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Cryptocurrencies hit the big time in 2017. The value of one bitcoin, the oldest and largest of what was a rapidly diversifying market, had skyrocketed from $900 on January 1 to almost $20,000 on December 31. Ethereum’s ether, the second-largest cryptocurrency, rose even more sharply, gaining a staggering 10,000 percent over the course of the year, creating somewhere between 20,000 and 200,000 newly minted millionaires.
That’s why, in January 2018 — both for journalistic purposes and out of fear of missing out on the fabulous sums of money to be made — I got out my debit card and sat at the computer, ready to seek my fortune trading cryptocurrency.
It was immediately quite a bit more difficult than I was expecting. There were an overwhelming number of options to trade cryptocurrencies, and they proliferated rapidly as prices rocketed during 2017. The barriers for entry to a lot of these markets were high because of the technical complexity of cryptocurrencies and the need for solid general computer literacy.
There are several tiers of cryptocurrency investing. Most exchanges that take the fiat currencies of dollars or sterling will only exchange them for the larger cryptocurrencies, like bitcoin and ether. To access the more febrile world of the smaller, more niche cryptocurrencies, you have to buy bitcoin from one of the larger exchanges, such as Coinbase, and then transfer it to another exchange.
The infrastructure around cryptocurrencies is groaning under the weight of new users, even after the price has slumped from its high at the end of 2017. After reading some reviews, I decided to start by signing up with a Canadian exchange called Kraken, but when I did, the site was slapped with bar at the top reading, “The service is under heavy load and performance is degraded. Upgrades coming soon.”
I immediately forgot what username I had used to sign up, so I clicked “forgot my email” and requested a reminder. The site crashed. I reloaded it. My reminder email stubbornly failed to arrive. Eventually, I managed to retrieve my password but was brought up short: Before I can trade cryptocurrency, I must first verify my account, but the feature is disabled. Not a great start.
I tried several other exchanges before lighting on the largest, Coinbase, headquartered in San Francisco. Setting up an account on the site is relatively easy, but as with most sites, you have to verify your identity by uploading a picture of your identification. Once that’s done, you’re able to buy bitcoin. Using a debit card, new users are limited to a maximum purchase of $200 per week, which at the going market price of more than $12,000 bought me a tiny fraction of a single bitcoin.
What Are You Getting Yourself Into?
All cryptocurrencies are essentially units of information tied together in a string and distributed across a network made up of all participating computers. (See my quick primer on blockchain for more.) Unlike cash, it exists only in the digital space, so once you’ve bought some, you need somewhere to store it.
Cryptocurrencies can be stored within the exchanges where you purchased them, but that’s not advisable. One large exchange — the formerly dominant Mt. Gox, which had handled as much as three-quarters of global bitcoin trading volume — spectacularly imploded in 2014 amid allegations that it had been hacked and had $350 million in bitcoin stolen. Thousands of investors who were keeping their bitcoin on Mt. Gox’s servers lost their money, and the price of bitcoin dropped 36 percent overnight, leaving many others high and dry.
A better option is to store your currency with a digital wallet service. These can be web-based, such as BitGo or CoinSpace, or hardware-based, meaning the codes that prove you own your currency will be kept, encrypted, on your own computer, phone, or USB drive. That can also have its drawbacks: In 2013, Welshman James Howells threw away a computer on which he had kept his bitcoin wallet containing cryptocurrency now worth more than $80 million. Some people have taken up the services of “bitcoin hunters” who specialize in tracking down lost cryptocurrencies on old computers.
Once you’ve bought entry into the market with your first bitcoin from an entry-level exchange like Coinbase, you then move your new digital cash by setting up an account and sending it, either from your Coinbase account or your wallet, to more complicated exchanges where you can put it to work.
To do that, you’ll need to move your digital capital to a site like Binance, where you can execute more complex trades. Unlike Coinbase, Binance is not designed for easy beginner access. In fact, it looks like a Bloomberg terminal — that is, it’s pretty confusing for anyone without a background in high finance — but it allows you to place short and long sell and buy orders on a wide range of cryptocurrencies, and to try day-trading (playing them off against each other for profit). Short- and long-sell orders are a mechanism familiar to anyone who has ever played the stock market: You make an offer to buy or sell at a certain price, and others make similar orders, which are then executed as the market moves. If you correctly guess the direction of the market’s movement, you win; if not, you lose.
This space is still largely unregulated, which means there are ways to cheat this system — more on that later.
In hindsight, it is unsurprising that the system remains opaque and, to some extent, Kafkaesque. Kraken, the first exchange on which I unsuccessfully tried to register, was receiving 50,000 new users every day during the week I tried to join. It even briefly shut down under the strain, which is presumably why I was unable to verify my account. Coinbase was receiving 100,000 new users per day, and Binance at one point was seeing 250,000 new user registrations daily.
It’s easy to understand why people were suddenly flocking to cryptocurrency exchanges and overwhelming places like Kraken: The price of bitcoin had rocketed to $17,000 in December. It felt like a new gold rush.
The Wild West
Cryptocurrency investing is a Wild West space, made more fearsome by the comparative lack of regulatory oversight, and if you don’t know what you’re doing, you can easily get bitten.
According to David Yermack, the Albert Fingerhut professor of finance and business transformation at New York University’s Stern School of Business, the market for cryptocurrencies currently “resembles the ‘era of free banking’ in the 19th century, prior to the existence of the central bank, when most currency was issued privately by banks and there were very few rules.”
“Back then, banks issued money privately, and the government had no central bank or official currency,” Yermack tells me. “Banks were subject to very little regulation and held whatever reserves they chose. Money rose and fell in value based on the reputation of individual banks — like bitcoin and Litecoin today, for instance.”
This was, Yermack says, “a difficult period for the U.S. economy,” as it became subject to “repeated booms and busts,” and the movement of goods throughout the country was “encumbered by limits in the money supply and variations in the prices of individual banknotes.”
“The only real regulation of cryptocurrency in the U.S. is by the Internal Revenue Service for income tax purposes,” Yermack says. “The SEC is interested in regulating certain coin offerings under the securities laws, but it has brought enforcement actions against only a handful of them up to now. The area is still in flux and evolving.”
The market for cryptocurrencies may seem like a new ecosystem, and it certainly has its predators. Some are scammers, such as those behind fraudulent initial coin offerings (ICOs), where new coins are launched and then disappear, the creators vanishing with everyone’s money. These predators can be caught: In April, two men behind the launch of a cryptocurrency called Centra — which raised $32 million last year after being publicly endorsed by Floyd Mayweather and DJ Khaled — were arrested and charged with fraud.
Perhaps even more insidious are the “pump and dump” groups. “Imagine 15,000 people orchestrating a price pump of a stock, and then all of a sudden dumping it all when it goes up 20 percent,” said one cryptocurrency enthusiast we’ll call Robin, who has been a member of such a group in the past and spoke on condition of anonymity. Members are invited to pay extra to be on a higher tier of the group, which means they get the privilege of being among the first to receive the instruction of when to buy and when to sell a particular token in order to make the most profit.
“The pump groups are almost entirely beneficial to the people that create and manage them. As the managers are the ones who know which coin will be pumped, most of the users are exploited,” Robin said.
“It’s completely unethical and would be national news if it happened on Wall Street.”
Robin described watching as one pump-and-dump group’s actions increased the price of a cryptocurrency by 100 percent—doubling its value. When the group exited a currency, the price would collapse, and “those that didn’t sell in time either sell at a loss or are forced to hold.” There are, Robin estimates, “at least a few dozen” such groups.
“Where people’s hopes and expectations exceed reality, you will see people take advantage of that with pump-and-dump schemes where people manipulate the market” Charles Hayter, CEO and founder of cryptocurrency data analysis firm CryptoCompare, told me. “Obviously, there are rules against that in traditional markets. There are no rules here. It’s difficult to regulate; it’s a global phenomenon. So…naturally, you’re going to get people who are trying to pull a fast one.”
The global nature of cryptocurrencies, which operate on the distributed model of the blockchain, combined with the fact that scammers tend to organize via encrypted chat apps such as Telegram or Discord, means scammers are extremely difficult to catch or even predict.
“People are playing jurisdictional arbitrage,” Hayter says. “A rate changes in [mainland] China, they just move to Hong Kong, or Bermuda, or Malta. It’s basically whack-a-mole when you have companies that can just close up a laptop and move country.”
Faced with scant options, the U.S. Commodity Futures Trading Commission (CFTC) announced in February that it will try to tempt potential pump-and-dump whistleblowers with a cash bounty.
And yes — pump-and-dump also has an interesting history and actually dates back to the early 18th century, to a man named John Law.
Mississippi Bonds and the Emergence of the ‘Pump and Dump’
John Law was born in Edinburgh, Scotland, in 1671. His father, a wealthy goldsmith and banker, was successful enough to afford a Midlothian country estate, Lauriston and Randleston, and thus purchased entrance for his family into the landed gentry.
Law followed his father into the family trade and found himself “very young, very vain, good-looking, tolerably rich, and quite uncontrolled,” according to Charles Mackay, a Scottish journalist who tells Law’s story in his 1841 book, Extraordinary Public Delusions and the Madness of Crowds. An “irrevocable” gambler and famous womanizer, the 26-year-old Law was almost executed for killing a love rival in a duel, but he escaped to the continent.
After wandering around Europe’s capitals for 14 years, attempting various moneymaking schemes and minor scams without enormous success, Law wound up in France, where the extravagant rule of Louis XIV had brought the country to the brink of financial ruin.
Law’s travels through the nascent capitals of European finance, especially several months spent speculating on the Amsterdam stock exchange, allowed him to perfect a certain kind of banking scheme. Though not called “pump and dump” at the time, it bore many of the same hallmarks as Robin’s cryptocurrency group almost exactly three centuries later. Among the bankrupt ruling classes of France, Law found an abundance of eager marks, including the regent, Philippe II, who was ruling on behalf of the child king Louis XV.
On credit, Law finagled himself a series of agreements with the French government, most notable of which was a monopoly license for trading on behalf of France with the East Indies. Based on this license, he founded the Mississippi Company and then began to leverage the promise of riches to come from the company’s overseas monopoly, offering shares and bond notes. Law had tried this scam before to no avail, but the spark of hope he offered to France’s financially overstretched aristocracy ignited the market like a rocket.
Soon, “There was not a person of note among the aristocracy…who was not engaged in buying or selling stock,” Mackay writes. “People of every age and sex, and condition in life, speculated in the rise and fall of the Mississippi bonds.”
In one particular act of showmanship, Law dragooned 6,000 of Paris’ poor to parade through the streets with shovels and pickaxes, pretending they were about to be sent to the largely fictional mines and plantations of the Mississippi Company. Two-thirds of them never even left France: Law just moved them out of the city and turned them loose. In the meantime, demand for his bonds grew along with his fame.
As a grandiose gesture, Law even paid off the entire French national debt — with a low-interest loan paid for by a new issue of 300,000 Mississippi Company shares.
The Mississippi bubble finally burst in May 1720, when confidence in Law’s enterprise finally collapsed. Facing an immense national crisis and a run on its national bank — which Law had set up himself — the French government even briefly banned the sale of gold. When it reversed the edict soon after, a stampede in Paris killed 50 people.
It was an object lesson in how greed overcomes sound judgment. But was it one that the cryptocurrency industry was doomed to repeat? Or, for that matter, was I about to repeat it myself?
He Who Does Not Study History
During the heady days of 2017, as a class of newly minted cryptocurrency millionaires and even a few billionaires were processing their own seemingly farcical success, the possibility of regulation began to raise its head. In January, China’s national bank warned that its country’s cryptocurrency exchanges had to start complying with “relevant laws and regulations.”
China had begun the year as a bitcoin powerhouse: Since 2013, up to 90 percent of the cryptocurrency’s trading volume had run through China’s so-called big three exchanges—BTCC, OKCoin, and Huboi—according to CoinDesk’s State of Blockchain report for the second quarter of 2017. But the crackdown led to panic selling, and the price of bitcoin dipped precipitously as, one by one, the big three were shuttered.
The cryptocurrency community was worried. There was talk of a return to the bad days of Mt. Gox, the collapse of which had come hot on the heels of a similar move by China in 2013 to restrict the use of bitcoin as a currency. The People’s Bank of China announced that bitcoin was “not a currency in the real meaning of the word,” but rather was a “virtual commodity that does not share the same legal status of a currency. Nor can, or should, it be circulated or used in the marketplace as a currency.”
Many took the first Chinese crackdown and the collapse of Mt. Gox as a sign that cryptocurrencies weren’t ready for prime time, and the value that was wiped off bitcoin in 2014 took more than three years to recover. It wasn’t until 2017 that bitcoin’s price regained its November 2013 high of $1,150.
But when it finally did, in April 2017, bitcoin blew past that price at an extraordinary rate. Every day of 2017 seemed to smash new records. By June, it was worth more than $2,000. By November, $7,000. By December, one bitcoin was worth $15,000.
Suddenly, the mainstream media started to take notice, and a rush of new first-time users flocking to the seemingly endless moneymaking machine that bitcoin had become pushed the price up still further. By the end of 2017, bitcoin’s price had climbed more steeply than any asset in human history — even more than tulips during the infamous Tulipmania bubble of 1636.
We don’t know nearly as much about Tulipmania, perhaps the most famous bubble of all time, as we do about John Law and the Mississippi bubble. Much of the story as it is popularly understood is also derived from Mackay’s Madness of Crowds, but scholars in recent years have debunked some of his claims about Tulipmania, pointing out that the sourcing was dubious because of the limited contemporary records available to him. (You can find an excellent breakdown of the Tulipmania myth here.)
But in describing the explosion in demand during Tulipmania, Mackay could easily be describing the cryptocurrency market in 2017. “Many individuals grew suddenly rich. A golden bait hung temptingly out before the people, and, one after the other, they rushed to the tulip marts, like flies around a honeypot. Every one imagined that the passion for tulips would last forever.”
So, How Did I Do?
Though I stayed in the relative shallows of the major cryptocurrencies like bitcoin — which, because of their enormous market caps, are much less susceptible to exit scams or pump-and-dump groups — I still got burned pretty good like perhaps every newbie will.
The day after I bought, bitcoin’s price sank 20 percent, and it has been in a slow slump ever since, effectively halving my money in a matter of weeks.
Though it has not returned to anywhere near as low as it began the previous year, the price of bitcoin has fallen to little more than half of the point at which I bought in. I can’t help thinking of Mackay’s “flies around a honeypot.”
But even in their short history, cryptocurrencies have fallen and then quickly recovered. In the parlance of cryptocurrency aficionados, the advice is always to hodl, a slang term based on a misspelling of the word “hold” that originated in 2013 on a bitcoin message board.
“These bubbles blow up, fall back, blow up again,” Hayter says. “It happens across all sectors, but as the industry matures, you get less volatility. But you’ll see various phases where it does increase, then reduces again. It’s swings and roundabouts.”
I hope he’s right. In the meantime, all I can do is hodl on and try my best to avoid the deeper waters where the pump-and-dump groups hunt.