Follow the Money: Ponzi Schemes

Imagine the following scenario: you’re presented with an investment opportunity that promises quick, guaranteed returns that are far above what’s offered by traditional financial platforms. While you’re not quite sure how it works (you’re not a professional investor), a few friends and colleagues have already vouched for the program’s validity. So you decide to invest a small amount to test its worth. To your delight, you see returns exactly as advertised. Buoyed by your quick gains, you re-invest a larger amount and tell a few friends and colleagues. This cycle repeats until suddenly there are no returns, and your investment—all of it—is wiped out. You’ve just become a victim of a Ponzi scheme.

Similar to a pyramid scheme, Ponzi schemes generate cash by recruiting participants. The investments of new participants are used to pay the dividends on older participants’ investments. In a pyramid scheme, individuals are aware that their monetary gain is coming from the recruitment of new participants, but in a Ponzi scheme, this element is hidden from investors, who assume their money is being made legitimately through calculated investments.

A Ponzi scheme reaches its end when one of three things happens: it is unable to draw in enough new capital to pay outstanding dividends; the founders of the scheme run off with all of the accumulated cash; or regulators and investigators bust the scheme as it’s in progress.

Ponzi schemes have a long history in America, from Charles Ponzi peddling coupons to Bernie Madoff weaving a web of imaginary financial securities. Some Ponzi schemes only run for a few weeks before they collapse. Others can run for decades before they’re finally exposed. For over 100 years, the Ponzi scheme keeps showing up across the country with the same dirty tricks as before, just dressed up in different, fancier clothes.

The Crypto Ponzi Scheme: Bitconnect

Cryptocurrency proved to be one of the most exciting, and most lucrative, investment opportunities of 2017. Blockchain projects like Bitcoin and Ethereum reached the mainstream, and their prices (as well as the prices of their many imitators) skyrocketed. New all-time highs were hit practically every other day. This was an industry moving faster than regulators could keep up. And for every legitimate investment opportunity, there were countless scams lurking alongside it.

Bitconnect arrived just in time to ride that wave of greed and optimism. Starting in 2016, it marketed itself as a lending platform that offered extremely high-interest payments. Users could sign up, deposit funds (in Bitcoin) and receive Bitconnect tokens (BCC). Users could then ‘loan’ those tokens out and, after a certain period of time, recoup both the loaned tokens and a significant slice of interest (also in the form of tokens) that could be sold back into Bitcoin and cash.

Bitconnect utilized a tiered structure where the more one invested, the more one could earn. One of its most outlandish claims was that users could expect Bitconnect roughly one percent interest every day. Compounded over time, a user could thusly expect approximately 3,780 percent profit per year. To put it more starkly: an initial investment of $1,000 would become over $50 million within three years.

The premise had more red flags than a parade in Beijing. But cryptocurrency was a relatively new idea to the average investor, one shrouded in mystery but still putting up otherwise incredible financial returns. Bitconnect assured its users that they were able to put up such high numbers through the use of a futuristic trading algorithm, which they called a ‘trading volatility bot.’ But naturally they couldn’t disclose how this futuristic creation actually worked, or else they’d threaten their edge in the market.

Greed is blinding. Even as intellectual heavyweights like Vitalik Buterin, the inventor of Ethereum, openly called Bitconnect a Ponzi scheme, the market value of Bitconnect continued to grow. And some investors in Bitconnect did get their promised interest payments, and so they spread the word further. To bolster this word-of-mouth recruitment, Bitconnect paid large sums in referral bonuses to YouTube and Twitter influencers who preached the gospel of Bitconnect. The more people they recruited, the higher returns they got on their investments. Bitconnect’s value reached over $3 billion in market capitalization.

When the UK government threatened legal action against Bitconnect in November 2017, Bitconnect’s promoters and influencers rushed to their microphones to call it all fake news. The value of the Bitconnect token continued to climb and the number of investors soared. It wasn’t until early 2018 that US regulators intervened, with the states of Texas, North Carolina, and eventually Kentucky all ordering Bitconnect to cease and desist. When Bitonnect complied, the value of its coin immediately plummeted from over $400 to pennies, leaving its users holding tokens that were virtually worthless.

In early 2019, the FBI told the global public it was looking to speak to victims of the Bitconnect scheme. Critically, it did not limit this search to merely American citizens, as Bitconnect was a global operation that defrauded people across at least ten different countries. So when criminal cases against the founders were finally opened later in the year, it came as little surprise that their location lay outside the US, in India.

In cooperation with a division of India’s Criminal Investigations Department (CID), FBI agents made their first agency visit to the country in July 2019. While there, they interrogated Satish Kumbhani, the man alleged to be the mastermind of the Bitconnect scheme. Unfortunately, however, they were unable to interrogate his partner in crime, Divyesh Darji, who is currently on the run and involved in new cryptocurrency scams that look frighteningly similar to Bitconnect. The FBI’s investigation is still ongoing and likely to remain that way for quite some time.

How Forensic Investigators Stop Ponzi Schemes

Each Ponzi scheme has the same ingredients: a lure, a justification, and a marketing plan. The lure is a quick financial gain that requires little work and even less intelligence. The justification is some sort of ‘magic box’ that is, according to the creators, too complicated to be fully explained. Finally, the marketing plan is users recruiting more users, an act which validates their own investment.

Today’s magic boxes (volatility trading bots in cryptocurrency markets) may seem more complicated than yesterday’s magic boxes (refund coupons or lucky stock picks), but that’s precisely the point. Everything in a Ponzi scheme is designed to take advantage of the blinding aspect of greed, and divert attention away from the details. But the details are exactly where forensic investigators are trained to look.

Once a Ponzi scheme is identified, it’s easy enough to shut down. But today’s Ponzi schemes are more difficult to uncover for two reasons: a multinational financial landscape and an increasingly complex set of financial instruments. While the old adage to follow the money remains as important as ever, money is now stored in more ways than ever before.

Today’s forensic investigators need to be trained to catch the next Ponzi scheme, not just the last one. To do so will require interdepartmental collaboration, multinational understanding, and awareness of emerging technologies like cryptocurrency. Foundational skills in forensics will remain critical to the blocking and tackling of a white-collar crime investigation: checking financial reports, interviewing participants, and catching red flags. But proficiency in new areas like blockchain forensics will allow investigators to trace digital cash from source to source, even if it’s encrypted, which can be critical for building a modern case.

The future is largely unregulated and ripe for scams and white-collar crime. While regulators have to move at the pace of legislation and bureaucracy, today’s forensic professionals can get a head start by training for the future. If you’re ready to join them, check out some of the programs and experts below.

Three Experts Leading the Charge Against Ponzi Schemes

Joshua McAfee, PhD McAfee Institute

Dr. Joshua McAfee is the founder and CEO of the McAfee Institute, a major provider of professional training to law enforcement investigators across the world. He earned his bachelor’s and master’s from Colorado Technical University before pursuing a PhD from the Chicago School of Psychology. Prior to founding the institute, McAfee spent over 20 years in law enforcement, where he specialized in fraud and cybercrime investigations. His career has seen him collaborate across numerous federal agencies, including the FBI, DOD, and DEA. In addition to his work at the institute, McAfee has been a prolific writer, authoring blogs, whitepapers, academic articles, and over a dozen books.

Patrick J. O’Guinn, Sr., JD University of Maryland Global Campus

Patrick O’Guinn is the program chair of the graduate digital forensics and cyber investigation program at the University of Maryland Global Campus. He earned his JD from the University of California’s Hastings College of Law, and his MPA from Golden Gate University.

Prior to joining UMGC, he spent 23 years teaching at Howard Community College, where he designed courses in criminal justice and computer forensics. He also created and directed Howard’s digital forensics program before retiring as the school’s Professor Emeritus of Criminal Justice and Digital Forensics. As a scholar-practitioner at UMGC, O’Guinn emphasizes problem-solving labs for students to prepare for work in digital forensics and cyber investigations. Outside of academia, O’Guinn maintains his community involvement as an author, keynote speaker, consultant, and mentor.

David M. Shapiro, JD, MBA Jay College of Criminal Justice

David Shapiro is a distinguished lecturer at John Jay College of Criminal Justice, where he teaches classes in forensic accounting and white-collar crime. He’s also the coordinator of John Jay’s fraud examination and financial forensics (FEFF) program He earned both his JD and his MBA from Seton Hall University.

Prior to joining John Jay, he worked as an FBI special agent, a corporate investigator, and an assistant public prosecutor. Considered an expert on financial investigations and law enforcement, he’s published numerous articles on accounting and finance, and he recently authored a chapter for the book How They Got Away With It: White Collar Criminals and the Financial Meltdown.