How crypto fell from grace

Moshe Hogeg  credit: Jonathan Bloom

A technology meant to generate trust has become fertile ground for the oldest con in the book.

Last week, Moshe Hogeg, chairperson of the Singulariteam venture capital fund, owner of the Alignment Blockchain Hub and of the Beitar Jerusalem football club, was arrested. Hogeg is suspected of a long series of offences centering on his activity in cryptographic currencies, a field that has attracted vast amounts of money in the past year. What exactly happened, and what can be learned from the affair? Here are four points.

1. Use of investors' money

The arrest application states: "The crypto field, which is under the radar of the enforcement agencies, is suspected of having been used by the suspects and their partners, through false presentations, in a methodical and sophisticated way vis-à-vis investors." How did it work? The allegation is that the investors were presented with an plan for investment of money and development of ventures in cryptocurrencies, and false reports of investments made by influential people. They were thus persuaded to invest millions of dollars in the ventures. The arrest application states that the money was not invested in accordance with the plans that were presented, but was stolen after the money was invested in the projects, and transferred to Hogeg and other suspects who were arrested along with him.

There is still a gag order covering some details of the affair and names of suspects, but the story is widely known from the welter of private claims filed against Hogeg. From the claims and the criminal allegations, it would appear that, despite the innovative nature of cryptocurrencies, the trick was the oldest in the book: raising money from investors and using it for purposes very different from those for which it was raised. It happens in every field, but in cryptocurrencies it's much easier.

People who invest in cryptocurrencies these days are largely people who dream of getting rich quickly. It's easy to sell dreams to people like that. How many of them really understand what they're investing in? What does the currency they buy really represent? How many have read the code of the project represented by the currency? Very few. Most of them are simply looking to make 400%, and ask for tips from people who have already invested in a cryptocurrency and made 400%.

The cryptocurrency industry is an industry of dreams, and money flows into it unceasingly, with investors ranging from the big funds of Silicon Valley to the small investors who doesn't want to be left behind. The industry is backed by innovative technology that one day will affect all of us in practically every sphere. For the time being, it is chiefly a large collection of pilot schemes. Some will succeed, some will fail, and some will be abused by businesspeople who will raise money from investors and use it for other purposes.

The Israel Tax Authority has already announced that there will be further arrests in this area, and no-one in the industry is at all surprised. Who will they be? As in the Hogeg affair, you can simply look up private lawsuits against cryptocurrency people in Israel and find the hints there.

2. On the elusive line between crypto and forex

We have to talk about an interesting phenomenon. There's a fine line between investment in crypt and investment in foreign currency, or forex. Both offer a trading alternative to the stock exchange. Forex, which was the previous decade's hot area for investment, is there in the Hogeg affair as well. Some of the people connected to the affair are also connected to forex trading. Hogeg himself had a forex trading company that was liquidated, and people in a forex company have recently been arrested on suspicion of crypto fraud.

Forex and crypto - in its current stage - work on the same feelings on the part of investors: the desire for excitement, the high volatility, the possibility of massive leverage, and the get rich quick dreams. It is therefore not surprising a prominent branch developed in crypto is DeFi (decentralized finance), decentralized trading platforms with very sophisticated financial instruments. What's the tuition fee of this new financial development? Risk management company Elliptic released a report this week according to which, in 2021, investors have lost $10.5 billion in DeFi frauds. In 2020, the amount was $1.5 billion.

Let's try to understand why we need DeFi ventures at all. After all, the idea behind cryptocurrencies is to replace what doesn't work, to develop a system outside the control of the banks.

Devotees of decentralization claim that there is no real need for restrictions. Why should a regulator limit leverage? Let there be products with unlimited leverage on the shelf, and let the buyer beware. That is to say, anyone who doesn't understand, shouldn't invest.

There's a great deal of logic behind all this. The banking system is indeed cumbersome and inefficient, and a technological system that challenges it from the outside is a good thing. But are financial services consumers equipped to deal with the complexity of DeFi? Most of us don't understand all the different kinds of fees and commissions that our pension funds charge, so how are we supposed to cope with a new world of unsupervised financial products meant to replace the banks? At present, it's not so much the economy of tomorrow as a world of volatility and emotions that provide fertile ground for abuse.

Pros and cons of decentralization

Contrary to what one might perhaps think, the crypto world has huge value. In effect, it amounts to investment in companies that develop technology called blockchain, in which records are created in a chain and cannot be changed or erased. This technology is relevant to all areas of life.

For example, if the Land Registry were recorded on blockchain, there would be no uncertainty about ownership of land. These projects work according to smart contracts written in code and executed as soon as the terms of the contract are fulfilled.

These projects issue currencies, which have monetary value in accordance with the venture's likelihood of success, and they also carry voting rights. Investment in digital currencies is an investment in a kind of security of technological startups. Within this world there is also the concept of decentralization - no-one controls the technology and it is for the benefit of all. This is a revolutionary idea, and when you talk to people in the crypto community and ask how it can all possibly work, the response is uniform: trust. Regulation and supervision will be replaced by code with a smart contract, and the concept of trust. And it must be remembered that trust can also be abused, certainly in the world of financial investment.

4. The regulators' uncertainty

Regulators, and any kind of guiding hand, are concepts alien to the crypto world. Therefore, investors active in that unsupervised world must be all the more cautious.

In the end, however, the interface between the industry and the regulators in unavoidable, and the main points of contact are money laundering and taxation. Most of the investors in this field are people who just want to obtain a return in an environment of zero interest rates, which pushes them to take greater and greater risks. The regulators on the other side of these points of contact look at the crypto world, don't know how to deal with it, and hesitate.

Their progress is much slower than the pace of the market, and this slowness is to the detriment of the investors, who don't know how to distinguish between entities that play according to the rules and those that don't. A money laundering prevention ordinance applying to crypto market players has come into force, and there will be further regulation and more arrests, but at present the regulators are very long way behind.

Moshe Hogeg and the other people who have been questioned are suspects only, have not been indicted, and are entitled to the presumption of innocence.

Published by Globes, Israel business news - en.globes.co.il - on November 23, 2021.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2021.

Moshe Hogeg  credit: Jonathan Bloom
Moshe Hogeg credit: Jonathan Bloom
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