Trendon Shavers, alias "pirateat40,"1 ran a bitcoin fund called "Bitcoin Savings and Trust." BCS&T was apparently a Ponzi scheme. We knew that; the Securities and Exchange Commission brought a civil case against him last year, which resulted in a $40 million judgment. But other people knew it before the SEC did. Individual-2, for instance, had a pretty good idea:
In or about early July 2012, SHAVERS and another participant on the Bitcoin Forum ("Individual-2") made a bet as to whether BCS&T was a Ponzi scheme. Specifically, Individual-2 alleged that SHAVERS was operating BCS&T as a Ponzi scheme. SHAVERS denied that allegation and placed a bet with Individual-2 that BCS&T was not a Ponzi scheme.
That actually happened! They found another person (Individual-1) to serve as escrow agent, they each escrowed 5,000 bitcoins with him, they specified the terms of the bet (if Shavers failed to meet a withdrawal request within 14 days, he would be deemed to be running a Ponzi), and the bet paid off less than two months later. This is how the bitcoin legal system operated:
On or about August 30, 2012, Individual-1 declared Individual-2 the winner of the bet, and wrote:
I hereby declare the bet decided, in favor of [Individual-2] . A withdrawal request made on August 15[,] 2012, is still outstanding as of today, Aug[ust] 30[,] 2012, which triggers default as specified in the contract, via "late by at least 14 calendar days, in disbursing either any regularly-scheduled interest payment, or any withdrawal request, by a valid account holder of [BCS&T]" clause.
In private communication, pirateat40 [i.e., SHAVERS] has agreed with this assessment and conceded the bet.
This is all from the federal criminal complaint against Shavers unsealed today, because I guess if you run a multi-million-dollar bitcoin Ponzi scheme you go to prison. Which is a very un-bitcoiny solution! The appeal of bitcoin is that it doesn't require trust in people or institutions. You don't have to believe that people are honest, or that governments will keep them honest. You can just exchange bitcoins with them and trust in the cryptography. It says it right on the coin! (There is no coin.)
That works great for giving people bitcoins in exchange for drugs or whatever. It works less great for investment management: If you give money to someone to invest for you, and want to get it back, you have to either trust her to give it back or have some enforcement mechanism to make her give it back. In that bet, you can see the bitcoin forum groping toward a bitcoiny solution to that problem, with the carefully specified bet and the escrow agent. It's not quite pure cryptography,2 but it is a very bitcoiny and libertarian and charming gesture at private regulation.
It did not especially work, though, insofar as Shavers took the bet and nonetheless continued to operate what sure looks like a Ponzi.
That is the other charming thing about bitcoin, that it recapitulates all of the discoveries and failings and hard-to-solve problems of a modern, or pre-modern for that matter, financial system. So this Ponzi is, at least on the FBI's allegations, a very classic, and very obvious, Ponzi. Shavers promised no risk3 and returns of 7 percent a week. There were high-pressure sales pitches:
On or about February 3, 2012, in response to a comment made by a forum participant, SHAVERS posted: "I can get you into this rare investment opportunity but it[']s very exclusive and I'm doing you a favor here by just requiring a 200 [Bitcoin] non-refundable sign-up fee. Trust me you will make that back in a week. Oh and did I mention you need to jump on this now[.] I have so many waiting on the list."
There was ... look, I have been a lawyer and a derivatives marketer, I have used my share of Capitalized Defined Terms, but the FBI has more fun with them than I ever did:
In mid-2012, Victim-1 traveled to Las Vegas and met SHAVERS in person. The purpose of this trip was, in part and among other things, to question SHAVERS directly about BCS&T and SHAVERS' postings on the Bitcoin Forum. Victim-1 had dinner with SHAVERS and other investors at a steakhouse (the "Vegas Steak Dinner"). At the Vegas Steak Dinner, SHAVERS told Victim-1, and others, that (i) BCS&T was doing great things; (ii) that BCS&T was also trading with hedge funds; and (iii) these hedge funds were paying a hefty premium in order to borrow Bitcoin from him.
What I love here4 is the vagueness. I assume that the FBI is abbreviating somewhat, but still, imagine going to a pitch and hearing:
- We are doing great things!
- We are trading with hedge funds!
- Those hedge funds are giving us piles of money for no apparent reason!
- Any questions?
What could possibly etc. I was hoping, in the FBI or SEC complaint, to get a sense of what Shavers was telling his investors he was up to, but as far as I can tell the actual pitch was completely impenetrable, just some mumbo-jumbo about bitcoin arbitrage and lending.5 And, similarly, when Shavers shut down his scheme in August 2012, he explained it impenetrably:
The decision was based on the general size and overall time required to manage the transactions. As the fund grew there were larger and larger coin movements which put strain on my reserve accounts and ultimately caused delays on withdraws and the inability to fund orders within my system. On the 14th I made a final attempt to relieve pressure off the system by reducing the rates I offered for deposits. In a perfect world this would allow me to hold more coins in reserve outside the system/ but instead it only exponentially increased the amount of withdrawals overnight causing mass panic from many of my lenders.
Here's what Shavers told the SEC in a sworn deposition last year, according to the FBI complaint:
c. BCS&T was allegedly primarily in the business of lending Bitcoin to "various investors or lenders" for a fixed period of time. A small percentage (about 10%) was used by SHAVERS to "buy and sell [B] itcoin  locally."
g. In or about July 2012, SHAVERS lent about 202,000 Bitcoin to a borrower he identified as "The Big One" and those 202,000 Bitcoin were never returned. SHAVERS has no record or proof that he (SHAVERS) made this loan to "The Big One," nor does SHAVERS know who "The Big One" is.
h. In or about August 2012, SHAVERS shut down BCS&T, redeemed recent investors, and kept some investor Bitcoin in order "to be able to trade so [he] could make [Bit]coin to pay them back."
Did you ... did you guess that "The Big One" was imaginary? The FBI says flatly: "SHAVERS never made a 202,000 Bitcoin loan in or about July 2012." Instead, says the FBI, of the 764,000 bitcoins he raised from investors, 618,000 were paid out as interest or principal returns, Ponzi-style; the rest he day-traded or stole.
What are the lessons here? The big one is, don't invest with people you meet on Internet forums. That is not a rule of bitcoin, it is a rule of life,6 and you can find scams on gold and foreign-exchange and penny stock and for all I know Rainbow Loom forums too. The amusement here is that bitcoin forums are full of skeptics, so Shavers was constantly being asked if he was running a Ponzi scheme.7 And constantly denying it incomprehensibly.8 And still raised 700,000 bitcoins.
The other lesson has to do with that number. At the end of July 2012, at the time of the Vegas Steak Dinner, those 700,000 bitcoins were worth around $6.4 million; at the time Shavers shut down BCS&T, they were worth around $9.5 million.9 When the SEC sued Shavers last year, they were worth $60 million. When it got its judgment, in September of this year, they were worth $280 million, though the court went easy on him and only required him to pay $40 million.10 Now they're worth around $240 million.
Shavers returned most of the money to investors, as Ponzis tend to; he also lost some day-trading and, according to the FBI, "misappropriated at least the dollar equivalent of about $147,000 of Bitcoin for his own personal use." That's things like spending $17,000, in April 2012, for "a 2007 BMW M5 automobile." He bought a used car with call it 3,400 bitcoins.11 At today's exchange rate, that's a $1.2 million BMW, and Shavers's misappropriations look like $10 million or more. Which is not great for his sentencing guidelines calculation. (If he's convicted!) The problem with bitcoin is that small-time bitcoin swindling can turn into big-time swindling, without the swindler being able to do anything about it -- or make any money from it.
2 The interesting future of bitcoin, or of bitcoiny things, is in smart contracts, where the computer programming doesn't just define a currency but also creates obligations that self-execute without requiring trust or enforcement. Like, you write an algorithm saying that Shavers will take your money and invest it in X, Y and Z and give it back to you with interest, and if he invests it in Q or doesn't give it back when you ask for it, the program overrides him. That would be cool. It seems rather far away.
3 "My clients [i.e., purported borrowers] deal in cash only and I don't move a single [Bit]coin until the cash is in hand and [I]'m out of harm[']s way (just in case :) ). So risk is almost 0."
4 Besides the FBI's omission of "Las" in the defined term "Vegas Steak Dinner," which is pure poetry.
5 Can you ... can you even borrow bitcoins?
6 OTHER RULES INCLUDE:
- Don't do anything with people you meet on Internet forums!
- Don't go on Internet forums!
- Don't go on the Internet!
7 There's this guy, for instance:
On or about January 19, 2012, a participant on the forum wrote: "IMHO [i.e., in my honest opinion] if you put your money in these schemes you deserve to lose them or be found out (I doubt pirate's [i.e., SHAVERS'] business is 100% legal)."
I feel like IMHO means "in my humble opinion" though?
8 A favorite:
Although, theoretically I could have run a Ponzi scheme for a while early on, it just wasn't something I would ever want to be a part of. If I wanted it to be one, it would have been at much lower rates and I'd be asking for everyone to join.
Guys don't worry, when my ponzi scheme dies I'll pay those closest to me first. ;)
The ;) is how you knew it wasn't a Ponzi scheme. (It was a Ponzi scheme.) If he'd wanted to signal that it was a Ponzi scheme, he'd have used a shrug emoticon, though I guess that hadn't been invented yet.
9 Based on prices of $9.10 as of July 30, 2012, and $13.50 as of Aug. 16, 2012. Price data from Bloomberg (XBT <curncy>). The SEC noted that Shavers's take "amounted to more than $4.5 million based on the average price of Bitcoin in 2011 and 2012 when the investments were offered and sold."
10 From the opinion:
The Commission has established through the evidence in this action that Defendants’ illicit gains are at least 180,819 bitcoins. A reasonable calculation of disgorgement in U.S. dollars terms (particularly in light of Shavers’ willful refusal to produce his verified accounting which has been ordered three times by the Court) utilizes an average daily price of bitcoin from August 26, 2012, when Shavers’ scheme collapsed, to today, thus averaging out the effect over this time period of the large fluctuations in the exchange rate of bitcoin to the U.S. dollars. Applying this methodology, the Commission requests that the Court order Defendants to disgorge, on a joint and several basis, $38,638,569, plus prejudgment interest thereon of $1,766,098 (using the IRS underpayment rate, as detailed below), for a total of $40,404,667.
Those 180,819 bitcoins of gains subtract out the amounts that Shavers returned to his victims.
11 The money transfer to buy the car occurred "Between on or about March 29, 2012 and on or about April 20, 2012," when bitcoins were trading around $5.
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