If It’s Too Good To Be True…

…There is a very good chance that it isn’t! Just before the end of 2022, one of the big news items was the arrest of the former CEO of FTX, Sam Bankman-Fried (even central casting couldn’t come up with a better name than that!), in the Bahamas. Since then, he has been extradited to the U.S., where he faces wire fraud as well as other charges. All of this is as a result of his supposed mishandling and/or diversion of funds at the cryptocurrency exchange, FTX. As is stipulated in the indictment, beginning in 2019, Bankman-Fried “intentionally devised a ‘scheme and artifice to defraud’ FTX’s customers and investors, diverting their money to pay expenses and debts at his crypto hedge fund, Alameda Research, and to make lavish real estate purchases and large political donations.” And if all of this sounds like just another chapter in “robbing Peter to pay Paul” economics (a strategy that I am almost certain is not taught in Econ.101), then you are way ahead of me! While I fully realize that people have been harmed, some even losing their life savings, by these types of schemes and schemers, my interest has more to do with why people, many of whom are financially aware and astute business people, fall for these “snake oil salesmen?”

From what I’ve read (and this is probably as good a time as any to inform you that what I know about cryptocurrency could be placed atop of one of its coins, if such a thing even exists, with lots of room left over), this particular scheme by Bankman-Fried has made at least $1 billion in customer funds disappear into thin air, not to mention the residual damage triggering a “surge in outflows across other global crypto exchanges.”  Now, $1 billion is a great deal of money, but it pales in comparison to the $20 billion in individual loses suffered at the hands of Bernie Madoff’s giant Ponzi scheme discovered in December of 2008, which is only 14 years ago. It would appear that investors have short memories! The difference between Ponzi schemes and Pyramid schemes, other than the former being named for a person and the later a shape, is that a Ponzi scheme generally only requires investment in something from its victims, with promised returns on that investment at a later date, while a Pyramid scheme usually offers the victim the opportunity to “make” money by recruiting more people into the scam.

It was 1920 when the Italian-born Charles Ponzi, operating in both the United States and Canada, duped his victims. Ponzi’s money-making scheme involved his customers purchasing discounted postal reply coupons (think “forever” stamps now widely available); however, the end result was the same. He was using new investors money to pay off older investors and…well, you know the rest. While Mr. Ponzi did not invent the scheme, it became so identified by him that the name stuck. Before he was caught, he had bilked investors out of approximately $15 million, which in 2022 dollars is $224 million, not exactly chicken feed. Between Ponzi in 1920 and Madoff in 2008, there have been six major (there may be more) schemes that have cost investors an approximate total of $13.3 billion, which is why Madoff’s scheme received so much attention, with $7 billion more lost by investors than the previous seven biggies! I suppose that it was only a matter of time before the next one hit, and I am not the least bit surprised that in happened in the world of cryptocurrency.

We have all, at some time or another, been victims of the “if it’s too good to be true…” adage: The price of some product or service that usually results in yet another adage: “You get what you pay for;” a food that is so sweet but said to be non-fattening; front row tickets that are really in the “nose bleed” section; the Rolex watch that isn’t, and on and on it goes. However, the difference here is that while you may feel cheated or duped, the cost to you is minimal by comparison. All of which brings us full circle back to my original question: Why do we do it? Why do we let ourselves get sucked in to the promise of a “huge” payday, when conventional wisdom should tell us: “Buyer beware?” Well, I have a theory, and it is just that, a theory of one individual who is by no means an expert on these affairs, but here it goes. I feel that there is a fundamental difference between working for your money and having your money work for you. When you work for your money, you are expending a certain amount of physical or mental labor and being paid for that expenditure. But when it is the later, you the investor are not really doing any WORK, in the traditional sense of that word. What you are doing, though, when you give your hard-earned money to someone else to invest so that money will hopefully multiply, is take on more risk, which is, in its own way, a form of mental expenditure. Many of us do this regularly with retirement funds or other types of investments, and if you are like me (and I am not in the least bit proud of this); you have no idea what is transpiring with those funds, except for those monthly statements telling you that it’s up or down.

What’s the difference, then, between socking away money in “legal” investments for your retirement with the hope of it growing enough to sustain you, and investing in dubious schemes promising you 10, 20, 30 percent more? The answer to this depends really at what point of your life you are making these dubious investments, but if you are, let’s say 20 years away from retirement age, you are most likely doing this hoping for a large enough windfall that you won’t have to WORK anymore. There are enough examples out there demonstrating how this has worked for some people, and I guess it is human nature to think about those rather than the ones that didn’t!

Los Angeles 2023