How to Avoid Crypto Scams

Ruth Saldanha: Earlier this month, celebrity Kim Kardashian was fined more than $1 million for promoting Ethereum Max on her Instagram page. Well, that’s because she hasn’t disclosed that she was paid $250,000 to promote the cryptocurrency, which is now worth next to nothing. This raises an interesting question. In a field as new as crypto, how should investors spot scams or even unwanted investments? Madeline Hume is a Senior Research Analyst at Morningstar and is here today to tell us.

Madeline, thank you for being here today.

Madeline Hume: Thank you for having me Ruth.

Saldanha: Cryptocurrencies are still evolving and there aren’t many research reports to base your decisions on. So how should investors decide which coins or currencies to buy?

Hume: Yes, it’s a tricky question to answer in crypto right now. Much like cryptocurrencies themselves, research on cryptocurrencies is still highly decentralized and spread across a variety of sources. Surprisingly, one of the most common areas where investors look for cryptocurrencies is social media. This is why some of the ads like Kim Kardashian’s are so effective, because people are already looking for investment insights into crypto.

There are pros and cons to the approach that crypto assets and investors in those assets have taken in terms of posting ideas and stuff like that. The advantages are that much of this research is free and highly democratized and accessible to the standard user. The downside, however, is that this information is often not fact-checked and authorized by various regulators or other types of gatekeepers within the crypto industry because it simply doesn’t exist yet. This has the side effect that there are many risks that these crypto tokens do not have the correct disclosures. As such, it is always in investors’ best interests to treat crypto assets as a kind of entry fee into the amusement park of the broader crypto ecosystem, to get a handle on the technology and understand the mechanics of the space without necessarily expecting appreciation from capital or something like that. And most importantly, not to take investment advice from celebrities.

Saldanha: It’s interesting that you mentioned social media because a lot of these coins are memes or maybe pushed by certain parties including celebrities. So how should an investor recognize a pump-and-dump scheme versus a legitimate opportunity?

Hume: It’s a pretty true statement throughout the investment universe that legitimate opportunities very rarely need to advertise themselves. Take a coin somewhat related to the one Miss Kardashian sold, Ethereum Max. Its name borrows from Ethereum, a very popular cryptocurrency. And around the same time this SEC announcement came out, Ethereum was actually going through a major technological shift. The crypto token now essentially allows investors to pool their wealth on the platform, helping ensure the health of the blockchain and receiving cash flows in return.

Well, Morningstar doesn’t recommend cryptocurrencies as investments today, but the fact that the second-largest crypto asset by market cap is returning capital to investors means that it might one day be possible to arrive at something of a cryptocurrency valuation, which is helpful its could reduce much of the volatility that has plagued the space. Unfortunately, this major technological advance was not publicized by any major celebrity. So when you have these platforms used by the likes of Kim Kardashian and Elon Musk, it means that investors are much more likely to hear about something like Ethereum Max or Dogecoin than Ethereum. And so it remains with cryptos as well as many other asset classes that it is very important to do your own homework.

Saldanha: To step back for a moment and look at it from a broader perspective, how should investors view cryptocurrencies in general, especially as we move into a more complex economic environment?

Hume: Yes. So the general market environment is pretty bearish across all major asset classes right now, and crypto certainly hasn’t been immune to that. In addition, you also had several unforced errors due to the space’s lack of maturity. And the entire industry is still getting a grip on risk management. It’s still a very nascent space. Many of the things that traditional finance has built over centuries to serve investors are still being built from the ground up by crypto, and they’ve only been around since 2008. So there’s still work to be done.

But I would separate crypto as an investment from crypto as a technology. And what’s happening with crypto is you have these long periods of investment declines called crypto winters. And this is a time when many of the marketing teams around crypto and the people working on these projects are actually able to put their pitch decks back for a bit and get back to focusing on the technology and improving it and develop it in a way that ultimately bears fruit in a subsequent market event that takes it further up. So we’re seeing one of those periods right now, and it’s brought with it developments like Ethereum’s upgrade to a proof-of-stake blockchain. So, on the technology front, there’s a lot to be excited about, even if the investment itself is still very high risk.

Saldanha: Big. Thank you for being with us today.

Hume: Thank you for having me Ruth.

Hume: For Morningstar, I’m Ruth Saldanha.