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September 3, 2021

“Textbook Ponzi scheme”: BitConnect sued by the SEC

By Eric Johansson

At the end of 2017, BitConnect seemed unstoppable. Barely a year after its initial launch, the platform’s own altcoin had become one of the leading 20 cryptocurrencies in the world. Riding high on the cryptocurrency bull run of the time, the digital currency’s value had climbed from $0.17 to $463.31 within the span of 12 months. And then in October it hosted its first annual ceremony in Pattaya, Thailand.

It would also be its last. Not that this possibility seemed to cross Carlos Matos’ mind at the time. He was one of the investors who had been invited to speak at the event – and speak he did.

During almost four surreal minutes, Matos delivered a bizarre speech that went viral shortly thereafter and would end up cementing his place in the internet hall of fame for excitedly and repeatedly shouting “BiiiiiitCoooonnect” throughout the speech.

“We are really changing the world as we know it,”  Matos said, adding that his wife didn’t want him to invest in the digital token, fearing it might be a con. Matos dismissed those fears, saying he’d soon be rolling in dough.

Then BitConnect collapsed.

Matos’ speech had seemingly not only helped drum up a buzz among crypto evangelists, but had also raised regulators’ suspicions that something fishy might be going on. So they looked into it.

The Department of Justice (DoJ) later described BitConnect as a “textbook Ponzi scheme” where investors paid off earlier investors. It was in the face of this growing scrutiny that BitConnect went belly up on 17 January 2018.

Three years have now passed and the dust is yet to settle. Promoters and executives are still being prosecuted by law enforcement agencies. BitConnect founder Satish Kumbhani is still in the wind, hunted by the authorities.

Despite law enforcement agencies’ inability to locate the Indian scammer, he was sued this week by the Securities and Exchange Commission (SEC). The US regulator also sued BitConnect and its top US promoter, Glenn Arcaro, and his affiliated company Future Money. The market watchdog accused them of defrauding retail investors of $2bn.

“We allege that these defendants stole billions of dollars from retail investors around the world by exploiting their interest in digital assets,” said Lara Shalov Mehraban, associate regional director of SEC’s New York Regional Office. “We will aggressively pursue and hold accountable those who engage in misconduct in the digital asset space.”

The SEC’s continuing pursuit of BitConnect and its leadership bears out the previous statement by Gary Gensler, the regulator’s new chief, that the watchdog will be cracking down harder on cryptocurrencies from now on.

The SEC isn’t alone in prosecuting the defunct exchange’s leadership. Around the world, BitConnect promoters have faced prosecution and been barred from providing financial services.

The BitConnect implosion in 2017 even saw a class action lawsuit levied against YouTube for having hosted videos promoting the scam and for alleged negligence in not policing content on its platform more stringently.

On the same day that the SEC announced its new BitConnect suit, Arcaro pleaded guilty in a federal court case spearheaded by the DoJ.

“Arcaro has accepted responsibility for his actions of defrauding thousands of individuals worldwide to invest in BitConnect,” said Eric Smith, special agent in charge of the FBI’s Cleveland Field Office. “He lined his pockets with millions of dollars, money from victims that believed their funds were being invested into a new cryptocurrency with a high rate of return.”

Matos has claimed victimhood after losing his initial $25,610 BitConnect investment and the $250,000 earnings he made at the time. Matos has also claimed to have fallen victim to other online scams. His wife left him him during the aftermath of the BitConnect collapse.

The case serves as a textbook example of how cryptocurrency Ponzi schemes work, with BitConnect being spoken of in the same way as infamous scams like OneCoin, PlusToken and GainBitcoin.

“The BitConnect affair is only one of the many examples out there,” Michael Stroev, COO and head of product at Nebeus, the cryptocurrency lending platform, tells Verdict.

“Unfortunately, even today, many scams are happening in the cryptocurrency industry,” Stroev adds, saying it’s up to people to “do their research before transferring their funds onto any platform.”

To explain what investors should look out for and how it fits in with the SEC intensifying its scrutiny of cryptocurrencies, we must first give a bit more detail about what BitConnect was and why people are still fuming about it.

What was BitConnect?

“BitConnect is an important, obviously hugely negative, event in the evolution of crypto, it’s one of the reasons why crypto today is viewed with a great deal of scepticism,” Nicklas Nilsson, senior analyst at GlobalData and the author of a new thematic research report on blockchain, tells Verdict.

When people talk about BitConnect they talk about two things: an exchange and a cryptocurrency.  The BitConnect platform was launched in 2016 with the official goal of becoming a world-leading peer-to-peer bitcoin lending platform. In the platform, people could deposit and borrow bitcoin in exchange for BitConnect Coins (BCC).

On the face of it, BCC worked similarly to other altcoins like Etherum, but with one big twist: it basically guaranteed a monthly interest of up to 10% for customers who held the cryptocurrency in their wallets. Read that again: it guaranteed a profit.

BitConnect claimed to have achieved this astounding feat by utilising a “volatility software trading bot”. If that sounds too good to be true, it’s because it was. In its lawsuit this week, the SEC alleges that instead of trading, BitConnect executives siphoned money off to line their own and their top promoters’ pockets.

The guarantee of users getting a profit has been highlighted by industry experts, including Ethereum founder Vitalik Buterin, a sign that something was amiss with the exchange. But it wasn’t the only thing that should’ve alerted users to the notion that something was wrong. It had all the hallmarks of classic Ponzi schemes.

BitConnect had numerous red flags; it managed to attract a lot of unknowing retail investors through a combination of familiar tactics, taking inspiration from Ponzi schemes, such as paying back early investors with money from new investors, and multi-level marketing strategies used by companies like Avon and Herbalife, such as the use of national and regional promoters,” Nilsson explains.

It is important to recognise that not all cryptocurrencies are part of scams and frauds. Many of them are perfectly legitimate. However, the sector has a reputation for being used by criminals either to launder money or to prey on new victims.

“Illicit entities are known for adopting new technologies quickly, including cryptocurrencies,” Kim Grauer, director of research at Chainalysis, tells Verdict. “Cryptocurrency scams are still a massive challenge, and unfortunately it is often society’s most vulnerable people who are victims.”

And while BitConnect may have been one of the biggest cryptocurrency Ponzi schemes so far, it won’t be the last. The alleged Russian Ponzi scheme Finiko went belly up this summer and one of its founders was arrested after hundreds of users reported the exchange to the police. By then, victims had reportedly lost up to $95m.

BitConnect and the SEC

The new SEC suit against BitConnect, its founder and top promoter follows an earlier case against two other promoters this summer.

The previous proceedings saw the court deliver judgments against promoters Michael Noble, a.k.a. Michael Crypto, and Joshua Jeppesen for their role in the BitConnect debacle. They were ordered to pay more than $3.5m and 190 bitcoin in disgorgement and prejudgment interest.

The SEC’s new chair has called for more firepower from Capitol Hill to reel in the industry.

“This asset class is rife with fraud, scams, and abuse in certain applications,” Gensler said in August. “We need additional congressional authorities to prevent transactions, products, and platforms from falling between regulatory cracks.”

Among other things, he said that it’s time to take the gloves off when it comes to scrutinising the use of cryptocurrencies for frauds and money laundering. It’s against this backdrop that the SEC has now taken action against BitConnect.

“The SEC cracking down on BitConnect is exactly the type of action the crypto space was hoping for when Gensler called for a tougher stance on digital assets and platforms last month,” Nilsson says. “Getting rid of and discouraging bad apples is essential to ensure the long-term legitimacy of crypto.

“The sad reality is that there will always be people (retail investors) that invest without understanding what they invest in, and that is particularly true for emerging areas and technologies. This is why tougher regulation is critical and encouraged by most people in the crypto space. Boosting investor confidence and protection can pretty much only be seen as a good thing. It’s almost impossible for crypto to go mainstream without clear regulation.”

Verdict deals analysis methodology

This analysis considers only announced and completed artificial intelligence deals from the GlobalData financial deals database and excludes all terminated and rumoured deals. Country and industry are defined according to the headquarters and dominant industry of the target firm. The term ‘acquisition’ refers to both completed deals and those in the bidding stage.

GlobalData tracks real-time data concerning all merger and acquisition, private equity/venture capital and asset transaction activity around the world from thousands of company websites and other reliable sources.

More in-depth reports and analysis on all reported deals are available for subscribers to GlobalData’s deals database.

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