Chapter 1: The Way of the World Chapter 1: The Way of the World 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. That was the message received by customers of 9THWONDER, an online drug dealer on a marketplace known as "Evolution" when they logged on in January 2015 to check why their merchandise hadn''t arrived. The apology and confession were unusual but the scam wasn''t. The unlisted websites where contraband is bought and sold over confidential web browsers (known as "dark markets," because online criminals are addicted to science-fiction language) have been absolutely rife with frauds from the start. On the one hand, this might be seen as predictable--if you are looking for ideal targets to steal from, participants in illegal drug markets have the attractive property that they can''t report you to the police without raising lots of awkward questions about themselves. On the other hand, this obvious fact was not lost on the original designers of the Silk Road (the first such site to get real traction) and its competitors, and the aim of these entrepreneurs was to build fraud protection into the architecture of the system. Many of them produced long and windy political manifestos on this very point, claiming that their virtual online realm was a techno-libertarian paradise that did not need conventional laws.

So how did they all get ripped off? Pleased to meet you Actually, at this point I should probably explain why I''m so interested in these things. And maybe reassure you that I''m not a criminal and this book isn''t going to end with a superficially plausible invitation to join in with a pyramid scheme. About half a dozen friends forwarded the news stories about 9THWONDER to me when they came out, and as soon as I read the opening lines, I could guess what had happened, because I''m extremely familiar with the pattern. This particular fraud has been around since the Ancient Greeks, in fact, although I''m personally most familiar with it from autobiographies of gangsters in Swinging London of the 1960s. I collect fraud stories, because they fascinate me. And they fascinate me because they''re a sort of counter-template. All the things that you miss out on by studying normal economics come sharply back into focus if you take a moment to think about its criminal counterpart. I made my living for twenty years on the fringes of bank regulation.

Early on, while I was young and innocent (and broke), I was a junior economist for the Bank of England, helping to analyze the loopholes and unintended consequences of the ferociously complicated international banking rulebook. Later on, I was older, considerably less innocent, and a lot better paid to help investors make money out of exactly those loopholes. But early on in my career, I noticed that although you might expect something like bank regulation to be one of those gray areas where economics and criminology meet each other, there''s actually no overlap at all. If you''ve ever had the misfortune to read a lot of bank regulation, you''ll see that it''s made of numbers--measures of capital, measures of risk, probability distributions, and ratios. On the other hand, if you''ve ever had the misfortune to be involved with a bank going spectacularly bust, you''ll probably notice that the reasons why everything went wrong usually have very little to do with those numbers--they tend to be very human in nature and made up of varying proportions of incompetence, dishonesty, and bad luck. The reasons for this disconnect took me years to understand--they''re very deep in both psychological and economic terms. Unfortunately, while I wasn''t able to understand the problem, nor was I able to keep my mouth shut about it, and before long, me and the Bank of England decided to seek our fortunes separately. As soon as I got another job, I quickly grew to realize that I would never be all that good at forecasting stock prices or calculating probabilities.

So I decided that if I was going to have a career in the competitive world of stock market trading, it would have to be based on things which were impossible to forecast and which weren''t part of any probability distribution. Luckily for me, shortly after I made that decision Russia defaulted on its debt, the internet bubble popped, and Enron went bankrupt. Also, Nassim Taleb started publishing books that gave a sort of intellectual respectability to the whole project of looking at the implications of unpredictable events. For my part, and with the support of a couple of far-sighted bosses, I spent the next decade gathering details and stories and trying to build a mental toolkit for living through those strange historical episodes when everything you thought you knew turns out to be untrue. It involved a lot of digging through out-of-print books and reading up on unfashionable management theorists, looking for the gaps between theories and the awkward things that people didn''t like to talk about. Did any of this help, when 2007 arrived and it turned out that the previous decade''s prosperity had been built on a mountain of lies? Yes and no. Later in the book I''ll discuss some of the big frauds where I had front-row tickets. I think my record in spotting them was better than random chance, but maybe not much better.

But anyway, back to 9THWONDER and the online drugs fraud. Money for nothing The mechanics of the dark market scam are almost so simple as to need no explanation: you take money (in this case, electronic money such as bitcoin) on the basis of a promise to send someone illegal drugs, and then you don''t send the drugs. The interesting bit is that the controls that were put into the system to rule out this absurdly obvious possibility didn''t work. The way that things were meant to happen is that payments were meant to go through "escrow." You sent your bitcoins to a central address associated with the marketplace itself, so that the vendor could see that you had paid. Then, when your goods arrived, you sent a confirmation message and "released" the payment, allowing it to be sent on to the vendor. Or, if your goods didn''t arrive, you submitted a complaint to the marketplace, which, via its (surprisingly efficient) dispute arbitration service, took evidence from you and the vendor about who was likely to be lying, and if it thought you were in the right, gave you your money back. All of this signing and acknowledgment was carried out on an anonymous basis via clever cryptographic protocols that don''t need to be discussed here because for the most part they worked--there was no technical weakness worth speaking of.

The escrow system would seem to be a pretty solid protection against fraud, and it was available even for quite small deals, whereas normal trading companies only use the comparatively expensive services provided by lawyers and banks when the size of the transaction warrants doing so. And for the most part, the escrow service worked. The vulnerability came in because people didn''t use it. Why didn''t they use it? That''s the best kind of question--it''s relatively easy to answer, and the answer not only tells us something useful, but sets us off on a train of thought that ends up with a much deeper understanding of fraud in general, and of its relation to the honest economy of which it is the mirror image. The simple answer here is that the failure of the Silk Road escrow system was a specific instance of a general problem in computer security--that if something is a pain in the ass, it will not provide any protection because people will not use it. It turns out that there was not (and is not yet) a technological solution powerful enough to overcome an elementary fact of business--that the conventions of who pays cash and who gets credit reflect the relative power of buyers and suppliers in the market. The escrow system was highly inconvenient for vendors. They had the normal cash-flow problems associated with extending trade credit, in that they had to finance their inventories before getting paid.

Against this, they had a degree of protection from deadbeat customers through the escrow system. But they could still be made the victim of fraudulent or frivolous customer disputes; it was not uncommon for unscrupulous dealers to send in dozens of orders to a rival and then dispute them all, to drive one of their enemies out of business. The biggest problem for the vendors, though, was that the online payments were all made in bitcoin and its equivalents. The ways in which the financial system has been recruited as a tool of law enforcement are interesting in themselves (we talk about them at length in Chapter 11), but for the time being it''s just important to note that bank accounts are always linked to named people, and their transactions are monitored and can be subpoenaed by the cops. So if you do business with a variety of drug dealers using cash transferred to and from a bank account (or a PayPal account, or any other legitimate means), you''ve effectively started the clock ticking for when one of them gets busted and the narcs start following all the trails of banking data, one of which will lead.