The $10B Stablecoin Industry Has a Fraud Problem It's Not Addressing

If stablecoins are used for apparently illegal activity, should issuers step in to stop it? So far, they've been reluctant to do so, says our columnist.

AccessTimeIconMay 27, 2020 at 5:41 p.m. UTC
Updated May 9, 2023 at 3:08 a.m. UTC
AccessTimeIconMay 27, 2020 at 5:41 p.m. UTCUpdated May 9, 2023 at 3:08 a.m. UTC
AccessTimeIconMay 27, 2020 at 5:41 p.m. UTCUpdated May 9, 2023 at 3:08 a.m. UTC

J.P. Koning, a CoinDesk columnist, worked as an equity researcher at a Canadian brokerage firm and a financial writer at a large Canadian bank. He runs the popular Moneyness blog.

Often described as the world’s first distributed computer, Ethereum is run by a network of independent and anonymous nodes. This setup ensures no one can be prevented from writing programs on top of Ethereum or using its in-built currency, ETH, to make transactions.

And so Ethereum has become a useful place for financial rulebreakers to set up shop. A few years ago I wrote about one of the first big Ponzi schemes, POWH3D, which at its peak held $40 million in ETH. Last year, the FairWin scheme harvested as much as $10 million worth of ETH before it was drained.

MMM Blockchain Smart Contract, or MMM BSC, is the newest apparent Ponzi to appear on Ethereum. According to the Securities and Exchange Commission (SEC), a Ponzi is a form of fraud that “involves the payment of purported returns to existing investors from funds contributed by new investors”. 

Describing itself as a "global mutual aid fund," the operators of MMM BSC make bold claims about “changing the world" and “casting off the slaved money-making life.” The giveaway is MMM BSC advertises a 30% per month return, an impossibly high payback. If that doesn't convince you, it pays homage to Sergei Mavrodi, once the world's most notorious Ponzi scheme operator. Versions of Mavrodi's MMM scheme operated across the globe between the early 1990s until his death in 2018.

What differentiates MMM BSC from previous Ethereum Ponzis is that it doesn't use ETH as its currency. It uses U.S. dollar stablecoins issued by Paxos Trust Company, based in New York. After tether and USD Coin, Paxos-issued dollars are the most widely circulated stablecoin on the internet.

Paxos Trust has also chosen to implement its stablecoin on top of the Ethereum blockchain. But whereas MMM BSC is a shady operator, Paxos is a clean-cut financial institution. Regulated by the New York Department of Financial Services, it is required to back each PAX stablecoin with an equivalent dollar in accounts by FDIC-insured banks. It counts Sheila Bair, former head of the FDIC, as a board member.

Thanks to the transparency of the Ethereum blockchain, we can learn plenty of details about the apparent MMM BSC Ponzi. The scheme's wallet contains around $4 million in PAX, down from $7.3 million last month.

When your third-largest (non-exchange) wallet is apparently a ponzi, then something has probably gone wrong somewhere

Of the 77,500 or so PAX dollar wallets in existence, MMM BSC’s wallet clocks in as the ninth-largest holder, at 1.6% of all PAX issued. Take out the big exchange holders like Binance and Huobi, plus Paxos' own internal wallets, and MMM BSC is Paxos's third-largest holder. Just last week it was the largest

MMM BSC does far more transactions than any other PAX wallet owner. According to Etherescan, the PAX Standard token contract handled around 25,000 transfers per day over the last month. About 5,000 of that was due to MMM BSC transfers. 

How much is Paxos to blame? It's pretty much impossible for a financial institution to prevent all usage by fraudsters. New bank-backed instant payment systems such as Zelle and U.K.’s Faster Payments are plagued by authorized push payment fraudsters, who sell non-existent concert tickets and keep the buyer’s funds. Walmart and Google Play gift cards are the preferred medium of Indian call center scammers to trick Granny out of her money. And back in 2017, PayPal was accused of allowing an $134 million Ponzi to operate.

“While we engage in blockchain monitoring of PAX in the wild, we cannot have perfect knowledge of every transaction or business conducted using PAX, nor can we unilaterally stop them,” a PAX spokesperson told me. 

But when your third-largest (non-exchange) wallet is apparently a Ponzi, then something has probably gone wrong somewhere.

A cynic would say that all financial institutions surreptitiously welcome a bit of fraud. For each dollar a fraudster holds, an issuer of that dollar can buy a Treasury bill, earning a profit on the difference between the interest rate it pays the fraudster and what it receives on the T-bill. They also earn fees and commissions. The allure of profits is why billions of dollars in illegal money was allowed to filter through Danske Bank’s Estonian branch from 2007 to 2015.

On the other hand, the SEC deems Ponzi schemes to be unlawful. A payments processor caught abetting one could face government shutdown, angry customers and lawsuits. It might become stigmatized as that shady payments provider. Better to nip this all in the bud.  

Paxos Trust is well aware of MMM’s reported activity. It says that it “has been in touch with law enforcement” regarding the matter and that “any PAX users should do careful analysis and not interact with Ponzi schemes and affiliated organizations.”

Pax balance
Pax balance

The company even has a way of stopping these sorts of payments. Because it is regulated, Paxos has built a tool that allows it to freeze or seize PAX stablecoin balances. However, it has never frozen an address to date.

"We do have the ability to freeze or seize specific tokens, but Paxos cannot substitute its discretion for that of law enforcement; we will only freeze or seize tokens when directed pursuant to legal authority, such as a court order," the spokesperson said. 

So Paxos won’t move until the FBI, or some other law enforcement agency, tells them they must. This seems like a cop-out. MMM BSC is apparently a Ponzi scheme, and Ponzis are illegal. Adding this together would seem to indicate some sort of action is warranted.

On the other hand, if Paxos freezes a Ponzi scheme’s wallet, to whom would it return the seized PAX tokens? Many of the members of the MMM BSC scheme are located in relatively undeveloped African, Asian and Latin American countries. According to Alexa, a majority of traffic over the last 30 days has been generated from India. With so many innocent low-income households having tied their hopes and dreams to a Ponzi masquerading as a legitimate opportunity, Paxos will have to tread gingerly. This sounds like a huge headache, and I wouldn't want to be Paxos' CEO. 

MMM BSC is apparently a ponzi scheme, and ponzis are illegal. Adding this together would seem to indicate some sort of action is warranted

Let’s not single out Paxos. YouTube hosts MMM BSC’s main video channel. Thousands of members have uploaded videos to help promote the scheme. But this is against YouTube’s policies. Content that promotes scams, get rich schemes or pyramids is prohibited. Facebook is also full of MMM BSC promoters, despite Facebook’s policy against pyramids and Ponzis. 

There's a bigger picture to all of this. Paxos' adoption by apparent Ponzi scheme operators captures some of the underlying paradoxes of blockchains and stablecoins.

Bitcoin and other permissionless blockchains embrace openness and censorship resistance. Any business can install a bitcoin wallet and deal in the stuff, no questions asked and no worries over financial de-platforming. Stablecoins have continued this practice. Any business can set up a Paxos wallet and accept and send PAX stablecoin tokens, no name or identity required. The same goes for other stablecoins such as USDC, TrueUSD and tether.

Why this light touch approach? Stablecoin issuers are part of the larger cryptocurrency community. And according to the ethos of this community, digital cash is supposed to be like physical cash: open to everyone and unstoppable. Paxos’ spokesperson draws a comparison between PAX tokens and cash, noting the U.S. Federal Reserve, which issues cash, does “not monitor each transaction conducted in dollars, nor do they monitor every business or individual that uses dollars.”  

The second reason for a light touch? It's probably cheaper than the traditional model. Before merchants can accept traditional payments like credit cards, PayPal or debit cards, their identity must be verified and their business approved. This is an expensive and time-consuming process. But it tends to weed out the Ponzi schemers and other fraudsters at the outset.

So why shouldn't stablecoin issuers like Paxos also abide by this same standard and vet each wallet? The claim is sometimes made that the transparency of being on a public blockchain absolves stablecoins issuers from a policy of screening new users. All transactions can be seen, analyzed and stopped.

That sounds fine, but then why does such an apparent Ponzi scheme continue to operate on Paxos? Surely the company must have noticed the tell-tale signatures a long time ago. According to Etherescan, MMM BSC’s wallet has been actively dealing in PAX stablecoins for almost a year.

This reticence to freeze is typical of the stablecoin sector in general. Actions taken against wallets are almost unheard of. According to cryptocurrency researcher Eric Wall, only 16 freezes have ever been implemented by the major stablecoins, all by Tether. 

Stablecoins are growing. The amount in circulation has doubled to more than $10 billion in just a few months. As they become more prominent, stablecoins will attract more fraudsters. The industry may want to be sure that it pushes them away – or not?

NOTE: This post has been updated to say MMM BSC is Paxos's third-largest holder, not client.

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