I am sorry guys but I have scammed you. I am not going to try to justify it with my reasons, I am just a terrible person. I am sorry for each and every person affected. I am ashamed about the way I have deceived so many people for my own personal gain. For what it is worth, the money is not going to stupid lifestyle enriching purposes. Even though I could likely go on for a few more days making fake promises and feedback I have reached my goal and will lock myself out of my account. For anyone interested. This started on 19–22 December. After that I have not had a single gram of weed or hash in stock. That is all I had to say.

Customers logging onto the “Evolution” marketplace in January 2015 were greeted with an unusual message from 9THWONDER, an online drug dealer. Rather than an update on their delayed merchandise, they received an apology and confession. While this scenario was uncommon, the underlying scam wasn’t. Dark markets—confidential web browsers where contraband transactions occur—have been rampant with fraud since their inception.

On one hand, this trend might seem predictable. Illegal drug market participants are attractive targets for theft, as they can’t seek help from law enforcement without implicating themselves. Yet, the original architects of platforms like the Silk Road (the pioneering site in this domain) and its competitors were aware of this vulnerability. Their goal was to embed fraud protection into the system’s architecture. Many even crafted extensive manifestos asserting that their virtual realms, free from conventional laws, were techno-libertarian utopias.

So, how did they fall victim to scams?

Nice to make your acquaintance

However, I should clarify my keen interest in these matters at this juncture, just to assure you that I’m no criminal, and this book won’t conclude with a deceptively plausible invite to join a pyramid scheme. When news stories about 9THWONDER surfaced, several friends forwarded them to me. Upon reading the opening lines, I could anticipate what had occurred because I’m well-versed in this pattern. This particular fraud dates back to ancient times, though I primarily encountered it through gangster autobiographies in the Swinging London era of the 1960s. Collecting stories of fraud is my passion; they captivate me because they serve as an inverse template. They bring into sharp focus all the aspects overlooked in conventional economics when contemplating its criminal counterpart.

For two decades, I dwelled at the edges of bank regulation. Initially, as a young and financially strapped junior economist at the Bank of England, I analyzed the intricacies and unintended repercussions of the immensely complex international banking regulations. Later, I became more seasoned, less naive, and considerably more lucratively involved in assisting investors profit from these very loopholes. Yet, I noticed early on that while bank regulation seems like the nexus where economics and criminology converge, there’s actually no intersection at all.

If you’ve delved into bank regulation, it’s a world of numbers—capital measures, risk assessments, probability distributions, and ratios. Conversely, encountering a bank’s spectacular collapse, you’d realize that the reasons for such debacles rarely align with those numerical constructs. They tend to stem from very human factors—a blend of incompetence, dishonesty, and ill fate. Understanding the disconnect took me years; it delves deeply into both psychological and economic realms. Unfortunately, my inability to stay silent about this issue led the Bank of England and me to part ways.

Upon securing another position, I swiftly realized forecasting stock prices or computing probabilities wasn’t my forte. Hence, I resolved to base my career in the competitive stock market domain on elements impossible to predict and absent from any probability distribution. Fortunately, my decision coincided with Russia’s debt default, the bursting of the internet bubble, Enron’s bankruptcy, and Nassim Taleb’s publications that lent intellectual legitimacy to scrutinizing the implications of unpredictable events.

With the backing of forward-thinking superiors, I spent the subsequent decade compiling details and narratives, aiming to construct a mental toolbox for navigating those peculiar historical junctures where everything assumed to be true falters. It entailed sifting through out-of-print books, studying unpopular management theorists, and identifying gaps between theories and the less discussed uncomfortable truths.

Did this preparation prove beneficial when 2007 arrived and revealed the previous decade’s prosperity as a facade? Partly. I’ll delve deeper into significant frauds I had front-row seats to later in this book. I believe my knack for spotting them surpassed random chance, but perhaps not by a considerable margin. Nonetheless, let’s return to 9THWONDER and the online drug fraud.

Money for nothing

The mechanics behind dark market scams are almost straightforward to the point of not requiring much explanation: you accept money, notably electronic currency like bitcoin, promising to deliver illegal drugs, and then simply fail to follow through. However, what’s intriguing is that the controls meant to thwart this glaringly obvious possibility didn’t function as intended.

The intended process involved payments passing through an “escrow” system. You’d send your bitcoins to a central address linked to the marketplace, allowing the vendor to confirm your payment. Upon receiving your goods, you’d signal confirmation and “release” the payment for transfer to the vendor. If the goods didn’t arrive, a complaint to the marketplace triggered a dispute resolution service. This system, employing anonymous cryptographic protocols, generally worked well, devoid of significant technical weaknesses.

On paper, the escrow system appeared a robust defense against fraud, available even for smaller transactions, unlike traditional trading companies that use more expensive legal and banking services for substantial transactions. For the most part, the escrow service functioned effectively. However, the Achilles’ heel lay in its underutilization.

Why wasn’t it utilized? That’s the kind of question that’s relatively easy to answer and provides insight into a deeper understanding of fraud, mirroring its relationship with the honest economy. The simple answer lies in a general issue in computer security: if something’s cumbersome, people won’t use it, rendering it ineffective in providing protection.

There wasn’t (and still isn’t) a technological fix powerful enough to overcome a fundamental business truth: the conventions of cash payments and credit assignment mirror the relative power of buyers and suppliers in a market. While the escrow system was a hassle for vendors, offering protection against unreliable customers, it imposed cash flow challenges and made them vulnerable to fraudulent disputes. Dishonest dealers often flooded rivals with orders, disputing them to sabotage competitors.

Moreover, the primary problem for vendors was that online payments were conducted in bitcoin or equivalents. Unlike bank accounts, bitcoin accounts didn’t necessarily link to identifiable persons. However, the challenges emerged when vendors needed to convert their bitcoin earnings into US dollars for their costs, creating a typical small-business issue—revenues in one currency and costs in another. Markups on drugs were susceptible to weekly fluctuations in the bitcoin-to-dollar exchange rate, erasing profit margins. Various attempts were made to hedge against currency movements, but they were costly and ineffective.

The escrow system exacerbated this issue for drug dealers, causing substantial delays during currency fluctuations. Large, reputable dealers began using “finalize early” (FE) payments, allowing customers to skip escrow protection for better quality and competitive prices. This practice set an implicit price customers were willing to pay to safeguard themselves from scams.

This “implicit price” forms the basis of fraud as an economic phenomenon—a trade-off always present, whether victims recognize it or not. The optimum level of fraud is seldom zero and is often influenced by market dynamics. High levels of dishonesty prompt increased precautions, reducing fraud levels (to the extent of market disappearance if exceedingly high). In a trustworthy environment, the implicit value of fraud protection diminishes, leading fewer people to pay for it.

Despite technology enabling a different approach, the dark market evolved to mimic most conventional small-business credit structures. Unlike the legal economy, however, few aim for a lasting career in online drug dealing. Many businesses closed due to various reasons, leading to the dilemma of maintaining goodwill while exiting. Exiting ethically by declining new orders was challenging when dealing with untraceable money. Hence, the “exit scam” emerged, where vendors vanished after receiving payments, leaving disappointed customers unable to retrieve bitcoins or vendor details.

Silk Road’s shutdown due to law enforcement led to smaller competitors gaining market share. Exit scams became prevalent enough to affect the darknet economy’s dynamics, prompting warnings to newcomers. Yet, the remedy of dealing exclusively through escrow presented its own drawbacks. For instance, customers of 9THWONDER might have avoided his scam via Evolution’s escrow, but the platform itself turned out to be run by scammers, disappearing with $12 million in bitcoins from escrow accounts.

While there’s a technological solution—multisignature escrow—to prevent such scams, it’s inconvenient for users, deterring its widespread adoption. The lesson from darknet frauds is clear: while technical controls can be built into systems, fraud adapts around them. Trust is free, and precautions are expensive or inconvenient. Thus, people often substitute trust for precautions until the “shadow cost of trust”—expected fraud loss—surpasses the direct cost of precautions. This trade-off ensures a perpetual existence of trust and scams, a consequence primarily driven by economic factors.

These recurrent features persist due to inherent blind spots, an intrinsic part of the system. Throughout modern capitalism’s evolution, individuals have engaged in fraudulent activities. Gaining a comprehensive understanding is challenging, as evidenced by the failures of online drug buyers, who have fallen prey more spectacularly than most.

The Cazique of Poyais

Young men often rush into career decisions, but few have erred as profoundly as Gauger, a London banker in 1822. Despite his good family background, he sought faster career progression than what Thomas, Jenkins & Co. offered. Gauger opted for a high-risk opportunity: the role of general manager at the Bank of Poyais, a new British colony in Central America led by Sir Gregor MacGregor. Gauger invested a considerable sum of his family’s wealth to secure this role. His trust seemed justified when he received $5,000 worth of freshly printed Poyais dollars for transport to the capital, St. Joseph.

Weeks later, knee-deep in a foreign swamp, Gauger likely regretted his decision. Poyais wasn’t a real country—no city, no fertile plains, just swamp and dense rainforest. The engraved Poyais dollars were appealing only to local children. Unfortunately, Gauger had encouraged other colonists to exchange this worthless scrip for valuable English and Scottish currency. He became both victim and accomplice to one of early capitalism’s audacious investment frauds.

Around 250 families from Britain, including cobblers, musicians, and soldiers, sailed to the Black River in modern Honduras on vessels like the Honduras Packet and Kennersley Castle. Dreams of an idyllic life in Poyais quickly shattered. Unskilled colonists realized their retirement fantasies of sugar plantations were unrealistic without extensive, unplanned work on the Mosquito Coast. Disillusioned, some fled to Belize; Gauger sought fortune in the USA, disappearing from records. Others faced dire ends due to harsh conditions.

Meanwhile, in London, self-styled Poyais leader Sir Gregor MacGregor, hustled bankers for a bond issue. MacGregor, a descendant of Rob Roy, embellished his service history and claimed to be appointed king by the Poyais tribe. This fictitious narrative fueled bond sales and land parcels on Kennersley Castle and Honduras Packet. The Poyais fantasy persisted, begging the question: How did this ruse deceive so many?

The shallow explanation unveils the historical context of the Poyais fraud. In the early 1800s, unrecognized countries in the Americas raised money on the London market. Speculators bought discounted loans, gambling on states’ survival. Colonists’ naivety, though incredible, could have been mitigated by research—yet, MacGregor’s false literature and fabricated land documents misled them. Additionally, Latin American territories enticed settlers with incentives, resembling successful plantation fortunes, clouding the scam’s visibility. The difficulty of accessing information compounded this deception.

However, despite the advantages of the internet age, similar scams persist today.

ICOs and cryptocurrency

As previously discussed regarding the Silk Road payment system, bitcoin operates as a system of “magic numbers,” managed to function as a currency. However, these digits, constituting bitcoins, hold no intrinsic significance beyond the identification by the bitcoin algorithm. Multiple numbers could serve as “magic” under different algorithms or parameters. The realm of numbers is vast.

Inventing a personal magic number system akin to bitcoin allows for the creation of a personal cryptocurrency. This isn’t a rare feat; platforms automate this process. Possessing these numbers implies potential currency value, prompting the crucial query: How can you trade it for value?

The answer lies in the non-magical part of bitcoin—the cryptocurrency’s anonymity stems from a decentralized transaction record. Users maintain transaction logs across a network of computers, employing intricate communication to thwart fraud. Essentially, creating a cryptocurrency involves establishing a computer network with a shared database.

This database could serve various purposes: tracking predictions (like Gnosis), easing internet domain name trade (Domraider), or managing copyright ownership of digital images (KODAKCoin). Utilizing this database requires possession of the magic numbers. Generating these numbers grants you the power to potentially receive US dollars in exchange.

This entire process constitutes an “Initial Coin Offering” (ICO), where “tokens” (magic numbers) are sold for cash. Token marketing often involves a white paper outlining the technology and the case for the database’s utility. Buyers invest in the hope that the raised funds will develop the technology, making their tokens valuable to future users.

One might assume that most ICO buyers are potential users or tech enthusiasts drawn by white paper details. However, the majority are actually speculators, aiming for quick profit by selling their coins. Cryptocurrency investors often lack expertise in assessing a technical solution’s viability or the legitimacy of a “blockchain” database system’s business case. Their focus is on identifying promising ICOs for potential value escalation—a scenario resembling an unregulated securities market.

In this realm, fraudulent ICOs exist, exemplified by Benebit. Promising to track frequent flier miles via a distributed database, Benebit amassed funds and a substantial marketing team. It was only later discovered that the CEO portraits were stolen from a London school’s staff page, and the true orchestrators were traced to Mumbai.

This mirrors historical fraud patterns like Gregor MacGregor’s Poyais scam. The absence of securities regulation allows promoters to spin visionary tales without concrete financial statements. Similarly, an investment community, akin to traders in 1820s Latin American bonds, focuses on trade value, not reality. True believers trust confusing yet optimistic prospectuses. Misinformation thrives, skepticism is scarce, and the immediate feedback reinforces misdirection.

The shallow explanation attributing Poyais’ folly to a different era seems inadequate. Instead, Poyais appears absurd because modern blind spots differ from those of the early 19th century. The unsettling truth is that blind spots persist across eras.

The Canadian Paradox

Some places in the world are what they call “low-trust societies.” The political institutions are fragile and corrupt, business practices are dodgy, debts are rarely repaid, and people, rightly, fear being ripped off on any transaction. In the “high-trust societies,” conversely, businesses are honest, laws are fair and consistently enforced, and the majority of people can go about their day in the knowledge that the overall level of integrity in economic life is very high. With that in mind, given what we know about the following two countries, why is it that the Canadian financial sector is so fraud-ridden that Joe Queenan, writing in Forbes magazine in 1985, nicknamed Vancouver the “Scam Capital of the World,” while shipowners in Greece will regularly do multimillion-dollar deals on a handshake?

We might call this the “Canadian Paradox.”8 There are different kinds of dishonesty in the world. The most profitable kind is commercial fraud, and commercial fraud is parasitical on the overall health of the business sector on which it preys. It is much more difficult to be a fraudster in a society in which people do business only with relatives or where commerce is based on family networks going back for centuries. It is much easier to carry out a securities fraud in a market where dishonesty is the rare exception rather than the everyday rule.

The existence of the Canadian Paradox suggests that there is a specifically economic dimension to a certain kind of crime of dishonesty. Trust—particularly between complete strangers, with no interactions besides relatively anonymous market transactions—is the basis of the modern industrial economy. And the story of the development of the modern economy is in large part the story of the invention and improvement of technologies and institutions for managing that trust. In other words, many things about the way the business world is organized make a lot more sense when you realize that they exist because of the constant drive for countries to become less like Greece and more like Canada.

And as industrial society develops, it becomes easier to be a victim. In The Wealth of Nations, Adam Smith described how prosperity derived from the division of labor—the eighteen distinct operations that went into the manufacture of a pin, for example. While this was going on, the modern world also saw a growing division of trust. In previous eras, when people set out across continents to discover new worlds, they had known that they were stepping out into the unknown, but Mr. Gauger was at the cutting edge of a new reality. Already, he belonged to a class of people whose natural assumption was to take things on trust, to assume that the fact that an offer was extended publicly meant that it was probably legitimate. Nearly two hundred years later, his equivalents in the ICO craze were no more likely to expend personal effort on checking things for fraud than to throw their own pots and sew their own trousers. The more a society benefits from the division of labor in checking up on things, the further you can go into a financial fever swamp before you realize that you’re in one.

Trust and its abuses

The thread that links all these frauds together across space and time is that the blind spots are built into the system, and only become glaringly apparent once the whole thing has collapsed and people are watching the sun set over a pestilent swamp where a capital city ought to be. The problem is that whenever you’re creating an economic institution like Silk Road or the colonial system of the nineteenth century, you have to make decisions about what checks and balances you need to put into the system. And every decision about what you’re going to check up on is also a decision about what you’re not going to check up on. And when you’ve decided what you’re not going to check up on, then those are the things you’re going to have to take on trust.

We can see now that one of the truisms about corporate crime—that white-collar executives are given the benefit of the doubt—is not necessarily something we should regret or regard as an invidious fact about social class. It’s pretty much the definition of what it is to be a high-trust society. If you want to be like Canada, you more or less have to accept that you’re going to be the kind of place where people assume that a guy in a suit is probably honest. If you’re going to build the kind of society that Britain grew into in the nineteenth century, you might have to accept that every now and then you’re going to send hundreds of colonists and investors to a country that doesn’t exist.

The way we might describe this is to go back to the lesson about trade-offs that we learned from the online drug market, and say that fraud is an equilibrium quantity. We can’t check up on everything, and we can’t check up on nothing, so one of the key decisions that an economy has to make is how much effort to spend on checking. This choice will determine the amount of fraud.9 And since checking costs money and trust is really productive, the optimal level of fraud is unlikely to be zero.

This, then, is a book about trust and betrayal. But not all kinds of trust and not all kinds of betrayal. In popular culture, the fraudster is the “confidence man,” somewhere between a stage magician and the trickster gods of mythology. In films like The Sting and Dirty Rotten Scoundrels, they are master psychologists, exploiting the greed and myopia of their victims, and creating a world of illusion. People like this do exist (albeit rarely), and we will meet some of them later on. But they are not typical of white-collar crime.

The interesting questions are never about individual psychology. There are plenty of larger-than-life characters. But there are also plenty of people like Enron’s Jeff Skilling and Barings’ Nick Leeson: aggressively dull clerks and managers whose only interest derives from the disasters they caused. And even for the real craftsmen the actual work is, of necessity, incredibly prosaic. Even a master fantasist like Sir Gregor spent a lot of his time calculating agricultural yield tables and dealing with land claim documentation. The way in which most white-collar crime works is by manipulating institutional psychology. That means creating something that looks as much as possible like a normal set of transactions. The drama comes later, when it all unwinds.

Fraudsters don’t play on moral weaknesses, greed, or fear; they play on weaknesses in the system of checks and balances, the audit processes that are meant to supplement an overall environment of trust. One point that will come up again and again as we look at famous and large-scale frauds is that in many cases, everything could have been brought to a halt at a very early stage if anyone had taken care to confirm all the facts.10

But nobody does confirm all the facts. There are just too bloody many of them. Even after the financial rubble has settled and the arrests have been made, this is a huge problem. It is a commonplace of law enforcement that commercial frauds are difficult to prosecute. In many countries, proposals have been made, and sometimes passed into law, to remove juries from “complex fraud trials,” or to move the task of dealing with them out of the criminal justice system and into regulatory or other nonjudicial processes. Such moves are understandable. There is a need to be seen to get prosecutions and to maintain confidence in the whole system. However, taking the opinions of the general public out of the question seems to me to be a counsel of despair.

When analyzed properly, there isn’t much that is truly difficult about the proverbial “complex fraud trial.” The underlying crime is often surprisingly crude; someone did something dishonest and enriched themselves at the expense of others. What makes white-collar trials so arduous for jurors is really their length, and the amount of detail that needs to be brought for a successful conviction. Such trials are not long and detailed because there is anything difficult to understand. They are long and difficult because so many liars are involved. And when a case has a lot of liars, it takes time and evidence to establish that they are lying.

This state of affairs is actually quite uncommon in the criminal justice system. Most trials only have a couple of liars in the witness box. The question is a simple one; when a vault is blown, it’s obvious what happened and the mystery is who did it. When a bank goes bust, though, it’s the other way round. There’s only the CEO who could possibly have been responsible—the difficult question is to find out if a crime happened.

In order to promote an innocent explanation, a crooked businessman might employ the services of crooked lawyers, crooked accountants, even crooked bankers. Crucial documents will turn out to be ambiguously worded or lost altogether. And the question of guilt may turn on having to judge what was in the businessman’s mind at the time—was this an unfortunate series of deals, or an attempt to steal? The goal of the prosecution in a fraud case is to construct a straightforward framework, fitting all the disputed deals into a pattern. The goal of the defense is usually to insist on looking at every piece of evidence individually and burying the pattern in a mass of contradictory detail.

Not everyone accused of fraud is guilty. But if you want to understand how white-collar crime works—to protect yourself, enrich yourself, or just to understand the way of the world—you need to think like a prosecutor. Financial frauds might be presented as masses of overlapping documents and witnesses, but they are created from simple plans following basic principles. Stick to the broad sweep. Don’t get bogged down in the detail.11 Under the blizzard of paperwork, the chances are that you’re dealing with one of four basic maneuvers.

The four types of white-collar crime

The simplest form of fraud involves borrowing money or purchasing goods without intending to repay or pay for them, respectively. In real-world commerce, mutual trust between businesses, allowing payment post-delivery, is a linchpin often overlooked in economic teachings but is fundamentally critical. Most industries heavily rely on this credit extension between entities, facilitating operations at their current scale. The absence of systematic measurement in official statistics belies the substantiality of credit exchange between businesses, dwarfing the bank loan-dependent commercial credit by probably over 90%. A key fraudulent practice, exemplified by cases like 9THWONDER, exploits intentionally accumulated credit defaults, termed a “long firm.” This introduces the complexity of detecting and prosecuting such frauds as they often mimic legitimate businesses even after the money’s theft.

Another avenue of commercial fraud involves exploiting trust in ownership and value verification methods. Exploiting the reliance on unverified documents is akin to “counterfeiting,” where falsified documents endorse false claims. Multiple types of fraud interconnect, with a long-firm fraud potentially utilizing counterfeited documents to fabricate financial stability.

Sophisticated economies often separate capital provision from managerial activities within a company. This setup necessitates trust but also leads to “control fraud,” where the criminal extracts value through seemingly legitimate means, such as high salaries and dividends, based on fictitious profits and assets. This kind of fraud operates subjunctively, potentially never revealing itself if the fraudulent risks turn favorable for the business.

At the highest level, these frauds manipulate the overall fabric of trust in a modern economy. Actions like cartels or insider dealing rings constitute “market crimes,” impacting the market itself rather than individual monetary losses. These crimes, though lucrative, undermine the trust vital for a functional market economy. Their categorization varies, often depending on jurisdictional interpretations and local conventions.

Understanding these fraud types involves delving into profound questions about the functioning of modern economies. They test different levels of trust: from questioning individual trust to societal institutions and the market itself. As these levels of trust are indispensable for a functioning modern economy, fraud becomes an insidious threat. Terminology aside, grasping their structural breach of trust remains pivotal. Each stage of fraud abstracts further, shaking the foundation of trust at different societal levels essential for a well-functioning economy.

Diversionary tactics

How does this book operate? We’ll weave between narratives of infamous frauds, delving into the structures they exploited, and explorations of the foundational trust mechanisms supporting the modern world, with occasional insights into how notorious fraudsters manipulated them. Commercial fraud stands as the dark counterpart to the contemporary economy. Comprehending one provides profound insights into the other.

By the journey’s end through this landscape of corruption, you’ll grasp the inner workings of frauds and even gain the ability—though never entirely eliminating it—to navigate the risks faced by your own business or employer. Additionally, you’ll gain valuable insights into the functioning of the honest commercial system. Like the human brain, the market economy operates as an information processing system, revealing its hidden mechanisms when it falters. Just as neurologists study the repercussions of head injuries, examining currency forgers and pyramid schemes offers a window into understanding the economy.

Perhaps you might opt to use this book as a guide. It provides ample case studies and schematics to comprehend how such schemes operate. However, consider this: almost all the fraudsters spotlighted in this book eventually faced repercussions. Some relished lavish lifestyles before their downfall. Yet, many welcomed their inevitable exposure with relief, marking the end of a wretched and stressful ordeal. The time, effort, and commercial expertise invested in nearly any fraud would have typically yielded greater value if directed toward productive endeavors.

Almost always.

series-1

Fraud: The Art of Stealing Wealth and Trust - The way of the world (Ch. 1)

Table Of Contents