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Some virtual currency systems may be Ponzi schemes

Cryptocurrency use is legal in California and the United States, but although it is making waves throughout the country, many do not understand the pitfalls of this digital or virtual form of payment. NerdWallet.com explains that virtual currencies are often distributed by companies that allow customers to use the "money" in trade for their goods and services. People have to purchase digital currency with real money.

People do gain some security from the anonymity of virtual currency systems, which allow them to transmit money without revealing private information. Unlike many banks, these systems are not likely to be hacked.

According to the U.S. Securities and Exchange Commission, some companies use this concept as a way to offer fake investments. Those who buy into one of these offers may benefit if they are some of the first to purchase the digital currency because those who buy in later pay more as the value of the currency goes up. 

For a virtual currency to be a Ponzi scheme, existing investors must be paid their returns from the contributions of the new investors. In these cases, there are no actual investments other than the future demand for the currency.

Not all digital currency offerings available now are Ponzi schemes. Red flags include the following:

  • A guarantee of investment returns
  • Investments not registered with state or federal regulators
  • No disclosure statement or prospectus
  • Consistent returns that do not reflect market conditions

Companies and individuals who prepare to offer their own form of digital currency must be careful to avoid the appearance of a securities exchange, or they could come under scrutiny from the government.

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