Crypto markets are extremely volatile. You never know how wildly up or down the price may go or when. This turned out to be a disaster for US crypto exchange Poloniex when an obscure token that it offered peer-to-peer margin trading on suffered a flash crash.
On May 26, the price of CLAMdropped so violently that margin borrowers blew their margins multiple times over. The loss was huge: 1,800 BTC, valued at around $14 million.
Now Poloniex has to figure out how to extract the losses from the borrowers. For now, lenders will have to suck up the loss. On 14:00 UTC on June 6 — a full 10 days after the incident — Poloniex applied a 16.202% haircut to the principal of all active BTC loans. Even lenders not active at the time of the crash were affected.
David, it's straight out of the Bitfinex 2016 playbook. Haircut on unrelated lenders some time after the actual losses were incurred.
Prior to announcing the haircut, Poloniex suspended trading for several hours on Wednesday as part of a “planned” maintenance. It wasn’t until trading resumed that margin lenders realized a portion of their BTC was missing.
In a Medium post, Poloniex revealed that a large part of the loans were collateralized in CLAM — so both the borrowers’ positions and their collateral lost most of their value. In other words, the funds simply evaporated, and there was nothing to repay loans with.
The exchange says it has frozen all defaulted borrowers’ accounts until they repay their loans, as spelled out in the the company’s terms of service.
“As we recover funds, we will return them to affected lenders. We’re also exploring other ways to help defray margin lender losses,” Poloniex wrote.
Naturally, the margin lenders, which only account for 0.4% of Polo’s user base, are completely pissed off. Why did Polo not have better risk management in place? Why did it not have an insurance fund set up to absorb the loss? And why did Polo allow margin trades — and collateral loans — on an extremely illiquid coin in the first place?
What is margin trading?
Margin trading is risky business, even more so when you are trading crypto assets, due to their high volatility. When you trade on margin, you put down a collateral and borrow against that, doubling, tripling, quadrupling — or whatever — your trade.
Trading on margin magnifies your profits, but also your losses. If the trade goes in your favor, you can repay the loan and tuck in a nice profit. But if the price of the asset slips enough so it looks like your trade won’t pay off, the exchange can call in your margin, and you lose all of the collateral you put down for the loan.
Bitcoin derivatives exchange BitMEX loans you the funds for margin trades. Poloniex does something different. It uses peer-to-peer margin trades, where a common pool of lenders puts up BTC, CLAM, and other coins. They get paid in interest. According to Poloniex’s website (archive), only customers who are outside of the US are allowed to loan their funds on the exchange.
As a lender, you set your own daily interest rate, and Poloniex takes a fee of 15% from the interest earned. Margin traders consume lending offers starting with the lowest rate. If your rates are too high, your funds sit in the pool, and you don’t earn any interest.
CLAM, the casino coin
If you were paying close attention a year ago, you may have heard John Oliver mention CLAM on “Last Week Tonight,” along with Titcoin, Jesuscoin, Trumpcoin and a bunch of other coins with hilarious names.
CLAM stands for “Caritas Libertas Aequitas Monetas,” which roughly translates to freedom, fairness, equality coins — whatever that means. The coin launched in May 2014, as a fork ofBlackcoin (BLK), which launched in February 2014 as a fork of Peercoin, an early proof-of-stake coin.
On May 12, 2014, CLAM was sent to all active users of bitcoin, litecoin and dogecoin —three popular coins at the time. Every unique wallet address pulled from those blockchains that had a balance above zero got about 4.6 CLAM. The total amount of CLAM distributed to those addresses was 14,897,662.
CLAM was mainly intended for use on Just-Dice, a gambling site created by a Canadian known only as “dooglus.” Originally Just-Dice relied on bitcoin. But due tonew bitcoin regulation in Canada, dooglus decided to switch to CLAM in late 2014.
The circulating supply of CLAM is only 3,624,208. Nearly all of that—99.81%—is traded on Poloniex. At one point, CLAM was listed on Bittrex and Cryptopia, but Bittrex delisted the coin in October 2018 and Cryptopia went belly up in May 2019.
According to CoinMarketCap, CLAM has a daily trading volume of less than $100,000, meaning the coin barely has a pulse. Three months ago, two traders complained on Reddit of long delays withdrawing CLAM as they waited for the lifeless network to pick up their transactions.
“I withdrew CLAM 11 days ago. Poloniex Support said ‘as soon as a miner picks up the transaction’ How f@%#$%g long is that?,” wrote Reddit user interop5. (Technically, CLAM is a proof of stake coin, so it relies on stakers, not miners.)
CLAM’s lack of liquidity makes it extremely easy to manipulate. All you need is one person to put up a large sell order to crash the price. Poloniex has yet to release details on what happened, but we can guess it was something along those lines.
How to Clams Trade 1) accumulate cheap clams in account A 2) move some to account B and long your clams w/ your clams 3) dump your account A spot clams on your account B margin clam buy orders 4) rugpull 5) make 500-1k btc in account A while burning 50-200 btc in account B
As a result of the flash crash debacle, Poloniex has removed CLAM from margin trading, along with three other coins: bitshares (BTS), factom (FCT), and maidsafecoin (MAID). The exchange outright admits these coins lacked sufficient liquidity:
“In order for margin liquidations to process in an orderly manner, the market must have sufficient liquidity, and these tokens currently lack that liquidity. We will continue to monitor them and may reinstate margin trading for them in the future”
This is not the first time Poloniex removed CLAM as a margin market and collateral coin. It was removedin early November 2017 due to low liquidity, after an earlier flash crash, despite CLAM’s liquidity never recovering, at some point, Poloniex decided to add CLAM back as a margin market and collateral coin—though I’m not sure exactly when.
And then, of course, the exact same thing happened. In February 2019, the price of CLAM started to climb rapidly on Poloniex. In a matter of six weeks, it went from around $1.50 to a high of nearly $20 on May 26. At that point, the bottom fell out with CLAM losing three-quarters of its value in the blink of an eye. It sunk down to around $5.
According to Andrew Hires, a neurobiology professor at the University of Southern California, who has been watching the exchange, Poloniex had been struggling with its CLAM wallet for months. He tweeted:
“All deposits had to be manually credited via ticket. This screwed up the sell-side liquidity. Huge bids (>500BTC), presumably margin longs, crept up over months, pushing $ price up 17x. Just after it hit $20, everything imploded.”
Spreading the loss
Socializing losses is unique to crypto exchanges. Like Poloniex, OKEx alsosocializes extreme margin losses, but literally requires customers to pass a test on their terms of service before they can trade futures, so they are absolutely clear on how it works.
According to crypto lawyer David Silver, socializing losses could open Poloniex to a lawsuit. Another lawyer, Stephen Palley, disagrees. Palley told The Block, he doesn’t think Poloniex breached its terms of service.
On the other hand, Emilien Dutang, who was pinged by the haircut and says he offered margin lending on the exchange after the flash crash, is threatening legal action.
I was NOT lending on the 26 may, I started lending on the 27th.
THERE IS ABSOLUTLY NO JUSTIFICATION FOR YOU TO TAKE MY BITCOINS TODAY.
Do not try to hide your fuck up behind the fact that it impacted "only" 0.4% of your users
None of this bodes well for Poloniex. Circleacquiredthe exchange in early 2018 with the intention of cleaning it up and dealing with a humongous backlog ofsupport tickets. But at this level, Poloniex appears only slightly more competent than QuadrigaCX.
Bitfinex was not happy with the New York Attorney General’s April 24 ex parte court order, which demanded that the crypto exchange stop dipping into Tether’s cash reserves and hand over documents that were requested in November 2018. It struck back with a strongly worded motion to vacate, or overturn the order.
On May 3, the Office of the Attorney General (OAG) submitted an opposition to that motion. The agency argues that Bitfinex violated the Martin Act, New York’s anti-fraud law, widely considered the most severe blue sky law in the country.
Legally, Tether and Bitfinex are separate entities, but they are managed by the same individuals. To note, the OAG’s order does not prohibit Bitfinex from operating. Nor does it prohibit Tether from issuing or redeeming tethers (USDT) for U.S. dollars.
The order simply prohibits Bitfinex from helping itself to anymore of Tether’s funds. This, of course, poses a problem for Bitfinex, because it desperately needs cash to stay afloat. (It’s latest effort to fill the gap is a token sale, but that is another matter.)
There are currently 2.8 billion USDT in circulation, and each of them is supposed to be backed 1:1 with the dollar, but as of now, they are only 74% backed.
The alleged fraud
The OAG began investigating Bitfinex late last year. If there is any question as to how Bitfinex allegedly committed fraud and misled its customers, the OAG spells that out clearly in its memorandum. I’m paraphrasing some this.
Bitfinex failed to disclose to its clients that it had lost $851 million of “wrongfully commingled” client and corporate funds to Crypto Capital, an overseas entity, which it used as an intermediary to wire US dollars to traders on its platform.
Bitfinex knew in mid-to-late 2018 that Crypto Capital’s inability—or unwillingness—to return the funds meant it would have problems filling out client requests to withdraw cash off the exchange. Nevertheless, it told the public that rumors of insolvency were a “targeted campaign based on nothing but fiction.”
In November 2018, Bitfinex tried to cover up the loss by moving (at least) $625 million from Tether’s legitimate bank account into Bitfinex’s account. In return, Bitfinex “credited” $625 million to Tether’s accounts with Crypto Capital. OAG says the credit was “illusory,” because the money at Crypto Capital was lost or inaccessible.
(In its motion to vacate, the OAG notes that Bitfinex contradicted itself by saying the “credit” Bitfinex gave to Tether was $675 million—a $50 million discrepancy.)
Bitfinex later shifted to a new strategy. It engaged in “an undisclosed and conflicted transaction” to let Bitfinex dip even further into Tether’s reserves. The exchange took out a $900 million loan from Tether, secured by shares of iFinex—the parent company of both Tether and Bitfinex. OAG says there is little reason to believe the iFinex shares have any real value, especially in the event iFinex itself defaults.
In March 2019, $900 million represented almost half Tether’s available reserves at the time, but Bitfinex and Tether did not disclose this to its customers. In fact, up until February 2019, Tether telling its customers that USDT was fully backed. Bitfinex told the OAG that it has already dissipated $750 million of Tether’s funds.
Bitfinex demonstrates “a pattern of undisclosed, conflicted, and deceptive conduct” that its customers would “find material, and indeed, essential to buying tethers and trading assets, like bitcoin, on the Bitfinex platform,” the OAG said.
In its motion to vacate, Bitfinex argues that the Martin Act stands or falls on whether tethers are securities or commodities. It does not, the OAG says. In fact:
“The Bitfinex trading platform transacts in both securities and commodities (like bitcoin) and is of course at the core of the fraudulent conduct set forth in the OAG’s application.”
The OAG points to other events that underscore the need to maintain the status quo.
Since the original order, two individuals, Reginald Fowler and Ravid Yosef, were charged with bank fraud in connection with their operation of a “shadow bank.” Fowler was arrested on April 30, while Yosef is still at large.
The operation processed hundreds of millions of dollars of unregulated transactions on behalf of numerous cryptocurrency exchanges and associated entities—“several of which,” the OAG says, are at the center of its own investigation.
This appears to indicate the OAG’s is looking into other exchanges, which makes sense, given it sent out a questionnaire to more than a dozen cryptocurrency exchanges in April 2018, requesting they disclose key information about their operations.
While the OAG does not specifically state that the “shadow bank” is Crypto Capital, it points to the Memorandum in Support of Detention of Fowler, which said that companies associated with Fowler “failed to return $851 million to a client of the Defendant’s shadow bank.”
There is so much going on now with Bitfinex. My eyes are burning and my head hurts from reading piles of court docs. Here is a rundown of all the latest—and then some.
The New York Attorney General (NYAG) is suing Bitfinex and Tether, saying tethers (USDT) are not fully backed—after $850 million funneled through third-party payment processor Crypto Capital has gone missing.
It’s still not clear where all that money went. Bitfinex says the funds were “seized and safeguarded” by government authorities in Portugal, Poland and the U.S. The NYAG says the money was lost. It wants Bitfinex to stop dipping into Tether’s reserves and to handover a mountain of documents.
In response to the NYAG’s ex parte order, Tether general counsel Stuart Hoegner filed an affidavitaccompanied by a motion to vacate from outside counsel Zoe Phillips of Morgan Lewis. Hoegner admits $2.8 billion worth of tethers are only 74% backed, but claims “Tether is not at risk.” Morgan says New York has no jurisdiction over Tether or Bitfinex. Meanwhile, the NYAG has filed an opposition. It wants Bitfinex to stop messing around.
Bitfinex: No one is willing to audit us because they don't want to damage their reputation by auditing us! Asymmetric risk!
New York Attorney General: We'll audit you! For free! Bitfinex: NOT LIKE THIS! New York Attorney General: Send documents. Bitfinex: NO GOD PLEASE NO!
Football businessman Reggie Fowler and “co-conspirator” Ravid Yosef were charged with running a “shadow banking” service for crypto exchanges. This all loops back to Crypto Capital, which Bitfinex and Tether were using to solve their banking woes.
In an odd twist, the cryptocurrency saga is crossing over into the sports world. Fowler was the original main investor in the Alliance of American Football (AAF), an attempt to create a new football league. The league filed for bankruptcy last month—after Fowler was unable to deliver, because the DoJ had frozen his bank accounts last fall.
The US government thinks Fowler is a flight risk and wants him held without bail. The FBI has also found a “Master US Workbook,” detailing the operations of a massive “cryptocurrency scheme.” They found it with email subpoenas, which sounds like it was being kept on a Google Drive?
Yosef is still at large. She appears to have split her time between Tel Aviv and Los Angeles. This is her LinkedIn profile. She works as a relationship coach and looks to be the sister of Crypto Capital’s Oz Yosef (aka “Ozzie Joseph”), who was likely the “Oz” chatting with “Merlin” documented in NYAG’s suit against Bitfinex.
All eyes are on Tether right now. Bloomberg reveals the Commodity and Futures Trading Commission (CFTC) has been investigating whether Tether actually had a stockpile of cash to support the currency. The DoJ is also looking into issues raised by the NYAG.
Meanwhile, bitcoin is selling for a $300 to $400 premium on Bitfinex — a sign that traders are willing to pay more for bitcoin, so they can dump their tethers and get their funds off the exchange. This isn’t the first time we’ve seen this sort of thing. Bitcoin sold at a premium on Mt. Gox and QuadrigaCX before those exchanges collapsed.
Bitfinex is still in the ring, but it needs cash. The exchange is now trying to cover its Tether shortfalls by raising money via—of all things—a token sale. It plans to raise $1 billion in an initial exchange offering (IEO) by selling its LEO token. CoinDesk wrote a story on it, and even linked to my Tether timeline.
It's funny because LEO also means law enforcement organization
Tether wants to move tethers from Omni to the Tron blockchain. Tron planned to offer a 20% incentive to Omni USDT holders to convert to Tron USDT on Huobi and OkEx exchanges. But given the “recent news” about Bitfinex and Tether, it is delaying the rewards program.
Coinbase is bidding adieu to yet another executive. Earn.com founder Balaji Srinivasan, who served as the exchange’s CTO for a year, is leaving. It looks like his departure comes after he served the minimum agreed period with Coinbase.
Elsewhere, BreakerMag is shutting down. The crypto publication had a lot of good stories in its short life, including this unforgettable one by Laurie Penny, who survived a bitcoin cruise to tell about it. David Gerard wrote an obituary for the magazine.
The Los Angeles Ballet is suing MovieCoin, accusing the film finance startup of trying to pay a $200,000 pledge in worthless tokens—you can’t run a ballet on shit coins.
Police in Germany and Finland have shut down two dark markets, Wall Street Market and Valhalla. And a mystery Git ransomware is wiping Git repository commits and replacing them with a ransom note demanding Bitcoin, as this Redditor details.
The U.S. government wants a football businessman linked to an investigation into $850 million of missing Tether and Bitfinex funds to be held without bail.
According to a memorandum in support of detention filed with the District Court of Arizona on May 1, Reginald Fowler poses a serious flight risk due to his overseas connections and access to hundreds of millions of dollars.
The court doc also presents startling new twists in an already tangled plot—a “Master US Workbook,” which details the financial operations of the “cryptocurrency scheme,” fake bond certificates worth billions of dollars, and a counterfeit money operation.
Fowler, 60, is a football businessman. He was a former co-owner of the Minnesota Vikings and the original main investor in the Alliance of American Football (AAF)—an attempt to form a new football league. The AAF collapsed when Fowler withdrew funding—after the Department of Justice froze his bank accounts in late 2018.
I did a search on Pacer and got a number of hits showing Fowler has been in and out of courts for years. In fact, in 2005, ESPN reported that he had been sued 36 times.
Most recently, Fowler was charged with bank fraud and operating an unlicensed money services business (MSB). These crimes relate to his alleged involvement in a “shadow bank” on behalf of cryptocurrency exchanges, in which hundreds of millions of dollars passed through accounts that he controlled in jurisdictions around the world.
Fowler operated Global Trading Solutions LLC in the US, which provided services for Global Trade Solutions AG, the Zug, Switzerland-based parent company of Crypto Capital Corp, a third-party payment processor. At one time or another, Crypto Capital serviced QuadrigaCX, Bitfinex, Kraken, Binance, and BitMEX—some of the top crypto exchanges.
In October and November 2018, five US bank accounts were frozen—three of them were Fowler’s personal accounts and two were held under Global Trading Solutions. On April 11, Fowler was indicted in the Southern District of New York. And on April 30, he was arrested in Chandler, Arizona, where he lives.
Fowler is looking at spending the rest of his life in prison—the bank fraud counts alone carry a maximum sentence of 30 years.
The cryptocurrency scheme was not limited to the US. Fowler set up bank accounts around the world and coordinated the scheme with co-conspirators in Israel, Switzerland, and Canada. The scheme involves a “staggering amount of money,” and the government believes that Fowler still has access to overseas bank accounts.
Master US Workbook
Even more revealing, via email search warrants, the government has obtained a document entitled “Master US Workbook,” which details the operations of the scheme. The workbook lists 60 bank accounts. It shows the scheme received over $740 million in 2018 alone. As of January 2019, the combined bank balance was $345 million. Approximately $50 million is held in US accounts. The rest is located overseas.
Apparently, Fowler had “shown a willingness to help himself to these funds in the past.” In mid-2018, he sent $60 million from scheme accounts to his personal bank accounts. Scheme members set up a “10% fund” from client deposits, available for his personal use. The government does not know the location of those accounts.
After Fowler’s bank accounts were seized in October 2018, he agreed to cooperate with FBI agents and keep the investigation confidential, which he did not do. When agents sent him emails, he would share those with other scheme members.
Other illegal activity
Fowler appears to have been involved with other illegal activities, such as wire fraud related to the 10% fund. He also tried to take out loans by presenting banks with fraudulent bond certificates worth billions of dollars.
Even more shocking, FBI agents also found evidence that Fowler was involved in a counterfeit money operation. They found $14,000 in fake bills consisting of sheets of $100 bills in a filing cabinet in his Chandler, Arizona office.
After examining the sheets, a special agent for the US Secret Service “determined that they were undergoing a process common in counterfeiting schemes to turn paper bills into passable currency. In fact, the FBI also recovered black carbon paper from the office, which is often used as part of this process for making believable counterfeit bills.”
According to an April 24 court filing, New York State Attorney General Letitia James has alleged that crypto exchange Bitfinex lost $850 million and then tried to pull the wool over people’s eyes by dipping into Tether’s reserves.
Tether issues a dollar-pegged stable coin of the same name. According to the Office of the Attorney General (OAG), Bitfinex has so far siphoned $700 million from Tether funds, meaning that tethers are not fully backed. Given that tether is an essential source of liquidity in the crypto markets—currently, there are 2.8 billion tethers in circulation—this is not good news for bitcoin.
I’ve updated my Bitfinex/Tether timeline to bring you up to speed on the full history of these companies’ past shenanigans. Bitfinex and Tether are operated by the same individuals, and their parent company is Hong-Kong based iFinex. I recommend reading the entire 23-page courtdocument. It reveals a lot about what has been going on under the covers at Tether/Bitfinex. I’ll try and summarize.
Bitfinex was allowing people from New York to trade on its platform. This is not supposed to happen. Effective August 8, 2015, any virtual currency company that wants to do business in New York State needs to have a BitLicense. This led the OAG to launch an investigation into Bitfinex and Tether in 2018.
Banking has been an ongoing struggle for Bitfinex since April 2017, when it was cut off by correspondent bank Wells Fargo and its main banks in Taiwan. At different periods, Bitfinex has turned to Puerto Rico’s Noble Bank, Bahamas’ Deltec Bank, and more recently, HSBC, through a private account with Global Trading Solutions LLC.
Meanwhile, Bitfinex and Tether have had to rely on third-party payment processors to handle customer fiat deposits and withdrawals—a fact that the companies have never been completely up front about.
Since 2014, Bitfinex has sent $1 billion through Panama-based Crypto Capital Corp. Bitfinex also told the OAG that it had used a number of other third-party payment processors, including “various companies owned by Bitfinex/Tether executives,” as well as other “friends of Bitfinex” — meaning human-being friends of Bitfinex employees willing to use their bank accounts to transfer money to Bitfinex clients.
This is basically Bitfinex setting up shell companies and playing cat and mouse with the banks—and it sounds an awful lot like what Canadian crypto exchange QuadrigaCX was doing before it went belly up in January. (Quadriga also used Crypto Capital, but the payment processor is not holding any Quadriga funds.)
By mid-2018 Bitfinex customers were complaining they were unable to withdraw fiat from the exchange. This is apparently because Crypto Capital, which held “all or almost all” of Bitfinex funds, failed to process customer withdrawal requests. Crypto Capital told Bitfinex that the reason the $851 million could not be returned was because the funds were seized by government authorities in Portugal, Poland and the U.S.
Bitfinex did not believe this explanation. “Based on statements made by counsel for Respondents to AG attorneys… Respondents do not believe Crypto Capital’s representations that the funds have been seized,” the court document states.
(This is not in the court docs, but this is the letter Crypto Capital shared with its customers in December 2018. Global Trade Solutions AG—not the same company as Global Trading Solutions LLC—is the parent company of Crypto Capital.)
In communication logs from April 2018 to early 2019 shared with the OAG, a senior Bitfinex executive “Merlin” repeatedly beseeched an individual at Crypto Capital, “Oz,” to return funds. Merlin writes: “Please understand, all this could be extremely dangerous for everybody, the entire crypto community. BTC could tank to below $1K if we don’t act quickly.” A Crypto Capital customer that asked not to be named told me that Merlin is Bitfinex CFO Giancarlo Devasini.
Borrowing money from Tether
Rather then admit it was insolvent, Bitfinex/Tether tried to cover up the problem. According to the court docs, in November 2018, Tether transferred $625 million in an account at Deltec in the Bahamas to Bitfinex. In return, Bitfinex caused $625 million to be transferred from an account at Crypto Capital to Tether’s Crypto Capital account.
Essentially, Bitfinex tries to create the money by doing a one-for-one transfer of real money at Deltec for funds that don’t actually exist at Crypto Capital. Once they realized that this was probably a terrible idea, they re-papered the transfer as a loan.
Bitfinex then borrowed $900 million from its Tether bank accounts. The loan is secured with shares in iFinex stock. In case you didn’t quite follow that, Bitfinex and Tether are basically the same company, so you can think of this as Bitfinex borrowing money from itself—and then backing the loan with shares of itself.
According to the OAG, “The transaction documents were signed on behalf of Bitfinex and Tether by the same two individuals.”
OAG is fed up with the nonsense. It has obtained a court order against iFinex. Under the court order, Bitfinex and Tether are to cease making any claim to the dollar reserves held by Tether. iFinex is also required to turn over documents and information, as the OAG continues its probe.
The court has also ordered that iFinex identify all New York and US customers of Bitfinex whose funds were provided to Crypto Capital and the amount of any outstanding funds—and provide a weekly report evidencing any issuance or redemption of tethers.
Bitfinex has issued a response (archive), stating that the OAG court filings “were written in bad faith and are riddled with false assertions.” It claims the $850 million are not lost but have been “seized and safeguarded.”
The exchange continues to deny any problem. It writes:
“Both Bitfinex and Tether are financially strong—full stop. And both Bitfinex and Tether are committed to fighting this gross overreach by the New York Attorney General’s office against companies that are good corporate citizens and strong supporters of law enforcement.”
What does this mean?
It means Bitfinex is in real trouble. The New York’s Attorney General is one of the most powerful in the nation. That should worry Bitfinex.
New York law allows the attorney general to seek restitution and damages. On top of that, there is also the Martin Act, a 1921 statute designed to protect investors. The Act vests the attorney general with wide-ranging enforcement powers. Under the Act, the attorney general can issue subpoenas to compel attendance of witnesses and production of documents. Those called in for questioning do not have a right to counsel.
The attorney general‘s decision to conduct an investigation is not reviewable by courts. As Stephen Palley, partner at Anderson Kill, points out, the iFinex action arises out of a Martin Act investigation and “Violations of the Martin Act can be civil and criminal.”
The Martin Act is a New York law that gives the N.Y. Attorney General very broad power to investigate securities fraud.
Violations of the Martin Act can be civil and criminal.
Finally, if $850 million is really missing, not just stuck somewhere, bitcoin is in real trouble, too. Tether could lose its peg and drop substantially below $1. Remarkably, tether’s peg seems to be holding steady now.
Since the news broke, the price of bitcoin has dropped several hundred dollars. A valiant effort is being made to pump the price back up, and it’s working, sort of—for now.
Previously, I wrote that Quadriga cofounders Michael Patryn and the now-deceased Gerald Cotten worked together for a period at Midas Gold, a digital currency exchanger that ran from 2008 until May 2013, when it was pulled offline. But it appears their connections stretch back even further.
According to data posted by Reddit user QCXINT, the two business partners appear to have been active on TalkGold, a popular forum for pushing high-yield investment programs, aka ponzis, as early as 2003. Likely, that is where they first met. Evidence also suggests the two were active on BlackHatWorld, a site for discussing dubious marketing strategies for websites. Cotten also appears to have been a ponzi operator himself.
This is a long post, so here is a quick summary of what’s ahead:
Cotten likely began promoting ponzis in his teens.
He was posting on TalkGold under the username “Sceptre.”
At the same time, Patryn posted on TalkGold as “Patryn.”
Patryn and Sceptre joined TalkGold in 2003, within months of each other.
Patryn also posted as “Patryn” on MoneyMakerGroup and BlackHatWorld.
Sceptre first appeared on BlackHatWorld in 2012, but then changed his profile name to “Murdoch1337.”
Sceptre posted as “Lucky-Invest” on TalkGold to promote a ponzi.
What is a high-yield investment program?
HYIP is just another way of saying ponzi. These schemes typically promise ridiculously high rates of returns. But behind the scenes, no real investment is taking place. The operator simply uses money coming in from new investors to pay off earlier ones, all the while skimming funds off the top for him/herself. When the supply of new investors runs dry, the scheme collapses. All ponzis collapse at some point.
Ponzis are nothing new. The name stems from Charles Ponzi, an Italian immigrant who defrauded tens of thousands of Bostonians out of $18 million in 1920. Ponzi went to jail, and when he got out, the U.S. promptly deported him back to Italy. New York financier Bernie Madoff ran a $65 billion ponzi, the largest in history. His ponzi fell apart during the financial crisis when too many customers started trying to pull their money out. He was convicted in 2008.
In the early 2000s, the Internet and the advent of early centralized digital currencies, like E-gold and Liberty Reserve, saw a new wave of ponzis. Operators anonymously set up their storefronts online and used e-currencies to obscure the source and flow of funds.
HYIP operators typically rely on social media and referrals to create hype and make their offerings appear legitimate. Despite the red flags, many people still invest in HYIPs, thinking that if they get in early enough, they can make a buck.
An entire subculture has proliferated around HYIPs. There are sites that track and monitor HYIPs, and forums where people go to promote and learn more about HYIPs. There’s even an HYIP subreddit.
When an HYIP scheme collapses, the collapse is generally blamed on a hack, a theft, or a bad investment—some type of external event that is plausibly at arm’s length from the operator. When that happens, the HYIP operator begins issuing “refunds” — in good faith, of course.
Some HYIP operators even go to the effort of setting up long-winded spreadsheets and paying back dribs and drabs over months. Of course, the first people to get paid back are generally insiders or the operators themselves — under different names — who then loudly proclaim what a great guy the operator is, and how decent it is of him/her to spend all their time and effort refunding everyone.
The U.S. Financial Industry Regulatory Authority, the regulatory body charged with governing business between brokers, dealers and the investing public, writes that “virtually every HYIP we have seen bears hallmarks of fraud.”
TalkGold and MoneyMakerGroup
Starting in January 2003, TalkGold and sister site MoneyMakerGroup were two hugely popular Internet forums used to launch and promote HYIPs. The sites were pulled offline on August 21, 2017, a day after the U.S. Department of Justice filed an asset forfeiture complaint against Edward and Brian Krassenstein, the twin brothers that ran the sites. Homeland Security raided the twins’ Florida homes a month later.
“Since at least 2003, Brian and Edward Krassenstein … have owned and operated websites devoted to the promotion of fraudulent HYIPs. In particular, the Krassenstein run sites ‘talkgold.com’ and ‘moneymakergroup.com’ are discussion forums in which HYIP operators advertise and promote their fraud schemes to potential victims.”
“Patryn” on TalkGold
Michael Patryn, formerly Omar Dhanani, was arrested in October 2004 on charges related to his involvement with Shadowcrew, a cybercrime message board. Operating under the pseudonym “Voleur,” French for thief, he offered Shadowcrew members an electronic money laundering service — wire him cash, and he would fund your E-gold account, thereby adding a layer of anonymity to any purchases you planned to make.
After the Shadowcrew bust, TalkGold users began to speculate that “Patryn,” a prolific poster on TalkGold, was Dhanani — and there is good reason to suspect that he was.
“Patryn” joined TalkGold on April 3, 2003. His profile linked directly to VFS Network, a network for several digital currency exchangers, including Midas Gold, HD Money, and Triple Exchange— three that Patryn himself operated. VFS Network was also his business. (VFS stands for Voleur Financial Services.)
If that is not enough evidence, “Patryn” also openly admits on TalkGold that he operates Midas Gold. The business registration for Midas Gold also lists “Omar Patryn” (one of Patryn’s known aliases) as its sole director.
Patryn also appears to have used the profile name “Patryn” on MoneyMakerGroup, with the same link to VFS Network. He joined MoneyMakerGroup on November 27, 2007, six months after he got out of a U.S. federal prison, where he served 18 months related to his earlier Shadowcrew arrest.
Sceptre on TalkGold
Cotten was likely “Sceptre” on TalkGold. Sceptre joined TalkGold on July 4, 2003, three months after Patryn joined. Cotten would have been 15 or 16, at the time.
TalkGold members were able to list “friends” on the site. A May 2013 archivedprofile page for Patryn shows that he had six friends — one of whom is Sceptre. Similarly, a May 2013 archived profile page for Sceptre shows he had one friend — “Patryn.”
The two also interacted. Many of Sceptre’s TalkGold posts appear alongside Patryn’s in the same thread, either promoting or defending VFS Network, Midas Gold, or one of the other exchanges that Patryn operated. (There is also evidence to suggest that Cotten, not Patryn, was the main operator for Midas Gold.)
On December 7, 2009, when a user on TalkGold complains that he is having issues with Midas Gold, Sceptre replies: “I’ve never had any problems with M-Gold. They are usually very efficient.” Patryn follows on the same thread with, “M-Gold does not work during weekends. What is your order reference number? I will have it taken care of ASAP.”
On September 29, 2012, “Patryn” responds to someone complaining about Midas Gold keeping their money. (This was not unusual, by the way. There were many complaints about Midas Gold withholding customer funds. See here, here and here.)
“To the best of my knowledge, both of us have been responding to your emails. You sent me five emails yesterday demanding that I hurry up and resolve this issue. Your issue will be resolved ASAP. Unfortunately, I cannot force the banks to speed up their investigation process.”
In the same thread, Sceptre replies to “Patryn,” almost mocking the customer.
“lol, I’m surprised you’re willing to help him. You offer your dispute resolution for free, and he thanks you by spamming your inbox and complaining that you don’t reply while you’re sleeping.”
In September 2012, a poster asks, “I am looking for a LR Exchanger into HD-Money.” (Basically, the poster wants to convert one digital currency, Liberty Reserve, into another, without having to go through fiat). Sceptre replies, “For this type of trade I would use ecashworldcard.” Patryn follows by posting a link to his HD-Money site, which lists Ecash World Card as an offering.
Cotten and Patryn on BlackHatWorld
BlackHatWorld is a forum where people go to discuss “black hat” marketing tactics. Paid shilling (paying someone to promote your product on social media), negative SEO attacks (improving your SEO ranking by destroying your competitor’s) and gaming a search engine’s algorithm are all topics of discussion on this forum.
These tactics are generally used by Websites that only plan to stick around long enough to make a quick financial gain, which is exactly what HYIPs aim to do.
Someone going by “Patryn” was also active on BlackHatWorld. This person joined on September 6, 2012, and was last active on September 7, 2017. He only posted 9 messages.
Another poster — “Murdoch1337” — in BlackHatWorld, was much more active. He joined on February 12, 2012, and his last activity was January 8, 2017. This person appears to have previously been posting as Sceptre, and we believe this was Cotten.
(QXCINT also tells me that one of Cotten’s email accounts — email@example.com, which was tied to a number of Cotten’s domain registrations — has or had an active account on BlackHatWorld, but the method he used was too technical for me to confirm independently.)
Murdoch1337 appears as the original poster in a thread titled “Sceptre’s Spectacular Content Services!!! – $1.50 per 100 words” — an indication that Sceptre likely switched his profile name to Murdoch1337 sometime after he started the thread. He responds to other posters in the thread as if he is the one offering the content services. “That’s all the review copies for now,” he writes. “For everyone else, feel free to place your orders using the order info in my original post.”
On September 10, 2013, Murdoch1337 posts an ad for a developer to help him with an upcoming cryptocurrency exchange. In the ad, he writes:
“I am looking for a programmer who is familiar with Bitcoin to develop a website that is very similar to Bitstamp…Also, I’m looking to get this project built and online quickly, so if you are able to do it quickly, that is a bonus.”
This ad was posted three months before Quadriga launched in beta. The timing makes sense given that Quadriga was based on WLOX, an open-source exchange solution available on Github, which would have dramatically reduced the time it took to create a functioning crypto exchange. Alex Hanin built the Quadriga platform, though it is not clear if Cotten actually recruited Hanin via this ad on BlackHatWorld.
I’m looking for programmers who are knowledgeable when it comes to Bitcoin and I found you.
I have a number of projects that need work, including a new Bitcoin exchange. Are you able to build sites like this? If so, i’d like to get in touch
S&S Investments and Lucky Invest
One of Sceptre’s HYIPs was S&S Investments, a website that opened for business on January 1, 2004. (“Copyright @2004 Sceptre” is written at the bottom of the page.) He promotes the scheme as a way to double your money.
“You invest a sum of money into the program and within 48 hours (usually within 18) you will receive a return of anything from 103% to 150%, possibly more.”
He is sure to point out that this is “not what is called a ponzi or pyramid scheme.” It offers returns that are far better!
In case the first offer sounded a little too far fetched, he changes the text later to something only slightly more believable. S&S now becomes a “fixed-term investment,” which pays 115% in a week….”you can invest and walk away in profit after just 7 days!”
Of course, S&S ultimately collapses, and discussion around it gets moved to the “Closed / Scammed Programs” section of TalkGold, where Sceptre continues to string along anxious investors, who continue to hold out hope for a “refund.” He writes:
“Refunds WILL take some time. I cannot guarantee that they will all be made quickly. The refund process is likely to spread over a long period of time, but I am willing to do my best to refund everyone to the best of my ability. Please be patient and you will receive a lovely surprise in your e-gold, a refund from S&S Investments,” Sceptre writes.
One TalkGold user reviewed what he considered to be the 12 biggest HYIP “scams” on TalkGold. This is what he wrote about S&S Investments:
“S&S Investments is an interesting program because it was operated by a ‘well known’ person in the HYIP arena. I use the quote marks, because this person was not well known at all, in fact he was very anonymous. No one knew his name, other than his nickname he used to post with, Sceptre. He used anonymous proxies, he was very well hidden. Yet because he had over 1000 posts on TalkGold, he earned a kind of pseudo-trust that people get from being very visible and always online.
Sceptre started off with a small little program that promised to pay back a large amount after a few days. It soon grew to become very, very popular, and it was not long before he upgraded to a fully automated script.
Sceptre wouldn’t tell people how he made the money, he just said that was his little secret. Virtually everyone invested into S&S Investments based on his post count on TalkGold. “He’s made a lot of posts on TalkGold, therefore he must be honest” seemed to be the general opinion of the investors.
S&S Investments went for sometime before cracks started to appear. First the website went offline, then was back again, but withdrawals weren’t being honoured, then the site went offline again. Finally, Sceptre made an announcement that S&S Investments were closed and refunds were to promised.
For a while, refunds did proceed, but then things started to dry up. Since the summer, no more refunds have been processed.
Hey, just because someone has thousands of posts on a forum, doesn’t mean he’s a trustworthy guy. Use your head, look at what the whole program is offering.”
In May 2004, Sceptre appears to switch to another TalkGold profile, “Lucky-Invest,” to promote a Lucky Invest HYIP.
At one point in a thread, he apparently forgets to log out of Lucky-Invest and continues responding as if he were Sceptre, until another poster calls him out:
“You forgot to sign in as ‘sceptre’. ohhhhhhhhhhhhhh . .. looks like Lucky-Invest changed their message!!! . . . too funny!!! . .. did you get caught Sceptre??? hahaha ;)”
“I’m not trying to hide. Lucky Invest, the Newest Investment/Game. My profits go to help pay refunds. THIS IS A GAME, IT WILL NOT HAVE ANY REFUNDS.”
This is a straight out admission that Lucky Invest was not an actual investment. It was a “game,” in other words, a fraud. When you give me your money, it is mine. There are no refunds in this game, just me sharing my profits.
Knowing that Cotten and Patryn did business together on TalkGold does not tell us where the CA$250 million worth of crypto and fiat that was on Quadriga went. (Only a fraction of those funds have been recovered so far.) But it certainly does bring up questions, such as, was Cotten really just a starry-eyed Bitcoin libertarian? Or was he a seasoned con artist, who had no qualms about taking other people’s money?
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