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How to Avoid Crypto Scams

Ruth Saldanha: Earlier this month, celebrity Kim Kardashian was fined more than US$1 million for advertising Ethereum Max on her Instagram page. Now, the reason is, she didn’t disclose that she had been paid $250,000 to promote the cryptocurrency, which is now worth, well, next to nothing. This brings up an interesting question. In a space as new as crypto, how should investors spot scams or even undesirable investments? Madeline Hume is a Senior Research Analyst at Morningstar and is here today to tell us.

Madeline, thank you so much for being here today.

Madeline Hume: Thanks so much for having me, Ruth.

Saldanha: Cryptocurrencies are still developing and there aren’t many research reports available on which one can base one’s decisions. So, how should investors decide what coins or currencies they should buy?

Hume: Yeah, it’s a tricky question to answer right now in crypto. Somewhat similar to cryptocurrencies themselves, the research on cryptocurrencies is still highly decentralized and distributed across a variety of sources. Surprisingly, one of the most common areas where investors do their research for cryptocurrencies is social media. That’s why some of the advertisements like the one that Kim Kardashian made are so highly effective because people are already looking for investment insights on crypto.

There are pros and cons to the approach that crypto assets have taken and the investors in those assets have taken with regards to posting ideas and things like that. The pros are that a lot of this research is free and highly democratized and accessible to the standard user. But the downside is that oftentimes this information is not fact-checked and not authorized by various regulators or any other kind of gatekeepers within the crypto industry because they just don’t exist yet. And so, that has the side effect of having a lot of risks that these crypto tokens do not have the proper disclosures associated with them. And so, it always is in the best interest of investors to treat crypto assets as something of an entrance fee into the amusement park of the broader crypto ecosystem to get a handle on the technology and to understand the mechanics of the space without necessarily expecting appreciation of capital or those things. And most importantly, not to take investment advice from celebrities.

Saldanha: It’s interesting that you mentioned social media because there is the fact that many 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 like a legitimate opportunity?

Hume: It’s a fairly true statement, kind of, across the investing universe, that legitimate opportunities very rarely need to advertise themselves. Take a coin that’s somewhat related to the one that Miss Kardashian was selling, Ethereum Max. Its name riffs off of Ethereum, which is a very popular cryptocurrency. And around the same time that this SEC announcement came out, Ethereum was actually undergoing a major technological shift. The crypto token now essentially allows for investors to pool their assets in the platform, help to ensure the health of the blockchain and receive cash flows in return.

Now, Morningstar doesn’t recommend any cryptocurrencies as investments today, but the fact that the second largest crypto asset by market cap is distributing capital to investors means that it may be possible someday to arrive at something like a valuation for cryptocurrencies, which may help bring down a lot of the volatility that has plagued the space. Now, sadly, this major technological advancement was not publicized by any major celebrities. And so, when you have these platforms enjoyed by people like Kim Kardashian and Elon Musk, it means that investors are much more likely to hear about something like Ethereum Max or Dogecoin than they are Ethereum. And so, it remains as true in cryptos as it does in many other asset classes that it’s very important to do your own homework.

Saldanha: Stepping back for a second and looking at a more wider lens, how should investors consider cryptocurrencies in general, especially as we are heading into more complex economic environments?

Hume: Yeah. So, the general kind of market environment at the moment is fairly pessimistic across major asset classes and crypto certainly has not been immune to that. In addition, you’ve also had several unforced errors due to the space’s kind of lack of maturity. And the entire industry is still getting a handle on risk management. It’s still a very nascent space. And so, a lot of the things that traditional finance has established over centuries of serving investors, crypto is still figuring out kind of from scratch, and they’ve only been around since 2008. So, there’s still quite a ways to go.

But I would separate crypto as an investment from crypto as a technology. And what happens in crypto is, you have these long periods of investment drawdowns that are referred to as crypto winters. And this is a time when actually a lot of the marketing teams around crypto and the people that work on these projects, they’re able to shelf their pitch decks for a little bit and start to refocus on the technology and start to enhance it and develop it in ways that ultimately bear fruit during a subsequent market event that brings it more to the upside. And so, we’re seeing one of those periods right now, and it’s brought about developments like Ethereum’s upgrade to a proof-of-stake blockchain. And so, there’s a lot to be excited about on the technological front, even though the investment itself is still very high risk.

Saldanha: Great. Thank you so much for joining us today.

Hume: Thank you so much for having me, Ruth.

Hume: For Morningstar, I’m Ruth Saldanha.

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