When the first major bit-heist, Mt. Gox, happened, many in the crypto community might have been forgiven for thinking that it had been but a minor case of arrhythmia. However with the latest incident involving MyCoin, a bitcoin exchange in Hong Kong, it appears that we might soon have a full-scale coronary. There will have to be stronger guarantees for client funds going forward if we are not going to abandon the promise of Bitcoin altogether.
MyCoin went belly up a week ago, disappearing with about US$ 387 million, leaving 3,000 clients out in the cold. This latest incident could not have come at a worse time for Bitcoin, which has been struggling in the lower 200s against the US dollar.
MyCoin – A Classic Ponzi Scheme
Ponzi schemes are named after Charles Ponzi. Ponzi duped residents in New England that he could provide a 50% return on their investment in three months. All they had to do was invest in the postage stamp scheme. At the time, the interest rate on a bank account was only five percent, making his scheme too good to be true, which it was. In the beginning, he bought a small number of international mail coupons as a cover for his ruse, but then, later on, started using funds from new investors to pay the promised returns to the initial investors. Ponzi schemes do share many features in common with pyramid schemes.
Legal Provisions Against Ponzi Schemes in Hong Kong
There are laws against Ponzi schemes in Hong Kong. In 2012, the island enacted the Pyramid Schemes Prohibition Ordinance (Cap 617) which gave a much broader definition of a pyramid scheme. The law sought to seal the loopholes that were inherent in the previous laws. It also imposed criminal liability on people who recruit others into a pyramid scheme, knowing well that the benefits accrued would largely be derived from such recruitment. The law gives courts wide-ranging powers to determine whether a scheme would fall under the definition of a pyramid.
A court would have to determine whether there was a genuine underlying business and whether the reward comes from the sale of goods and services. If the company promises a return through the recruitment of new members rather than through the sale of goods and services, the court is likely to find the existence of a pyramid scheme.
On paper, the legal provisions in Hong Kong law are excellent, and they address the problem of pyramid schemes adequately. However, the challenge with MyCoin is that it involved Bitcoin that is borderless and can be moved around the world very quickly. Randall Arthur, a partner at Kobre & Kim, a Hong Kong law firm, says,
“MyCoin and the perpetrators of the scheme would almost certainly use the opportunity to continue to try and hide investors’ funds in various jurisdictions around the world, making any judgment obtained that much harder to enforce.”
Global Manhunt – The Challenge
Focus would, therefore, shift to a global manhunt, or in the present case, a bit-hunt. While doing the research for this article, several countries emerged as Bitcoin-friendly, and any or all of them could provide the haven for the stolen funds. The top 10 most Bitcoin-friendly jurisdictions in the world according to data obtained from the geo-location web utility coinmap.org are Italy, the United States, the United Kingdom, Finland, Australia, Singapore, Netherlands, Canada, Slovenia and the Isle of Man which although is a Crown dependency of the UK, is nonetheless included due to its Bitcoin-friendly policies.
Of the list of 10 countries mentioned above, three do not have extradition treaties with Hong Kong: Italy, Finland, and Slovenia. The list is by no means exhaustive. There are many more including next-door China. However, this does point to how difficult a task it will be to bring the perpetrators of this crime to justice.
The Legal Challenge
There is more though. In the United States, it is possible to bring what is called a class action lawsuit. A class-action lawsuit is one in which one or more persons sue on behalf of a larger group of persons. Class action lawsuits invariably involve two factors. One, the issues in dispute are common to the larger group, and that the settlement of the case will usually follow the pattern of negotiation, court supervision, and notice.
In Hong Kong, the law does not recognize class-action lawsuits. Randall Arthur, previously mentioned, explains:
“There are no provisions under Hong Kong law or procedure which allow class-action lawsuits to be commenced. Individual investors have the right to commence legal proceedings in Hong Kong against MyCoin, or even join together as joint plaintiffs in a claim. However, they would only be pursuing the claim on behalf of themselves and not for the benefit of a class of investors. Even if one or more individuals were able to obtain a judgment against MyCoin, it appears that there may not be any assets in Hong Kong against which such a judgment could be enforced.”
A remedy offered by Hong Kong law would be to place MyCoin into provisional liquidation. Investors would present a winding-up petition against MyCoin. If successful, a provisional liquidator will be appointed to begin the process of recovering MyCoin’s assets wherever they may be found. Another route would be for the Registrar of Companies in Hong Kong to apply to wind up the company. Randall Arthur explains,
“Simply, as creditors of MyCoin, one or more of the investors would need to present a winding-up petition against MyCoin alleging that there are unpaid debts due to the investors and that it is appropriate for MyCoin to be wound up. It is also possible – although uncommon – for the Registrar of Companies to apply to wind up a company if it appears to the Registrar that the company is being used for unlawful purposes, as is likely to be the case with MyCoin. As soon as the petition is presented, an application can immediately be made to appoint provisional liquidators over MyCoin.”
Attempts at Regulation
The road ahead for the MyCoin debacle is likely to be long, involving multiple jurisdictions, often with varying and clashing interests. However, one issue that is going to be brought to the fore is one of cryptocurrency regulation. Several countries have started down that road. Some like Bangladesh has issued a blanket ban on the use of Bitcoin. Others have adopted a wait and see attitude while some have chosen to blow hot and cold.
Bitcoin and its parent technology, the blockchain hold enormous promise for the global financial system. As it is borderless, it will require agreement and regulation at the international level to prevent cases like MyCoin. Already, there are steps being taken in that direction. The Commonwealth Secretariat just hosted a Virtual Currencies Roundtable in London. While we wait to see what comes out of such deliberations, it is important to take steps to protect our crypto investments.
The Securities Exchange Commission website features to look for when determining whether an investment scheme may be a Ponzi. They are summarized below.
- Most Ponzi schemes promise high returns on investment with little or no risk. Investment always comes with risk as a corollary. Hence any promises of a guaranteed investment return should be treated with a high degree of circumspection.
- Secondly, if the investment offers consistent returns irrespective of market conditions, then it is also likely to be a Ponzi. Investment returns fluctuate over time due to market conditions.
- Third, Ponzi schemes are also usually not registered. Registration is key as it provides government, and would-be investors information they need to have so as to make sound investment decisions. Related to this, is also the issue of unlicensed professionals by a Ponzi scheme.
- If the investment model is secretive or too complex, then it would be a good idea to be careful with it. The same applies if the information about the investment is not clearly stated in writing. It would be helpful to pay keen attention to the legal documents and the accounting to ensure that the investment model or strategy is above board.
- If the investment scheme has difficulty in sending out your payment or cashing out the investment take it as a warning sign. It is common for Ponzi schemes to encourage members to pull back their investments, and even use higher returns as an incentive to keep them hooked.
With Bitcoin’s disruption of the global financial order, it is likely that the nations of the world are going to be debating its regulation for some time to come. Individual jurisdictions will in the meantime come up with all manner of regulations. Bitcoin exchanges that voluntarily submit to regulation may well become the choice of discerning clients, a choice that may do much to reduce incidents like Mt. Gox or even the latest case MyCoin.
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Last modified: March 4, 2021 4:42 PM