Cryptocurrency and its underlying blockchain technology is becoming increasingly mainstream, attracting an uptick in consumer participation in crypto markets and interest from traditional equity firms and institutional investors. However, excitement about the possibilities of this technology should be tempered with an abundance of caution. Digital assets are easy targets for bad actors who can drain the wallet of the unwitting consumer and represent a potential reputational risk for companies and institutional investors.
There are several reasons why this is the case. First, the public has a generally poor understanding of how cryptocurrencies, digital assets, and the blockchain itself work. See the multiple bemused explainer articles about NFTs as a prime example. As with any new technology, this presents an opportunity for scammers to exploit the idea that a seemingly magical bit of code can yield enormous returns on minimal up-front investment. In addition, paid promotion by celebrities and the endorsement of influential executives has rapidly expanded the visibility of cryptocurrency from enthusiast Reddit threads to national media outlets and the boardrooms of prominent financial institutions. At the same time, regulators are only beginning to address the gaps in traditional financial market and commodities rules where cryptocurrency and other digital assets currently roam free. The confusing patchwork of regulatory agencies that potentially have a hand in overseeing various aspects of the crypto market has thus far limited enforcement capability, with some exceptions. Perhaps most appealing to the aspiring crypto con artist is the fact that while transactions can be reversed or traced with expert or law enforcement assistance, it is much more difficult for the average crypto buyer to redress a fraudulent transaction on their own. The lack of government backing for digital currencies also means there is no established safety net for victims to guarantee the reimbursement of fraudulent transactions, in contrast to credit cards or traditional bank accounts.
This Wild West environment has made some people rich, but has also resulted in heavy losses for thousands of consumers and investors. According to the Federal Trade Commission, consumers reported $80 million in losses on crypto scams between October 2020 and May 2021. Recent high-profile incidents highlight the risk of falling victim to price manipulation and outright fraud. In July, several members of popular e-sports team and influencer hub FaZe Clan were fired or suspended after amateur YouTube sleuths found evidence that the team members participated in a pump-and-dump scheme. The FaZe Clan members promoted a charity coin to their millions of social media followers before allegedly selling off their holdings shortly after its launch, causing the coin’s price to collapse. The incident exposed the ethically questionable practice of social media influencers hawking altcoins to their mostly young, financially inexperienced followers.
The victims of cryptocurrency fraud are not limited to U.S. teenagers responding to Instagram campaigns. South African authorities are prioritizing new crypto regulations after several large scams cost investors approximately $4 billion so far this year. In a particularly egregious incident, two brothers who founded the exchange platform Africrypt mysteriously disappeared after notifying investors that $3.6 billion had been lost from client accounts.
The aforementioned examples underscore the necessity of common sense precautions when it comes to crypto markets. As with traditional financial system frauds, if a promised rate of return seems too good to be true, it probably is. Crypto experts recommend checking a coin’s website for a public white paper that has detailed information on its purpose and structure prior to an initial coin offering (ICO). If a coin website does not feature a clearly written public document of this kind, it may be an indication of a poor business plan or at worst, fraudulent intentions. Anonymous founders or a lack of transparency about a currency or exchange’s liquidity may also be red flags.
Potential investors and due diligence providers should educate themselves on the particular risks of the crypto space as well. Investigators might consider paying special attention to cryptocurrency exchanges, coins, and digital asset services companies in a subject’s background. Involvement in cryptocurrency markets is not a red flag in and of itself, but merits additional scrutiny to detect reputational risks such as consumer complaints or currency collapses under suspicious circumstances. On the technical solutions side, an ecosystem is emerging of companies that offer blockchain KYC services as well as AML, asset tracing, and investigative tools focused on cryptocurrency crime and fraud investigations. With Bitcoin reaching $1 trillion in market capitalization this year and blockchain-based currencies, trading platforms, and services catching fire with consumers and investors, cryptocurrency fraud is set to join traditional money laundering and FCPA violations as a top item of concern for regulators, financial institutions, and due diligence professionals alike.
Jon Ettinger is a Senior Associate at Vcheck Global
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