Have you ever heard of someone who claimed to make a lot of money by investing in a new cryptocurrency or a trading program that promised high returns?

Did they also tell you that you could join them and earn even more money by inviting your friends and family to do the same? Or maybe there’s some big secret change about to happen in the global marketplace and they have the secret key to make big bucks out of this yet-to-be unveiled change?

If so, you very likely encountered a crypto scam, a type of fraud that uses digital currencies to lure and cheat unsuspecting investors.

Crypto scams can take many forms, but two of the most common and dangerous ones are pyramid schemes and Ponzi schemes. These schemes are illegal and can cause huge losses for the victims. This article will explain what these schemes are, how they work and how you can avoid them.

What is a pyramid scheme?

A pyramid scheme is a scam that relies on recruiting new members to pay the existing ones. The scheme does not have a real product or service to sell, but instead offers a commission or reward for bringing in more people. The scheme may claim to be a legitimate business, such as a multilevel marketing company, but in reality, it is just a way to transfer money from the bottom of the pyramid to the top.

Pyramid schemes are unsustainable. They need an ever-increasing number of recruits to keep the payments flowing, but eventually, they run out of new people to join. When that happens, the scheme collapses and most of the members lose their money.

One example of a crypto pyramid scheme is Forsage, which was launched in 2020 and raised more than $300 million from millions of investors worldwide. Forsage claimed to be a decentralized platform that allowed users to enter into smart contracts on the Ethereum, Tron and Binance blockchains. However, Forsage was actually a pyramid scheme that paid commissions based on multiple levels of recruitments. The U.S. Securities and Exchange Commission charged 11 individuals for their roles in creating and promoting Forsage.

What is a Ponzi scheme?

A Ponzi scheme is a scam that pays returns to investors from their own money or from the money of new investors. The scheme pretends to have a profitable investment strategy or business opportunity, but in fact, it does not generate any real income or value. The scheme depends on attracting more and more investors to keep the illusion of success.

Just like pyramid schemes, Ponzi schemes are also doomed to fail. They need to pay higher and higher returns to keep the old investors happy, but eventually, they run out of new money to cover the payouts. When that happens, the scheme collapses and most of the investors lose their money.

One example of a crypto Ponzi scheme is EminiFX, which was operated by a New York man between 2018 and 2020. EminiFX promised investors a guaranteed return of 5% weekly through automated investments in cryptocurrency and foreign exchange trading. However, EminiFX was actually a Ponzi scheme that used new investors’ money to pay earlier investors. The FBI arrested the man behind EminiFX and accused him of running a $59 million crypto Ponzi scheme.

How can you avoid crypto scams?

Crypto scams are becoming more frequent and sophisticated as digital currencies gain popularity and value. These are the warning signs to help you spot and avoid them:

• Dazzling claims of sky-high profits: If something sounds too good to be true, it probably is. Crypto scams promise unrealistic returns or rewards not based on any real performance or value.
• Vague jargon-intensive sales pitches and unwillingness to answer your questions: Crypto scams often use vague or misleading language, covert pressure tactics or fake testimonials to persuade you to invest.

These are steps to take to protect yourself:

• Thoroughly check out any crypto program you’re interested in: Do your own research and verify the credentials and reputation of the company, the platform, the product and the people behind it. Look for independent reviews, ratings, complaints or reports from reliable sources. Ask an expert unrelated to the circle promoting the program.
• Don’t invest more than you can afford to lose: Crypto markets are volatile and risky, and crypto scams are rampant and ruthless. Only invest what you are willing to lose in case things go wrong.

Crypto scams are not only harmful to individual investors, but also to the whole financial industry and society. They undermine trust, innovation and regulation in the digital economy. Be aware and vigilant of these scams, and report them if you encounter one.

As a professor of microeconomics, I tell my students crypto scams are examples of market failures that result from asymmetric information, moral hazard, adverse selection and externalities. Put simply, these terms mean that there is an imbalance of power and knowledge between the scammers and the investors, that the scammers have incentives to behave dishonestly and recklessly, that the investors have difficulty distinguishing good from bad opportunities, and that the scams have negative impacts on others who are not involved.

Crypto scams are a serious threat. They can affect anyone who is interested in or involved in the crypto space. Therefore, it is crucial to be informed and cautious before investing in any crypto program. Remember: If it sounds too good to be true, it probably is.

Dr. Rik Chakraborti is an assistant professor of economics and director of the Center for Economic Education at Christopher Newport University.