, a better name for these things (if you're an investor) might be the Shaft: