Dangerous games

(gentle music) <v ->In this video,</v> we’re going to talk about the dangerous games that can be played in DeFi ecosystems and how to identify them. In order to do so, I’m joined by my colleague, Professor Sinclair Davidson, at the RMIT Blockchain Innovation Hub. Hi Sinc. <v ->Hello Chris.</v> <v ->Let’s start with a really common problem, Sinc,</v> in the DeFi space. How do you identify a Ponzi scheme and what is a Ponzi scheme? <v ->So, Ponzi schemes are ancient financial frauds,</v> which have occurred since basically the beginning of financial markets.

And that is more or less, you have an impossibly high return that you have promised people, and rather than going out and earning that return by making an investment, what you do is you keep on bringing in new investors, and you use the new investor money to pay out the old investors. So this looks like you’re earning a massive return and doing very well, which in turn attracts more new investors. And so, you have the sort of self-sustaining success story, but in actual fact, you’re committing a massive fraud because you’re not actually investing money. You are simply churning existing money in the system.

This is what Bernie Madoff got up to in the New York market a couple of years ago. And this happens too, in every market that isn’t well-regulated or well-policed. <v ->But it’s the sort of thing</v> that you would see a price go up, is there, and prices can go up for all sorts of reasons. How would I look at a token? How would I look at a DeFi project and be able to identify if it had Ponzi scheme characteristics? <v ->What I would be looking at is whether or not</v> they’re attracting a lot of new investors. And I would also be looking at very importantly, the underlying business model. How does this scheme purport to make money?

What are the supply and demand conditions going on in here? Because bearing in mind, in DeFi there are good returns. But the thing to do is to make sure that you are satisfied, that there is a genuine underlying business model let’s say, that’s happening here. And of course, watch community chats. What happened in the case of Bernie Madoff, for example, is that a lot of people were actually notifying the authorities that the returns that he was saying he was earning, were inconsistent with his purported investment strategy. So, actually try and look at, what do they say they’re doing and work out, can they really be earning those sorts of returns from that activity?

And if no, it’s probably a Ponzi scheme. <v ->Another risk might be a DeFi investor not understanding</v> their position in the market. So, presumably a lot of the listeners will become, join DeFi as retail investors, but there are also very large institutional investors that can be large venture capitalists. What risks can you face if you don’t really understand your position within a DeFi ecosystem? <v ->Well, one of the things you need to</v> always be on the lookout for, are pump and dump schemes. Now a pump and dump scheme, is where a large investor has accumulated an investment position and they want to sell down.

And one of the ways that they want to do this, is by not having the price fall while they’re selling. So they try to attract new investors into the market, by let’s say, providing misinformation or suggesting that the investment is much better than it actually is. And so, they pump up the market, they fill up the tires and then what happens is, they sell out and you end up with small investors holding an investment position, that isn’t as valuable as they had been led to believe. So, a very, also well-known investment technique, which people have tried on for years and years and years, that in unregulated markets is more likely to be the situation than in more regulated markets.

<v ->I guess what you’ve always got to know, in DeFi markets,</v> is that if you’re looking to sell, someone else is taking the other side of that bet and they’re looking to buy and vice versa. So, thank you so much Sinclair. There’s a lot to think about there. <v ->Thank you so much Chris.</v> (gentle music)