Chinese cryptocurrency exchange FCoin has been permanently shutdown while simultaneously losing up to $125 million of customer’s funds. The CEO claimed this was due to technical errors, but this situation has the tell-tale signs of a collapsed pyramid scheme and exit scam, as will be detailed in this article.
FCoin was the pioneer of ‘transaction fee mining’, which caused it to become immensely popular at one point with over $5 billion of trading volume per day, eclipsing the world’s top spot crypto exchanges like Binance and Huobi.
FCoin launched FToken (FT), which was distributed to traders on the exchange. Essentially, traders had their trading fees refunded 100% via FToken (FT), and 51% of the entire FToken (FT) supply was distributed this way. Further, holders of FToken (FT) received a proportional share of 80% of FCoin’s trading fee revenues each day.
In other words, FCoin incentivized trading on the exchange by 100% refunding trading fees with FToken (FT), and then giving holders of FToken (FT) daily dividends.
Binance CEO Changpeng Zhao was highly skeptical of FCoin’s business model. First off, Zhao pointed out that transaction fee mining is no different than an initial coin offering (ICO), an activity which is illegal in China. Specifically Zhao said “Then the platform pays ‘100%’ back to you with its token. Isn’t it just buying platform token with BTC and ETH? How is this different from an ICO?”
Zhao adds that it is nonsensical and suspicious that FCoin gives away pretty much all of its revenue, specifically saying “If an exchange doesn’t get revenue from transaction fees and solely profits from the price of its token. How would it survive without manipulating the token price? Are you sure you want to play against a price manipulator? The same price manipulator who controls the trading platform?”
Eventually, Zhao began to call FCoin an outright ponzi scheme starting in mid-2018. Lo and behold, FCoin has shutdown and lost a tremendous amount of money like any other ponzi/pyramid scheme.
Of course, the CEO of FCoin, Jian Zhang, claims FCoin was not a ponzi scheme in a long letter titled ‘FCoin Truth’. Zhang says 7,000 to 13,000 Bitcoins (BTC) have been lost due to technical problems.
Essentially, Zhang says that FCoin launched without having a proper technological backend, and the immense popularity of FCoin overwhelmed their system. According to Zhang, in mid-2018 it was discovered that the transaction fee mining system could be gamed to receive extra crypto.
Initially $10-20 million was lost, yet FCoin did not close down to fix the error. It is unclear why this problem was not fixed when it was discovered well over a year ago.
Zhang conveniently adds that he and the FCoin team used all of their profits to buy back FToken (FT), in order to keep the price of FToken (FT) from collapsing. Basically, Zhang is explaining how he has no money to refund customers, because he already heroically sacrificed all of his money.
Ultimately, it makes little sense that Zhang and his team would sacrifice all of their profits to try and fix the problem, rather than fixing the actual technological problem.
The letter ends with Zhang describing how he will manually process crypto withdraws via e-mail, and he will be the only one handling this process, which will make it last years.
Also, Zhang mentions how he is launching a new ‘project’, and that the full refund of FCoin users depends on the success of this project.
Beyond all of this, the way FCoin shutdown was extremely suspicious. On February 10 FCoin announced they were changing the dividend distribution rules, which could be viewed as a sign that they were running out of money.
Then FCoin suddenly announced that they had burned all of the FTokens (FT) held by the FCoin team, equivalent to $75 million. However, reports soon came out that an FCoin employee had maliciously deleted all of the tokens after getting angry at the company, and in the process deleted the FCoin database, rendering the exchange unusable.
Indeed, the same day that the dividend changes were announced and the tokens were burned, FCoin said they were doing a system upgrade. On February 11 FCoin said they had to rebuild some backend modules and it would take another 1-2 days to reopen, and blamed the problem on a ‘system loophole which could cause risk control problems’.
Based on Zhang’s letter after the incident, the reason given for the system upgrade seems like an obvious lie. In any case, FCoin never reopened after the initial system upgrade announcement on February 10.
In summary, FCoin has all the signs of being a collapsed pyramid/ponzi scheme, starting with a lucrative monetary incentive to use the FCoin exchange and hold FTokens (FT) via transaction fee mining and dividends, followed by a ‘system upgrade’ where FCoin lied about the reasons the exchange was down, and concluding with the FCoin CEO claiming that $125 million was lost due to technical problems while simultaneously claiming he spent all of his money trying to salvage the situation and therefore cannot refund customers.
Perhaps the moral of this story is to just stick with reputable and long running crypto exchanges, and not to use relatively new crypto exchanges, especially if the exchange is offering free money just for trading. Indeed, many crypto exchanges which offer transaction-fee mining popped up after FCoin launched, and it seems possible that some of these copycats will end in the same way as FCoin.