“ANOTHER ONE” FINANCIAL SCANDAL

Cryptocurrencies have been around for quite some time, but recently they surged in popularity. People are engaging in trading although they are not able to fully grasp the complexity of the market and lack the skills to analyse developments. The reasons behind cryptocurrency coins purchase are various such as investment in the technology of the future, earning high returns or storing value for the long term as the supply of cryptocurrencies is limited by algorithms.[1] At the moment, trading crypto is overpowered with speculative behaviour. New entrants to the market are at risk of falling into the trap of herd instinct, strongly encouraged by the market-manipulative behaviour of so-called experts in the form of influencers. They produce content in which they advise the purchase of a particular coin in exchange for financial compensation. The main aim is to increase the value of a coin and once it is raised, influencers and scammers sell their tokens. Initiators of the pump and dump scheme gain profit, while everyone else is left with a significantly lower nominal value.[2] The base enabling those tactics to work is people’s fear of missing out (FOMO). For the scheme to succeed one needs to create a new token through an initial coin offering (ICO), which is not difficult as already existing blockchains such as Ethereum can be used. Currently, almost no governmental regulation exists on ICOs allowing everyone to establish one. Afterwards, the essential part comes into play: the initiation of fake hype. Influencers are hired to generate the trust in a token by promoting it and obtaining financial compensation. The worth of the coin is directly proportional to its popularity. The driving force behind virtual currencies is influencer marketing as it serves the function of promotion.[3]

In 2017 the U.S. Securities and Exchange Commission (SEC) designated ICO tokens as securities in the form of investment contract. The decision to buy a particular coin is influenced by the potential to increase in value or gain a profit due to the efforts of others. Based on those characteristics it can be concluded that ICOs constitute securities and their offering. [4]The Securities Act of 1993 imposes an obligation of registration with the SEC and provision of information about the seller and stock offering to investors.[5] Consequently, the ICOs conceived to be deceitful to investors are subject to enforcement actions. One of the prominent examples is the SEC action against the professional boxer Floyd Mayweather Jr. and music producer DJ Khaled for failure to disclose money received to promote ICOs. Centra Tech Inc. paid $100,000 to Mayweather and $50,000 to Khaled for some posts on social media. Boxer used his Twitter account to tell his audience that Centra’s ICO “starts in a few hours. Get yours before they sell out, I got mine…” and DJ Khaled called it a “game changer’’. Moreover, Floyd Mayweather has been considered liable for not disclosing a sum of did not disclose $200,000 to promote two other ICOs.[6]

Founders of Centra were charged with violation of anti-fraud and registration provisions of federal securities law. They raised over $32 million from various investors using advanced marketing campaigns based on false partnerships with acknowledged businesses. Celebrities’ promotional activities on social media highly influenced the success of fraudulent schemes. [7]Due to the lack of disclosure about the advertisement, actions of DJ Khaled and Mayweather were viewed as candid and impartial. The charges against celebrities were settled without admitting or denying the findings. Both agreed to pay penalties and to cease promotional actions of securities.[8]

Currently, the celebrities and crypto-assets influencers can only be charged with non-disclosure of advertisements as there is no regulation and enforcement on pump and dump schemes in the whole cryptocurrency market.[9] This means that when they post content promoting a coin subjected to market manipulation and mark it as an ad, no violation of rules occurs. Nonetheless, the tactics used fulfil the definition of traditional market manipulation as they involve actions inducing others to trade with intent to affect the price of the traded security. [10] However, the SEC declared that the offer and sale of cryptocurrencies are outside its jurisdiction. They are not seen as securities, so only initial coins offering are subject to Federal Securities Act.[11] Pump and dump scams are illegal for stocks, but not for cryptocurrencies. This constitutes an enormous issue as they create price distortions of an average of 65% and approximately 23 million of individuals are engaging in manipulating practices. The research of Dhawan and Putnins identified 355 instances of these schemes with a $6 million gain extracted from other traders as a result.[12] Leaving these schemes unregulated, might accelerate the financial burden undertaken by retail investors.

[1] Nathan Reiff, ‘Question: Why Should Anyone Invest In Crypto?’ (Investopedia, 2021) <https://www.investopedia.com/tech/question-why-should-anyone-invest-crypto/> accessed 3 November 2021.

[2] Oscar Gonzalez, ‘Cryptocurrency Pump-And-Dump Schemes: Everything You Should Know About These Scams’ (CNET, 2021) <https://www.cnet.com/personal-finance/investing/cryptocurrency-pump-and-dump-schemes-everything-you-should-know-about-these-scams/> accessed 29 October 2021.

[3] ‘Influencer Marketing Has Taken Over The Crypto World’ (Medium, 2021) <https://medium.com/geekculture/influencer-marketing-has-taken-over-the-crypto-world-f72529841397> accessed 28 October 2021.

[4] ‘SEC.Gov | Statement On Cryptocurrencies And Initial Coin Offerings’ (Sec.gov, 2021) <https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11> accessed 29 October 2021.

[5] ‘The Laws That Govern The Securities Industry | Investor.Gov’ (Investor.gov, 2021) <https://www.investor.gov/introduction-investing/investing-basics/role-sec/laws-govern-securities-industry#secact1933> accessed 28 October 2021.

[6] ‘SEC.Gov | Two Celebrities Charged With Unlawfully Touting Coin Offerings’ (Sec.gov, 2021) <https://www.sec.gov/news/press-release/2018-268> accessed 29 November 2021.

[7] ‘SEC.Gov | SEC Halts Fraudulent Scheme Involving Unregistered ICO’ (Sec.gov, 2021) <https://www.sec.gov/news/press-release/2018-53> accessed 29 October 2021.

[8] ‘SEC.Gov | Two Celebrities Charged With Unlawfully Touting Coin Offerings’ (Sec.gov, 2021) <https://www.sec.gov/news/press-release/2018-268> accessed 29 November 2021.

[9] Anirudh Dhawan and Talis J. Putnins, ‘A New Wolf In Town? Pump-And-Dump Manipulation In Cryptocurrency Markets’ [2020] SSRN Electronic Journal.

[10] Merritt B Fox and Lawrence R Glosten and Gabriel V Rauterberg, ‘Stock Market Manipulation and Its Regulation’ (2018) 35 Yale J on Reg 67

[11] ‘SEC.Gov | Statement On Cryptocurrencies And Initial Coin Offerings’ (Sec.gov, 2021) <https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11> accessed 29 October 2021.

[12] Anirudh Dhawan and Talis J. Putnins, ‘A New Wolf In Town? Pump-And-Dump Manipulation In Cryptocurrency Markets’ [2020] SSRN Electronic Journal.