How to Avoid Buying Trash Crypto That Wastes Your Money

Original posted at The Bitcoin Consultancy

If you can imagine a way to lose money in crypto, I’ve heard it. Since 2017, I’ve heard from thousands of victims of every crypto scam imaginable.  

But for every crypto scheme which is outright theft, there are ten trash crypto-assets created mainly to take your money and run. Each project has a story of why they are a great investment. But dig deeper and the business model is a mirage. What the founders really want to do is create as much momentum as possible and sell at the top before the illusion of value vanishes.

Sometimes you don’t have to dig very deep. For example, “BabyCake” is an explicit Ponzi scheme, if you look beyond their promises of “bringing passive income into people’s lives.” It’s one of the first tokens to have a Ponzi scheme built right into the smart contract. I count 63 other “baby” named pyramid schemes.

Usually, though, the catch is buried deeper and requires understanding the crypto ecosystem. Let’s review why there are so many scams and trash coins in crypto and how to avoid them.

Why are there so many crypto scams?

Anonymity

Cryptocurrencies are only pseudo-anonymous. It’s impossible to know who owns some coins from an address alone. But if you interact with the legacy financial system, for example, by cashing out your gains for fiat, your identity can sometimes be found. If you commingle your funds by moving them together, it’s possible for a chainanalysis algorithm to link activity to an identity. When I try to help victims of fraud, I can often follow the transaction trail to the cold-wallet of some exchange where the crooks traded Bitcoin for a local currency. 

I think the bigger problem is that our legal systems aren’t adapted to deal with crypto fraud. Our legal institutions don’t take small-scale crypto fraud as seriously as fraud with “real” money. Lack of international cooperation means that even if I know which exchange was used to cash out stolen crypto loot, they are unlikely to cooperate with local law enforcement.

Bleeding Edge Technology

Bitcoin and cryptocurrencies are still very new. The tools needed to secure Bitcoins are still evolving and rough around the edges. I predict that in a few years, we will carry credit-card-sized devices with biometric readers that make storing and using Bitcoin both safe and foolproof. Until then, the tools for storing and transacting cryptocurrencies are rapidly evolving. There are safe methods to keeping your crypto safe (like hardware wallets, multi-sig, and steel seed backups), but many people aren’t aware of the proper techniques. Accidental and malicious loss of funds is, unfortunately still common.  

Transaction Finality

A bigger reason for fraud in crypto is that crypto transactions are irreversible for almost all coins. In the legacy financial system, a fraudulent credit card charge, bad check, or unauthorized wire transfer can usually be reversed. If the theft is big enough and your lawyers are good, the legal system will tend to intervene on the victim’s side. In the crypto space, however, no matter how unjust the theft, there is nothing that can be done.  

(Keep in mind though that government theft of savings through inflation and taxes is a far bigger problem than theft of crypto. While this is unfortunate for victims of theft, transaction finality is one of the primary reasons why Bitcoin is so revolutionary: it is impossible to conduct legal plunder of people’s wealth.)

A Free-Market Alternative to Wall Street

“Wall Street” (i.e. traditional securities markets) is often portrayed as the epitome of capitalism. The reality is that the government has regulated most of the profits out of securities available to the non-elite. Crypto-assets and exchanges allow novice investors access to venture capitalism for the first time since the Securities Act of 1933 limited investments in unregistered securities to “accredited” investors. Initial Coin Offerings offer normal people the ability to invest in startups without having to be worth or put up millions of dollars. DeFi (decentralized finance) exchanges operate using smart contracts, without any centralized entity to regulate. With DeFi, anyone to mint and create a market for a new token, outside the ability of any government to regulate.

The flip side is that just because everyone can create and sell their token does not mean they have a viable business model or any technical skills. All you need to be able to do is market your coin, not do anything useful with it. The vast majority of crypto projects trend back to a value of zero.

Bitcoin’s Success Inspires Copycats

Most crypto scams are not outright theft but an attempt to make a quick buck by riding on Bitcoin’s coattails. Profiting from Bitcoin’s rise requires an initial buy-in and patience. Want to make billions with an investment of zero? Too impatient for a mere doubling of your money each year? Just copy Bitcoin’s code, change a few parameters (invent some justification why they are needed) and launch your own altcoin. Repeat the scheme a few more times and get 12,881 crypto-assets tracked by CoinMarketCap.

Many projects start out well-intentioned. The founders may want to be revolutionaries just like Satoshi Nakamoto or they might have some justifiable disagreements with the team that maintains Bitcoin. However, the decentralized nature of crypto assets means that once a coin is out there, speculators will run with it. Quite often, the founder exits early with a small fortune and the project evolves in a completely different direction. The founder of Dogecoin sold everything to buy a used Honda Civic. His coin now has a $32 billion market cap.

Today, the crypto-asset market has a market cap of $2.5 trillion, 48% of which is Bitcoin. Many beginner crypto investors are branching out into altcoins hoping to see the same astronomic returns as Bitcoin in the early days. Let’s explore why they are wrong and why you should focus on Bitcoin.

How to Avoid Trash Cryptos

I’ve already written how to avoid having your crypto stolen by scams and how to safely store your Bitcoin. Unlike outright theft, “trash cryptos” are schemes where you might not realize that you’re the victim.

Buy And Hold Your Entire Crypto Portfolio In Bitcoin

The only guaranteed way to avoid falling for a crypto scam is to keep 100% of your crypto portfolio in Bitcoin. Investors fall for crypto scams when they try to beat the returns of Bitcoin through a variety of other coins and schemes.

Let’s analyze objections to a 100% Bitcoin portfolio and how it gets investors in trouble:

Objection #1: Bitcoin’s returns are not good enough

Over the last ten years, Bitcoin has consistently earned almost a 200% return. In other words, if you just kept your money in Bitcoin, you would have tripled your investment every year.  

No other cryptocurrency can match Bitcoin’s track record. Consider Ethereum, which has beaten Bitcoin over the last 4 years. But this assumes you had the foresight to participate in Ethereum’s ICO. Ethereum is up 2.7x since its 2017 high, whereas Bitcoin is up 3.3x. The point is that you’re not missing out by not buying the latest hot altcoin. By the time you hear about it, any potential for astronomical returns is long gone. If you had bet on Ripple when it was #2 In 2017, you would only have 1/3rd of your portfolio left.

The only way to become a successful long-term investor is to study the fundamentals of an asset, not its price. Bitcoin is the future of money. No other altcoin comes close to Bitcoin as money. Bitcoin’s top competitors are smart contract platforms of various kinds. Their usefulness for real-world business models is currently unproven.  

Objection #2: You heard some altcoin is better than Bitcoin

Novice Bitcoin traders want to be above-average investors. Of course, we can’t all be above average. But many nonetheless try to add some extra alpha to their portfolio by buying a hot new coin or timing the market. 

Those familiar with the efficient market hypothesis understand the difficulty of consistently beating the market. The prices of assets reflect all current information known by participants. Unless you can consistently evaluate the fundamental value of assets more accurately than others, you won’t beat the average. When you try to time the market, your emotions work against you, urging you to buy after an asset goes up, and sell when the asset is low.

Of course, if you invest in Bitcoin, you’re already disagreeing with the vast majority of investors who have little or no exposure to it. Why not disagree a little more and buy some altcoins? Here is the difference:

Bitcoin has a simple business model (“Hard Money You Can’t F*ck With”) and a 12-year track record. Altcoins are all either a technical variation on Bitcoin (fba vs proof of work, or dag vs blockchain) or an entirely different business model (smart contracts). It’s much more difficult to understand the technical merit and value proposition of these assets. None have Bitcoin’s track record.

As a managing partner of a cryptocurrency hedge fund, it is my full-time job to research and write about cryptocurrencies. Yet the vast majority of my crypto portfolio is in Bitcoin because I do not feel qualified to judge the technical merits of various projects. I have a background of 17 years in software development and architecture. I personally designed a Bitcoin exchange. Do you think you can do better based on YouTube and Twitter personalities?

For example, even if Dash is technically better than Bitcoin, is it going to beat Bitcoin’s network effects? What’s to stop Bitcoin from adding whatever killer feature Dash offers? Are you qualified to make these judgments, or are you buying based on the rumor mill?

If you are personally involved in a crypto project, I understand your decision to invest. But don’t expect to beat Bitcoin based on scrolling crypto news sites.

Objection #3: You want to be a crypto trader

It’s an awesome experience to sit down in front of an exchange trading screen full time. For many of us, crypto exchanges were our first introduction to the power interfaces of marketplaces, with their continuous order books, market depth & candlestick charts, and advanced orders. 

Once you master the advanced trading screen, you feel like you have the key to mastering the markets. By taking a few online courses, you can develop a unique system that consistently earns you profits. During a bull run, when everything is going up, it’s easy to conclude that you are in fact a pro.

It is possible to earn a consistent edge in crypto – just not by you. Crypto markets are manipulated by whales (big traders) with powerful marketing machines. There is no way to predict their actions, but they will use your emotions against you. They also pay lower trading fees than you, while your profits are eaten up by fees.

Objection #4: You want to diversify your crypto portfolio

One of the main reasons people hold a basket of crypto assets is that they don’t know which will be successful in the long run. This is a reasonable concern. In practice, however, choosing which assets should go into your portfolio is very difficult.

The principle behind diversification is that by holding uncorrelated assets, you can reduce the volatility of your portfolio while maintaining the rate of return. Diversification works great for the stock market because the profit margin tends to be the same across different sectors. Also, the stock market has 120+ years of precedent to predict future trends.

The same isn’t true of the cryptocurrency market. The price of crypto is based almost entirely on anticipation of future demand, not current demand. Bitcoin’s price depends much more on speculation than current demand as money. Furthermore, money is a natural monopoly, so it’s likely that only a single coin will emerge dominant. (Likewise for smart contract platforms.)

If we assume that a single asset will emerge dominant, which one do we choose? One option is to look at the total market capitalization of each coin (hence CoinMarketCap.com being the #1 crypto site). But this is misleading. If I create a token called “Veksler Coin” with a supply of 1 billion and sell a single coin to my friend for $1, I instantly have a $1 billion dollar market cap with a $1 inflow. MarketCap rankings are key for adoption, so there is extremely strong pressure to manipulate them. Even though Bitcoin has less than a 50% market cap, the vast majority of fiat inflows go to Bitcoin. In short, there is no reliable metric for market capitalization.

Some organizations advocate automatically rebalancing your portfolio in response to market cap changes. My fund does that to an extent, though we only trade coins that our research has vetted. However, if you are managing your own portfolio, are you prepared to continually rebalance your portfolio — and pay the capital gains tax on any profits?

Objection #5: You want to earn passive income from staking/yield-farming/crypto lending

Many Bitcoin investors believe that it isn’t enough to hold Bitcoin. You don’t just sit on your cash, right? You invest it in a productive enterprise to earn a return. Just holding an asset is speculation, and that’s bad, right?

There are two problems with this reasoning:

First, Bitcoin is fundamentally different from fiat money. The problem with fiat money is that it’s an inflationary asset. You have to put your money to work just to preserve your wealth. By contrast, when the quantity of money is fixed (as with hard money like gold or Bitcoin), a growing economy means that the share of wealth represented by each unit keeps increasing. Furthermore, the adoption and therefore demand for Bitcoin is rapidly increasing. Bitcoin is not just a static asset like cash or gold. It is also a money transmission network that provides ongoing value to people. Simply holding Bitcoin is an investment into the future of money.

Is a few extra percent return on top of Bitcoin’s 200% average worth risking your principal?

The second issue with many “crypto-investments” is their inflationary design. Consider staking. Cardano staking returns a 5.x% APY reward rate. Cardano also has a 5.7% inflation rate. You must stake to preserve your wealth. This is Cardano’s way of motivating users to delegate their ada to trustworthy stake pools. Staking may be a legitimate way to secure a crypto asset, but it isn’t a legitimate income stream.

More egregiously, consider coins like CAKE, which has a 73% APR (previously 450%+) in the Auto CAKE Syrup Pool. How is PancakeSwap able to offer those returns? There is a handy chart here. Clear as mud? The supply of CAKE is completely arbitrary and the reward rate is a combination of investor subsidies, high growth rate, and high inflation that changes day by day completely at the whim of the CAKE governance process. It’s fun to gamble with, but should you trust your life savings with this scheme?

Objection #7: You want to trust an expert (or algorithm) to trade your crypto

Never expect other people to be smarter with your money than you.

Many people will give you advice on how to invest your money. But just because someone made a lot of money managing other people’s money, doesn’t mean they did their customers a favor. Extensive research shows that index funds perform better than actively managed funds. Crypto isn’t any different.

Keep in mind that the volume numbers of many exchanges on CoinMarketCap are fake. It is much easier to manipulate the prices of crypto assets than you would think. Twitter, Telegram, and YouTube are filled with pump and dump schemes. If an investor finds a consistent advantage in the market, he will not give it up by publicly sharing it. Only those who can’t make a living by trading run YouTube channels about it.

The only reputable actively traded crypto funds are crypto hedge funds. They are open to accredited investors and have minimums of $50K and up. Be very clear on the value they are providing over you just holding Bitcoin before you decide to invest in one.

Conclusion: to avoid buying trash crypto that wastes your money, stick with Bitcoin

The crypto space moves fast. Dozens of new coins go live daily. The top 10 coins today look very different than five years ago. I can’t promise you who the leaders in this space will be in the future. What I do believe in is that fundamental value is what drives long-term trends. The asset that has the most universal business model, can scale to meet consumer demand, has the biggest real-world network, and the most robust community is Bitcoin. If that changes, I’ll be the first to let you know.

How Fiat Money Corrupted Savings & Made Us All Market Speculators

Originally posted at The Bitcoin Consultancy

Before the world switched to a fiat monetary system, people who wanted to build wealth kept their savings in a bank. Interest rates tended to equal the average rate of profit, which was enough for all but a small minority of professional investors and entrepreneurs. 

This all changed with the move to a fiat monetary system and the devaluation of money. Today, the majority of households own stocks — not because they wish to be investors, but because it is the simplest means of protecting savings. As a result, the political system has become highly involved in market outcomes. The real return of securities markets has been greatly diluted, created perverse incentives, and global risks for the economy.

Historical context

Before the creation of the Federal Reserve Banking System, the class of investors was small and limited to finance professionals. Everyone else earned income on their savings by keeping their savings in a bank. For example, the interest rate was 8.1% in 1798.

This changed in the 1920s, the Federal Reserve System fueled a huge credit expansion that caused the stock market bubble. Easy credit drove the return of the stock market to dramatically exceed the return on savings. We know what happened next

By 1952, 4.2% of the U.S. population owned stocks. The 2008-9 financial crisis had a dramatic impact on interest rates when the government injected massive amounts of money into the banking system. Rates have remained low ever since. Today, over 50% of households own stocks, rising to 88% of $100K households.

Savings in a pre-fiat, gold-backed monetary system

In a market economy, the rate of business profit tends to equal the interest rate. The rate of profit tends to even out across all sectors since money flows to more profitable sectors until the rate equalizes. Capitalists borrow money in proportion to the rate of return on investment. When investments are more lucrative, the interest rate increases until the cost of borrowing money equals the potential return — and vice versa. In this manner, savers in a pre-fiat monetary system needed to keep their money in a bank to reap the rewards of a growing economy.

Savings in a fiat monetary system

In a fiat monetary system, the government artificially lowers the interest rate by expanding the money supply. Savers have to shelter their wealth in inflation-protected assets because the fiat system devalues savings through inflation. 

Wealthy families have other channels to protect their wealth – such as real estate and business interest, but for the middle class, their main means of protecting savings are their 401k and their primary home. 

The corruption of the joint-stock company by fiat money

Passively managed index funds now account for the majority of U.S. equity funds. While they are great for investors, they only exist because the fiat monetary system has forced savers into the securities market. 

The publicly traded company exists to allow investors to pool funds together in a common enterprise, without incurring unlimited liability for its debts. Participation in a public company ought to come with high risks — offset by high rewards. 

When a company needs funds, it used to raise them through bonds and other forms of debt — with debtors being paid before investors.

This model is very different from the current system. By the time a publicly traded goes public, most of the risk and therefore return has already been taken by venture capital, which only a small group of private equity investors have access to. 

Because so many savers participate in the market, politicians are strongly motivated to intervene in market outcomes. The 2001 and 2008 financial crises led to the 2002 Sarbanes-Oxley and the 2010 Dodd-Frank Act. These regulations made it much more expensive to go public, which has led to an over 50% decline in the number of publicly traded companies. 

There are now just 3,530 publicly traded companies in the U.S. Anyone can buy a stock on their phone today, but by the time the government lets the company sell you shares, most of the profit potential has already been captured by wealthy venture capitalists and private equity investors.

Dividend yield has decreased from 5.49% in 1871 to 1.33%. Because government debt outcompetes private debt, companies issue stocks to raise money instead of bonds. 

Likewise, the price to earnings rate over double historical rates, as savers flock to the stock market — not seeking high returns, but trying to preserve wealth.

Furthermore, the political system is highly motivated to avoid downturns in the market. Politicians cannot prevent economic destruction (that mostly comes from the economic miss-allocation they cause), but they do inflate market prices through inflation.  Easy credit transfers wealth from dollar users to investors, while at the same time, capital gains taxes transfer much of those gains to welfare recipients.  (By “welfare” I mean all recipients of government benefits, individual and corporate.) All this activity accelerates the inflationary death spiral caused by our unstainable welfare system. 

Stock ownership in a free market should be high-risk, high-reward

Stock ownership should be a high-risk, high-reward endeavor for professionals. By contrast, savers should earn the rewards for their thrift by keeping their savings in a bank. A savings account is the original “index fund ETF.”

Bitcoin as a return to sanity

Bitcoin has a limited supply and cannot be manipulated by politicians. In a growing economy, Bitcoin is a deflationary currency. This makes it ideal as a means of saving money. 

Bitcoin savings accounts (such as currently exist in crypto-lending platforms) offer investors a higher return at a higher risk. Their stablecoin interest rate is around 9%. I would guess that this reflects a 6-7% rate of profit plus a 3% adjustment for inflation.

There is no easy way out of the current mess. The same forces driving more and more of the public to become market speculators also make those markets ever more unstable and unprofitable. Loan-bearing crypto deposit accounts (whether they hold stablecoins or cryptocurrencies) are rapidly growing in popularity and may become the high-yield savings accounts of old for savers everywhere.