Detecting Cryptocurrency Scams and Measuring Cryptocurrency Quality

Prof. Neil Gandal, Professor of Economics, Tel Aviv University;

Prof. Marie Vasek, Professor of Computer Science, University of New Mexico

Researcher

We will research two related issues. The first issue involves developing a methodology and using that methodology to detect cryptocurrency scams.  The second issue involves examining the relationship between coin quality and success.

(I) Over the past three years, the market capitalization for cryptocurrencies has exploded, soaring from $12 Billion in February 2014 to $414 Billion in February 2018! Further, the number of coins has increased tenfold in the same period.  By 2017, there were more than 1300 cryptocurrencies. Given the rapid changes, it is hard for users to tell the difference between legitimate businesses and frauds. The potential for fraud (cyber-crime) in such an unregulated market is significant. Cyber-crime includes actors deliberately manipulating prices to their own benefit as well as hucksters creating new coins promising benefits that deceive investors. 

(II) Perhaps as the cryptocurrency market develops, scams will be weeded out by people choosing not to invest in them.  The second bursting of the bitcoin bubble in 2018 will enable us to address this issue. The (I) rich data, (II) the “ideal natural experiment” of a huge rise followed by a significant fall in the value of the top cryptocurrency and (III) the stark differences between the behavior (returns of the coins) will enable us to examine why the coins behaved differently. With more than 800 coins and repeated observations over time, we will more than enough data to draw meaningful conclusions.  If quality (as measured by characteristics) indeed explains the returns of the coins, this will show that information (in the form of characteristics) has an important role to play in terms of weeding out frauds and scams.

Over the past three years, the market capitalization for cryptocurrencies has exploded, soaring from $12 Billion in February 2014 to $414 Billion in February 2018! Further, the number of coins has increased tenfold in the same period.  By 2017, there were more than 1300 cryptocurrencies. Given the rapid changes, it is hard for users to tell the difference between legitimate businesses and frauds. The potential for fraud (cyber-crime) in such an unregulated market is significant. Cyber-crime includes actors deliberately manipulating prices to their own benefit as well as hucksters creating new coins promising benefits that deceive investors.  This is not merely a theoretical risk, as our previous research shows.

We believe that the monetary impact of cyber-crime in the form of Ponzi schemes is large for cryptocurrencies. For instance, Bitconnect, a coin that was once as high as the 7th highest market capacity, in just a day, went from a market capitalization of over $2.5 Billion to collapse. The impact of these scams on consumers is high, particularly for novice consumers who do not recognize the warning signs of a Ponzi scheme. We believe that rooting out these scams at this early stage is important and feasible.  By identifying them publicly, we can help stop the mass, largely unknowing, support of them.  Cryptocurrency cybercrime matters because – in addition to the victims and the substantial amounts of money may be lost – scams undermine trust in the ecosystem and legitimate cryptocurrencies with innovative business models.  We believe that our work will make an important contribution to a nascent literature on cryptocurrencies and the financial sector. 

Tel Aviv University, P.O. Box 39040, Tel Aviv 6997801, Israel
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