SEC charges GAW Miners and ZenMiner as a Ponzi scheme [pdf]

http://www.sec.gov/litigation/complaints/2015/comp23415.pdf

by rbobby • 11 years ago

67 34 11 years ago

The title seems misleading; from the sounds of things, these weren't "mining companies" in the first place, they were scams from the start. To be a mining company, they'd have to actually do mining. Instead, it sounds like their primary product was the money coming in from people buying their product, which is the definition of a pyramid scheme.

Quoting the relevant bits of the ruling:

35. Second, contrary to its stated reason for existence, no mining actually occurred through ZenMiner’s ZenCloud interface. Though customers paid for equipment that they believed they were directing to mine in various pools available through the ZenCloud interface, and also paid for hosting services, very few pieces of the mining equipment purchased by customers actually existed in a ZenMiner datacenter. Most customers paid for a phantom piece of equipment that neither GAW Miners nor ZenMiner owned. Ne ither GAW Miners nor ZenMiner was directing customers’ computing power to any pools at all, much less the ones customers believed they were choosing.

37. Cloud Hosted Mining customers were entitled to request that the computer equipment they had purportedly purchased be sent to them, but neither GAW Miners nor ZenMiner owned that equipment to ship.

49. By October 2014, GAW Miners had oversold Hashlets to an even more extreme degree. It had oversold altcoin-mining Hashlets by at least about 100 times its computing capacity, and bitcoin-mining Hashlets by at least about 5 times its computing capacity.

50. Though GAW Miners built a data center that, by November 2014, contained significant computing capacity for mining bitcoin, it made no increases to its computing capacity for mining altcoin.

alvern• 11 years ago

It seems they started as a mining operation, then pivoted to sell shares or futures called "Hashlets". The scam started when they oversold these Hashlets and advertised to customers to use a cloud service instead of their physical mining rigs.

gawsuit2• 11 years ago

The reason for that is that it turns out that paying for power and cooling is more expensive than not.

cba9• 11 years ago

Right. At one point in the complaint, they say the company had oversubscribed its mining capabilities but kept selling to 4x IIRC, which rather implies that there was mining capability there in the first place (just much much less than they were selling).

teen• 11 years ago

definition of a ponzi scheme (not pyramid scheme)

scoot• 11 years ago

Ponzi rather than pyramid scheme, but otherwise I agree.

(A ponzi scheme paying current investors from the funds contributed by incoming investors, as distinct from a pyramid scheme where payouts are typically in return for recruitment of others to the scheme.)

JoshTriplett2• 11 years ago

Fair enough, though the two are often combined (paying the top of the pyramid from the bottom).

dang• 11 years ago

We changed the title to be less misleading. Submitted title was "SEC charges Bitcoin companies GAW Miners, ZenMiner as a Ponzi scheme".

LukeHoersten• 11 years ago

This is a surprisingly clear and articulate explanation of digital currency mining and how it was used to mask a ponzi scheme by over-issuing securities against it. Well done SEC.

jimrandomh• 11 years ago

The Bitcoin world seems to have an awful lot of incompetent fraudsters. This particular one is surprising, because I don't see how they thought they could get away with it; the scheme described in the SEC complaint is one that would be guaranteed from the start to unravel, and the perpetrators weren't anonymous.

What they did was, they sold shares in a Bitcoin mining operation corresponding to hashing power, and kept selling long after their actual mining equipment had sold out. They then used the revenue from those sales to buy Bitcoin on the open market, and misrepresent those purchased coins as newly-mined coins for withdrawals.

Seriously, how could they possibly have thought that would work out?

conistonwater2• 11 years ago

Good question. One guess is that the total amount of bitcoins mined by a given device is finite due to obsolescence — competition from newer faster devices would push returns to zero in the future. So long as the price of bitcoins falls/does not rise, the sale price of the device might be enough to purchase the equivalent number of bitcoins on the open market and still make a profit, and the customers would be none the wiser.

There is also another very general problem with selling/buying miners (beyond the general suspicion of bitcoin fraudsters): if you buy a money-printing device from someone, why on Earth would you trust them not to run the money-printing device for themselves? You'd think it only ever makes sense to sell obsolete or broken devices, never the real thing, so why would anyone want to buy any?

nemild2• 11 years ago

Just because you have a money making machine doesn't mean you'll necessarily want to keep it for yourself.

The businesses (technology providers vs the owner of a current mining machine) are a bit different. A technology provider might have the expertise to manufacture the rigs or run the datacenter. The "owner" (quotes because it might be on paper only) provides upfront capital, in exchange for future uncertain returns from mining (uncertain for a host of reasons including the uncertainties of mining success, uncertainties in the speed of depreciation, and uncertainties in the future price of Bitcoin). The technology provider may not want to take these risks - or be unable to provide the capital outlay.

This means there's potential value to both parties in making a trade.

(The question of whether the technology provider is reneging by running the machine for themselves is obviously a separate question)

gawsuit2• 11 years ago

I've followed this one with amusement for a while. Basically they tried to be legitimate in a sense, until that turned out to be quite expensive, at some point they tried again to be legitimate but again with the same result. There's lots of history you can read up about in the Bitcointalk thread (1500 pages of it), including details like the CEO causing tens of thousands of dollars of damage to a rental property by amongst other things, running a mining operation in his basement.

At one point they made a large mining facility in the US, with contracts with the power company to use a certain amount of service. They paid in the millions of dollars for mining hardware and power installation for their own small substation, they then ran it for a few months until the power company cut them off for never paying the power bill which amounted to $350,000 USD[1]. This was responded to as "a billing dispute" [2].

From my own calculations this farm was never able to be profitable (it always used more in power than it mined), and never covered even a small portion of the hashrate they were supposed to own. At one point they posted a video from within it, filmed without sound and in such a way as to hide the fact that there was only one rack of miners.[3] Many promotional photos were posted of their "farm", but none of the hardware is actually plugged in for these photos, so it was probably reboxed and shipped to customers afterwards.[4]

The part not mentioned in the SEC complaint is where the CEO flees the US to Dubai, one of the people in Dubai he defrauded of $200,000 from wins a legal battle against him, and the US Government bails him back to the US.

[1] http://www.scribd.com/doc/261395976/Mississippi-Power-vs-GAW...

[2] https://www.cryptocoinsnews.com/wp-content/uploads/2015/04/1...

[3] https://www.youtube.com/watch?v=2ZpZdeJNSV0

[4] https://i.imgur.com/9YTH5mB.jpg

Animats2• 11 years ago

"The Bitcoin world seems to have an awful lot of incompetent fraudsters."

Yes, it does.

The upside of this is that none of them have been able to break the basic blockchain mechanism and profit from doing so. That's an impressive achievement in computer security. It's the reason that blockchain technology is now being looked at as a way to record transfers of high-value bonds and such.

inoop• 11 years ago

The upside of this is that none of them have been able to break the basic blockchain mechanism and profit from doing so. That's an impressive achievement in computer security.

Not really. Merkle trees aren't exactly new, and neither is the transaction signing mechanism used in Bitcoin. Bitcoin didn't achieve anything novel here.

The major new idea Bitcoin brought to the table was proof of work. However, Satoshi couldn't predict mining pools, which has led to the situation Bitcoin is essentially controlled by a small cabal of miners and core devs. This is not the decentralized system Satoshi envisioned.

In fact, there have been cases in the past where a single pool actually had >50% of mining power for short periods of time. Since ownership of pools is not exactly transparent, we have no way of knowing if any pool out there is currently at 50%, or if there are multiple pools colluding. The classic argument is that there is no incentive for a 50%+ miner to hurt the network, but then you're trusting a random pool owner with your money, which goes against everything that Bitcoin set out to do.

Moreover, a large pool has been known to game satoshi dice by including a double-spend in its next block if it lost, and thus denying the original transaction to go through. Other games like selfish mining can be played as well.

Your statement that Bitcoin remains unbroken is not really true. A double spend has been demonstrated during the first big fork (around version 0.8, if memory serves me). It was announced with proof on Bitcointalk. I guess hat since the guy was a white-hat, and returned the money, you're still technically correct in that he did not profit from it.

Bitcoin is also notoriously vulnerable to DDOS attacks. We had several big DDOS events this year with Bitcoin transactions being backed up for hours, even days. In one case a company was 'stress testing' the system by filling up the blocks with dust transactions, and in another an attacker found a way to very cheaply fill up blocks with certain types of transactions (sigops).

Finally, Bitcoin simply does not scale very well because it's a massively replicated system that records and distributes transactions to every node in the network. This does not scale in number of nodes (network diameter, end-to-end latency) or in number of transactions (bandwidth, blockchain size).

All in all, calling Bitcoin an impressive achievement in computer security is a bit of a stretch imho.

jarcane• 11 years ago

It's almost as if a totally unregulated commodities market isn't the magical utopia the neoreactionaries and internet libertarians dreamed of!

If only we had centuries of historical precedent to learn from and prevent these sort of mistakes.

geoffbrown2014• 11 years ago

This happens regularly in highly regulated markets as well. Regulation doesnt stop people from being stupid. The beauty of the Blockchain is that it is still intact despite the stupidity. It doesn't depend on fragility of captured regulatory bodies or the honesty of salesmen. Stupids gonna stupid.

hughes• 11 years ago

After selling approximately 2,290 Remember [9/11 Memorial] Hashlets for a total of approximately $48,000, GAW Miners donated only $10,000 to a 9/11 related charity

That'll go over well with a jury!

Kinnard2• 11 years ago

I'd be careful about the use of the term ponzi scheme.

I think it's a rather dangerous example of doublespeak: https://en.wikipedia.org/wiki/Doublespeak

Social Security exactly fits the definition of a Ponzi Scheme[1], has serious sustainability issues[2], and could do far more damage to hundreds of millions of people if it were to collapse.

No one is going after the people running Social Security though it is far more dangerous.

[1] "operation where the operator, an individual or organization, pays returns to its investors from new capital paid to the operators by new investors, rather than from profit earned by the operator."

[2] Social Security is a Ponzie Scheme: https://en.wikipedia.org/wiki/Social_Security_(United_States...

ruddct• 11 years ago

Not to get into a tangent about social security and how the program manages money, but this isn't quite an applicable comparison. Gov't sponsored 'ponzi schemes' can pretty safely be assumed to exist for about as long as the sponsoring government does (or, if they're dissolved, one can pretty safely assume some kind of payout. At least in a revolution-fearing democracy).

If the government goes away, your investment into a pension program is probably a pretty low priority. A ponzi scheming company disappearing has a much more direct effect on the people who've invested in it.

drcode• 11 years ago

Social security isn't a Ponzi scheme because it's mandatory.

If it was a true Ponzi scheme, you'd have the option not to participate in it.

cjensen• 11 years ago

The claim that Social Security is a Ponzi scheme is nonsense -- though it seems to fit the definition at first glance, if you think through it far enough you will see it does not fit.

Since a Ponzi scheme is defined as an "investment", it is therefore voluntary. A Ponzi scheme can only obtain such volunteers if it promises each volunteer investor more than it pays in. It therefore requires an ever-growing pool of investors. Since there is a finite number of people on the planet, a Ponzi scheme must fail at some point.

By contrast, Social Security is a mandatory scheme, and the pay-in and pay-out can be dynamically adjusted to ensure that it remains solvent. In particular, no guarantee is made that pay-out will exceed pay-in. Do not mistake the impending Social Security deficit for an inherent outcome of the scheme. The deficit could easily be fixed if politicians on both sides would stop pandering to their bases.

Kinnard2• 11 years ago

The fact that it is compulsory while it would allow those who run it to extract more to prevent a collapse, would do nothing to assuage the damage were it to collapse.

0xcde4c3db• 11 years ago

The mechanism is similarly structured, but the goals are entirely opposite:

An ideal Ponzi scheme pays out all of its income to the organizer and none of its income to the participants.

An ideal Social Security scheme pays out all of its income to the participants and none of its income to the organizer.

jwatte• 11 years ago

That would be true if Social Security was an investment. However, it is a social welfare program and a tax combined into one.

In 2040 when the current balance is tipped, that program can become solvent without increasing the tax by reducing payouts by 25%.

Meanwhile, the current federal budget is only funded to about 2/3, so there are other programs I'd worth about earlier, if I'd care about programs and the taxes funding them.

Animats2• 11 years ago

That's what the SEC does. About once a week, they shut down some investment scam. This was a straight Ponzi, dressed up, as the SEC says, with techno-jargon.

These were some of the people behind Paycoin, too.[1]

[1] https://bitcoinmagazine.com/articles/death-paycoin-employee-...

SEC charges GAW Miners and ZenMiner as a Ponzi scheme [pdf]

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