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Cryptocurrency Scams

Conference Paper · January 2018

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Cryptocurrency Scams
Mateo Restrepo Sierra1 , Juan S. Cárdenas Rodrı́guez2 , and David Plazas Escudero3
1 Universidad EAFIT, mrestrepos@eafit.edu.co, Student, Medellı́n, Colombia
2 Universidad EAFIT, jscardenar@eafit.edu.co, Student, Medellı́n, Colombia
3 Universidad EAFIT, dplazas@eafit.edu.co, Student, Medellı́n, Colombia

ABSTRACT

In recent years, cryptocurrencies have become an important part of the financial and economical market all around the world;
a big portion of this success is due to their efficient and decentralized transaction system. Even though they were developed
for a more trust-worthy financial system, one that does not depend on banks or governments, there have been organizations
that had taken advantage of this and other key factors of today’s society, such as social media, news, etc. In this paper, we
approach the transaction system of cryptocurrencies using system dynamics for a more wide study of how this currencies can
increase their price only with a constant flow of investors and transactions. A dynamic hypothesis and Forrester diagram were
constructed after defining some relationships between the variables that were considered relevant in the system. The model
was validated and some policies were proposed in order to achieve some limits in the prices of cryptocurrencies.

1 Introduction
In the 1920s, Charles Ponzi duped investors when he convinced them that he will return a 50% revenue every 90 days; he was
actually paying the old investors with the money given by the new ones. This is known as the Ponzi Scheme nowadays; since
the virtual currencies lack of regulation and have enhanced privacy for trading, they can be and are being used by fraudsters
to perpetrate their frauds in similar fashion [1].
In 2017, the cryptocurrency company BitConnect launched its new coin BitConnect Coin (BCC, not to be confused with
BitCoin Cash), which assured every user that whatever investment they made in their currency and made part of their loan and
exchange platform (which allowed them to loan the company USD and Bitcoin to the company in favor of some interests) they
will return up to 40% of their initial investment every month. After using broad marketing strategies to avoid their investors to
know about their fraudulent intentions and recollecting thousands of investments, they closed the loan and exchange platform;
so, all the people who invested in the BCC lost all their money because of the 96% drop in the price of the coin. Even the
company promised to return some money for the people who got affected by given them the average of the price of the coin
in the last 15 days but, given that BCC was at such a low price there were several financial lossess by the investors. In this
day and age, there are new companies like XRPConnect, EthConnect, Bunny Token and NEOConnect that are replicating
the schemes that BCC made without any type of regulation which, as what happened with BitConnect, can lead to disastrous
results [2].
In this manner, cryptocurrencies can over-inflate their price by artificially manipulating the price by marketing it with unre-
alistic expectations so people start buying the coin and in some delay, selling it to other people to obtain profit through the
Exchanges or the Peer to Peer system, who would put more coins in the market through mining. As they exploit the price and
people invest more in the coin, they then can abuse this by incrementing by a big margin their Exchange rate or, on the other
side, the company changes the coins it possesses for USD or another currency and, proceed to devaluate their coin so they do
not have to pay people back. [3].
On the other hand, price leveraging is not as hard in cryptocurrencies as other stocks that are available in the market. An article
written in the Journal of Monetary Economics about the price manipulation in the bitcoin system, that the sudden spike in the
price of bitcoin in 2013 happened due to suspicious activity in an exchanges called “Mt.Gox Bitcoin Currency Exchange”,
which 600000 BTC valued at 188 million USD were acquiered using bots, artificially inflating the price without any real
substance; the article explains how this could have a massive effect in the growth rate of BTC in a positive manner, reaching
a 4% growth rate each day after [4].

1.1 Problem of cryptocurrencies

Taking account of all the above, the cryptocurrency system allows for people to abuse it in fraudulent ways to augment the
growth rate of the price of that coin without any type of repercusion, due to the lack of goverment regulation. On the other hand,
as an articles of forbes says, most of investors in this currencies like this investment because of the same lack of government
involvement [5]. In this manner, nowadays companies like Bunny Token, ETH Connect, XRPConnect and mire are expecting
1% growth in their price daily without any type of proof or security for the investors without too much control because, of the
lack of control they have, leading to a easier atmosphere to scam people.
To conclude, it’s important to notice that even if the problem and the variables have a very short span, there can be found
a lot of documentation about them because they were one of the trending topics last year. Most people see Bitcoin and other
cryptocurrencies as a safe economic investment and a way to make easy profit. Although we are not saying that is something
that we should thrive to eliminate completely, it is important to examine how this system works and start to make policies that
makes investing in this opportunity a safer place for the consumer and, stop catastrophes like BitConnect to don’t ever happen
again.

2 Important Concepts
• Ponzi Scheme: Is a fraudulent type of investment scheme that uses later investments to provided quick, high returns to
early investors. These schemes focus on attracting new investors rather than engaging in any legitimate investment. In
the 1920s, Charles Ponzi initially bought a small number of international mail coupons in support of his scheme, but
quickly switched to using incoming funds from new investors to pay returns to earlier investors. While dealing with
international exchange rates, postal organizations and foreign currency kept him from producing actual revenue, the
scheme did allow him to brag and advertise about the investment opportunity. In a few months, he managed to convince
hundreds of people to invest in his business; Ponzi used the funds to buy a mansion and deposited cash in banks all
across New England (today UK) [1] [6].

• Foreign Exchange Market: Global online network where traders buy or sell currencies, its main objective is to set
the exchange rate for currencies [7]. The basic concept behind the foreign exchange (or forex) market is for trading
currencies, one pair against another. In 2010, it was the worlds largest market, consisting of almost $2 trillion in daily
volume and is growing rapidly. The price of each currency within the pair is determined by a number of factors, such
as changes in political leadership, economic booms or busts or even natural disasters [8].

• ICO (Initial coin offering): It is a method in which a cryptocurrency startup firm sells a number of its cryptocurrency to
companies and investors to back their project up; it is similar to A IPO (initial public offering), where new companies
sell shares to other companies or investors. Early investors in the operation are usually motivated to buy the cryptocoins
in the hope that the plan becomes successful after it launches which could translate to a higher cryptocurrency value
than what they purchased it for before the project was initiated. Since these fund-raising operations are not regulated by
financial authorities, although there are successful ICOs, there are ICOs and crowd-sales campaigns that are fraudulent.
Funds that are lost due to fraudulent activities may never be recovered [9].

• Blockchain Protocol: It is used to serialize transactions of the currency among its users, it is maintained by a replicated
state machine that keeps user’s transactions and balances. This state machine is managed by nodes, called miners.
Cryptographic methods are used to ensure security on each transaction, the miners commit the transactions into a
global-decentralized log called blockchain. This is the protocol that several cryptocurrencies use for their trades and
transactions [10].

3 Analysis of the problem and variables identification

3.1 Scope of the problem
To approach the problem of this article, it is necessary to understand how the dynamic of buying and selling coins through
the exchanges can affect the price of that specific cryptocurrency; at the same time, it is important to notice how goverment
regulation can affect the price, so we can thoroughly determine how effective will goverment taxes affect the system.

3.2 Model purpose

Understand how the cryptocurrency buying-selling dynamic through exchanges, can increase growth rate and affect the price
altogether. Therefore, understanding how fraudelent schemes can leverage this system exponentially and artificially manipu-
late the price.

3.3 Variables identification and historical background

We identified 10 variables that affect the problem of over inflating this types of currencies for scams. These are:

1. Price of the cryptocurrency (CC): this is the market value in US dollars that the actual coin has. Measurement units: $
USD

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 2. Number of CC bought: is the number of CC bought by the users through the Exchanges. Measurement units: dimen-
sionless.

3. Number of CC sold: is the number of CC sold by the users to the Exchange company for another currency. Measurement
units: Dimensionless.

4. Investors: is the number of investors that have invested on the coin or the company releasing it. Measurement units:
dimensionless.

5. Number of Exchanges: this is the number of Exchanges that trade this specific CC. Measurement units: dimensionless.

6. Volatility: it’s the uncertainty in percentage of, given a value of winning fee, how much one can lose or win in relation
to that fee. Measurement units: %

7. Earnings: this is on average how much a given person earns by trading this CC. Measurement units: $ USD

8. Exchange fees: this is the fee that the Exchange uses in every trade you make with their rates. Measurement units: $
USD

9. Government taxes: this is the taxes that the government applies to the Exchange. Measurement units: $ USD

10. Growth rate: It refers to the price of the cryptocurrency divided by time[11]. Measurement units: USD/Time.

In order to give some historical background of these variables, we are going to use the BitConnect example because, although
there exists several companies who work in a similar fashion, this is the only one in this span of time that has completed the
scam completely. It is important to notice that, finding measurements of variables such as the CC sold and bought can be a
real hard task because the number of transactions per day with this coin considerably big; and, although we could check the
blockchain for every single operation in each CC, it is something to improve upon in the future with an algorithm that does
this automatically.
In this manner, instead of measuring the CC sold and bought will find the historical background of the Volume of the CC
which represents the amount of money in USD that has been traded of that CC every 24 hours; even if is not exactly the same
as the variables mentioned, we could have a good knowledge of this variables through that graph. Figure 1 shows trading data
on BitConnect.

Figure 1. Trading data on BitConnect.

On the other hand, the same occurs when we try to find the number of investors; it would be something impossible to find at
exact quantity of how much investors are investing in the CC. So, instead, we can find the graph of the Market Cap that is the
number of investors multiplied the price of a unitary action of the company. In this way, we would get a very good grasp of
the behavior of this variable. Figure 2 shows said data.

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 Figure 2. Market cap data on BitConnect.

Finally, the price of the CC is the easiest to find, as it is documented in a wide variety of websites. Figure 3 shows the price of
the BitConnect Coin.

Figure 3. Price on BitConnect Coin.

This data was obtained from Coin Market Cap on [12].

4 Dynamic hypothesis
4.1 Causal loop diagram
Figure 4 shows the causal loop diagram for the model in study.

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 Figure 4. Causal loop diagram for cryptocurrency exchange market.

5 Forrester diagram
The time scope selected for the simulation was 4 years (48 months for Vensim), this is due to the fact that the exchange market,
in general, is highly volatile and unpredictable; it would be a mistake to attempt a larger simulation. Besides, for the kind
cryptocurrency that is being modeled, the price tends to increase in a short period of time. The complete Forrester Diagram is
shown in Figure 5.
It is important to highlight that, in comparison with the dynamic hypothesis, the Forrester Diagram has a considerably more
variables; this is due to the fact that, during the construction of aforementioned diagram, we considered more calculations and
relations between than the variables defined in first place. Although, the dynamic hypothesis has the general system behavior.
This diagram was developed in Vensim.

6 Model Validation

6.1 Units Consistency

The units check validation was tested through the units check test in Vensim; though, it must be noted that the units check
approval was achieved using some parameters, this proves that some of the equations proposed for the model are not the best
options, even though they are consistent with whether the dependency was proportional or inversely proportional.

6.2 Base Model

Before continuing with further validation, it is necessary to show that, indeed, there is a problem and that it can be checked in
the model constructed. For this, the base model will be presented, with results for both price and growth rate.
The results for the base model test are shown in Figure 6, for both price (a) and growth rate (b).

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 Figure 5. Forrester diagram for cryptocurrency exchange market.

(a) Results for price. (b) Results for growth rate.

Figure 6. Base model test.

It can be noted that the plot of price (Figure 6.a) for the base model is similar to Figure 3, which shows price of BitConnect
Coin; showing a significant growth in the price of the CC in a very short time period. The problem that is going to be
addressed is attempting to limit this growth or, at least, extend the time that the market needs to reach similar prices. A
possible improvement to control the system using the model, can be through two specific variables: taxes and investors.

6.3 Stress Test

The variables selected for the stress test are CC Bought and New Investors. They were set as follows:

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 • CCBought= 0 • NewInvestors= 0

6.3.1 CC Bought

Setting the number of cryptocurrencies bought as zero, would imply an important drop in the price, this is shown in Figure 7.
This shows that the model behaves correctly after changing CCBought.

Figure 7. Price after setting CCBought as zero.

On the other hand, it is important to note that the growth rate also behaves accordingly, as it is shown in Figure 8. This is
because it settles after a few months, which proves that it depends on the price change and it if it does not change, the growth
rate will be constant.

Figure 8. Growth rate behavior for CCBought as zero.

6.3.2 New Investors

Setting the number of new investors as zero, implies that there will not be new buyers and the market would, kind of, get stuck
with the same people. As the cryptocurrency market needs people to invest and them being in a constant flow, the price of the
CC would drop after a few months. This was achieved during this test, as shown in Figure 9

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 Figure 9. Results for price after setting the new investors as zero.

Same for the growth rate, which proves accordingly the behavior, shown in Figure 10.

Figure 10. Results for Growth Rate for zero new investors.

7 Policies
7.1 Policies: Government Taxes to Exchanges
The first one is controlling the trading in the exchanges, this may be achieved through the government imposing taxes to the
exchanges; as the exchanges have to pay to the government, they have to augment their own taxes (exchange fees), so this will
represent a change in the price and obviously in the growth rate, as is shown in Figure 11.

(a) Results for price. (b) Results for growth rate.

Figure 11. Results after setting government taxes.

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 Note that the growth rate keeps a normal fluctuation and that the price is oscillating and tending to drop, as well as the
price maximum is around 175USD, whereas the base model was around 480USD; this shows that the policy is effective and
changes are taking place in the model results.

7.2 Policies: Limit the Number of New Investors

One of the most important factors that increase the price of a cryptocurrency is the number of investors that a certain cryp-
tocurrency can handle. Therefore, it is of the utmost importance to regulate the number of investors that can enter the system
monthly so the price grows in a more balanced way. The system was tested allowing only ten thousand people maximum to
enter the system per month; in the real system, is not extremely hard to control this aspect but it needs government regulation
to make it achievable. The results of this policy can be observed in Figure 12

(a) Results for price. (b) Results for growth rate.

Figure 12. Results after limit in New Investors.

7.3 About policies

As it was previously presented, the policies can only be for external factors that affect the system; this is because the cryp-
tocurrency system itself cannot be changed, as Silvio Micali [13] states: “A cryptocurrency cannot be fixed. If you ever want
to change something, you would have to create a new one”. Therefore, we can only change external factors in order to make
regulations without having to create a new currency.

8 Conclusion & future work

The model constructed gives a general idea of how does a cryptocurrency exchange market work. On the other hand, the
mathematical expressions used in the model could not be the ideal, since finding the optimal functions for the calculations
needed was not the objective of this research; though, this can be left for future work. Additionally, the policies purposed are
just some strategies, based on the model constructed, to give some regulation to the problem at hand; nevertheless, it should
be noted that implementing these policies out in the real world can be a different research topic.
This paper was focused on giving a basis to a relationship between system dynamics and the cryptocurrencies world;
therefore, this paper gives a basic grasp of how a model in this area can be constructed.

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