Fraud has been part of the crypto ecosystem since the industry began. In large part, the prevalence of this illegal activity can be traced back to the unregulated nature of the space. With no coordinated and meaningful oversight, and fewer punishments for non-compliant firms, scams are rife. According to blockchain data firm Chainalysis, the year 2021 saw a record number of crypto crimes, with investors losing a breathtaking $14 billion to scams.
Financial trading has always attracted unscrupulous elements, with established markets like FOREX and share investing having become very familiar with scams over the years. Now, crypto has joined the party. The troubling aspect for such a virgin industry is that crypto scams are not only perpetrated by shady outsiders trying to prey on investors, but also by custodians and insiders who are meant to have the best interests of the industry at heart. Each time a major crypto story breaks, it is a blow to the legitimacy of the industry as doubts persist about whether this payment form can ever make it mainstream.
Just as shady characters are on the lookout for ways to exploit traders’ lack of expertise and knowledge, so are established owners. In this article, we will delve into some of the most high-profile crypto scams to come to light in recent times. We will try to understand how they happened and what it means for the industry.
What is a Crypto Scam? 6 Common Crypto Scams
Crypto scams come in many forms. In the US alone, almost 7,000 people lost a total of $80 million in crypto scams in the last year, according to the Federal Trade Commission (FTC). This represents a tenfold increase in losses from the $7.5 million the year before. As we have mentioned, crypto scams can be perpetrated by shadowy criminals trying to phish password information from traders through old-fashioned methods like malicious links. Crypto scams can also be perpetrated from within, by the very crypto exchange traders we know and trust. We will discuss a few of the most common types of scams.
1. Internal Scams
Much like the “point spread” scam in FOREX trading, where a legitimate broker manipulates the spread between currencies to their advantage, internal crypto scams are perpetrated by the very broker you are meant to trust. In the case of the FOREX “point spread” scam, brokerages will knowingly and deliberately code the prices on their trading platform to carry a healthy profit for their benefit, which they, of course, do not disclose to the trader. It is a breach of trust and abuse of position of the worst kind.
In the crypto world, illicit crypto exchanges and brokerages are no less calculating. The first type of internal crypto scam is based along the lines of the Ponzi scheme. In this scam, traders are incentivized by large payouts if they can recruit other traders in their personal networks to buy a certain number of cryptocurrencies. The scam creates pyramids of participating traders who are keen to bring on board more traders under the expectation that they will be rewarded at a future point in time. Usually, some of the early crypto buyers are paid out, and they evangelize to other members of the scheme that their day is coming. It almost never does, as the Ponzi scheme collapses when traders realize that the deferred payouts are not coming.
Another type of internal scam is the investment scheme that involves crypto firms offering traders the chance to buy their in-house crypto for next to nothing, with the expectation that its value will increase in time. New crypto investment schemes are pushed by crypto platform senior managers who often promise a once-in-a-lifetime opportunity to invest in this new crypto with excellent returns. The crypto firm will often try to get the new investor to buy as much of the crypto as possible with investors being assured that other players will enter the market and take away the opportunity if the investor does not move fast. The unfortunate investors almost always find out later that the promised increase in value never happens.
2. Crypto-Only Payment Scams
In what is becoming an increasingly common occurrence, some parties are claiming they can only accept payment in cryptocurrencies. This is normally a scam. It is not likely that a credible entity only transacts in crypto, as it is not legal tender anywhere other than El Salvador at the time of writing. These entities may be insisting on crypto payments so they can receive it in a low trading phase and take advantage of price swings in the future.
Also, some of the crypto world still lacks many of the essential Know Your Customer (KYC) safeguards of the mainstream financial industry. So, a shadowy entity can open a crypto wallet and process transactions for any type of service without having to present identification. To be fair, most of the established crypto exchanges do operate by stringent KYC rules, but there are outliers. While crypto is based on immutable blockchain records that can theoretically be traced to individuals, in practice, tracing someone via blockchain transactions is a difficult and often an expensive exercise. You may be able to track their digital signature as transactions enter and exit crypto wallets but locating the wallet holders in the physical world is extremely hard work.
3. Fake Identity Scams
One of the best things about cryptocurrencies is their decentralized nature; but what they gain from operating outside of central control, they lose by being open to abuse by bad actors. Investigations of several scams have proven that it is remarkably easy for one person to open multiple wallets under fake identities and use this to run scams. These scams might involve criminals hacking your hot wallets, stealing your private keys, and, in essence, your funds, and sending them to a wallet in the name of a fake identity.
Therefore, the tools and the compliance framework of those seeking to regulate the industry need to catch up with the way crypto works. Many crypto security experts recommend that newbies stick to well-known crypto exchanges and also stick to the two most popular cryptos — Bitcoin and Ethereum — as they have a longer track record of operation.
4. Game- and Collectible-Based Scams
After the runaway success of the 2021 Netflix show “Squid Game”, an unaffiliated cryptocurrency with the same name entered the market. The founders of the crypto took advantage of the global success of the show and created a surge in publicity and demand. The value of the crypto ballooned from $1 per coin to $2,861 in a matter of days. However, when new Squid Game investors tried to sell their assets, they were told they needed to enter a separate pay-for-play game to qualify to withdraw their funds. This created an administrative delay, during which time the scammers sold their holdings and disappeared, causing the coin’s value to crash back to below $1.
The scam affected thousands of traders, some of them experienced investors who assumed the crypto was affiliated to its Netflix namesake. The scam was surprisingly simple to execute and resulted in a massive payoff for the scammers. Traders should be aware of scams like this. As this case demonstrated, when hungry traders are onto the next big thing, they can sometimes lose their discretion and fall for scams of this nature.
5. Dating Scams
Perhaps not surprisingly, the dating world is a haven for crypto scams. According to the FTC, about 20% of the money lost in romance scams from 2021 was sent in the form of cryptocurrency. It is a common ploy for scammers to pose as available mates and ask romantic partners to give them cryptocurrencies, with which they disappear.
6. Phishing Scams
This is a common scam that takes advantage of traders’ lack of knowledge. The playbook is the same. The scammer tries to get the trader’s attention by indicating that there is a golden opportunity waiting for them, if only they would click on a link and share sensitive personal information. In the case of crypto, this could be a criminal asking for your private crypto keys.
For these scams to be effective, the scammers often manage to perform some level of social engineering on their victims so that their offers contain a reference to someone in the target’s network. It could come in the form of a link bearing the call to action, “Your friend John Smith wants you to take advantage of this amazing opportunity.”
There have been many high-profile scams in recent times. It is an indictment on the industry’s lack of controls that the following list is not even an exhaustive one. Some of the excesses that CEOs and company founders have been able to get away with is breathtaking. Here are some of the most high-profile crypto scams to break in recent times:
The founder of now-defunct Turkish crypto exchange Thodex went on the run in 2021 after the company defrauded investors and collapsed. Interpol issued a red notice and swooped on the firm’s headquarters, arresting 62 staff members. Faruk Fatih Ozer, founder and CEO of the exchange, along with 20 key colleagues, were eventually fingered for a cumulative 40,000 years in prison by Turkish prosecutors. It was alleged the accused used the crypto platform as a criminal organization where they fraudulently laundered proceeds from illicit activities.
Despite being hunted by Interpol, the former CEO went missing for a year. What was most egregious was that Thodex attracted investments from many young Turks who were seeking safe havens from high inflation and a volatile Turkish lira. After capturing up to 400,000 investors, the exchange went offline overnight. It is alleged that Ozer got away with $2 billion in investor money
In 2022, Paul Vernon, CEO of the long-collapsed Cryptsy crypto exchange, was indicted for tax evasion, wire fraud, and money laundering. The US Department of Justice (DOJ) accused Vernon of stealing $1 million directly from wallets of customers. He was said to have removed the funds from wallets the exchange controlled and used his own crypto wallet to transfer the funds into his personal bank account.
The transgressions took place as far back as 2013, but Vernon did not make any disclosures to his customers. In fact, in 2014, he told his employees that a hacker had stolen $5 million in bitcoin and other cryptocurrencies. He did not disclose the event to his customers until November 2015.
Vernon left the US in 2016 and moved to China, from where he hacked the company’s servers, got hold of the database containing customers’ funds, and destroyed the database to cover his tracks. He was only successfully indicted this year, but authorities retain hopes that some 11,000 bitcoins that went missing can be tracked on blockchain if they are ever transferred.
BitConnect Founder Satish Kumbhani was accused of running a $2.4 billion Ponzi scheme that defrauded investors. The Securities and Exchange Commission (SEC) litigated against Kumbhani in September 2021, citing fraudulent activities. He remains on the run today.
BitConnect was founded in 2016 and raised billions of dollars from global investors. What made the firm more attractive was that it offered investors a handsome 10% interest earnings on its coin if only they could successfully refer other investors. Facing scrutiny from authorities, the exchange shut down in 2018, causing the price of BCC coin to tank from $500 to $1 overnight.
Endpass Etherium, US
The CEO of crypto exchange Endpass Ethereum was accused and arrested for laundering $4.5 billion worth of bitcoin along with her husband. CEO Heather Morgan and her partner Ilya Lichtenstein were implicated in a 2016 hack, the proceeds of which the couple attempted to launder by investing almost $1 billion in non-fungible tokens (NFT). They employed other laundering methods, including using fictitious identities to set-up online accounts.
What Is Different about CEO-Level Fraud?
It is arguably more disappointing when CEOs and founders abuse customer’s money. After all, these people should have the investor’s interests at heart. In the case of regulated financial entities, it is normal practice for the senior management of the brokerage to be verified for their skills and background in the industry. This is not done in the crypto space, meaning anyone can enter positions of power.
For example, the UK’s Financial Conduct Authority (FCA) performs what is known as a “fit and proper” test for anyone wishing to set up a trading brokerage. As cryptocurrencies are not regulated in the UK, these tests are not required for crypto companies. However, to evidence how hard it is to establish brokerage firms dealing in regulated financial assets, they must pass stringent tests. Anyone wishing to hold a senior management function (SMF) in a brokerage firm is thoroughly vetted by the FCA for:
● Honesty, integrity and reputation.
● Competence and capability.
● Financial soundness.
The regulator expects total honesty from the start. You are expected to disclose if you have ever been convicted of a crime. The regulator also calls for provable industry references for the last six years, qualification certificates, credit checks and criminal record checks. The FCA leaves no stone unturned in ensuring that only the most experienced and competent people make it through.
Many other tier-1 regulators around the world share this level of thoroughness. It is not unreasonable to conclude that none of the high-profile crypto scams we have discussed above would have happened if the founders and CEOs had been subject to such strict vetting.
Why Is All This Crypto Fraud Happening?
The main reason is that cryptocurrencies are not regulated. Regulation does not cease at vetting the senior managers of a company. It goes much further than that. Regulators have a say in a variety of important elements of a broker’s service that affect customers. First, behind the scenes, brokers must perform stringent reporting in a defined format that regularly lays out their liquidity position and paints a picture of their financial standing.
With brokers dealing in other financial assets like FOREX, regulators insist that broker capital is ring fenced and kept separate from trader funds. There are also strong guidelines around important trading aspects, such as leverage and minimum balance protection, which must all be geared to allow traders to invest responsibly and safely. Regulators also frown upon many of the extravagant promotions that typically ensnare crypto investors. This point alone would stop many of the overly generous investment schemes that characterize many crypto fraud cases.
Finally, crypto firms are not compelled to offer compensation schemes to investors. If this were a requirement, they would surely conduct themselves with more diligence. In saying that, there are a great many crypto exchanges that operate responsibly and ethically and provide an essential service to the growing crypto market. Many crypto exchanges are well capitalized, have prestigious and well-known investors, and a voluntary list on prominent stock exchanges, subjecting themselves to all the layers of scrutiny required to be traded on a bourse.
What Regulators Are Saying?
Regulators are rightly concerned with fraudulent activities in the crypto world. However, regulation starts at the most senior levels of government. Before a regulator receives its mandate, the go-ahead normally comes from the national government of a country. To this end, in 2021, US President Joe Biden commissioned a groundbreaking study on cryptos, with one of the objectives being to settle on a way to regulate the industry. Likewise, the European Commission has commissioned its own study.
However, government attitudes around the world differ on the matter of crypto classification and treatment. Also, different geographical regions are adopting crypto at differing rates, adding to the complexity. Countries like Australia, Canada, and Singapore have already released tax guidelines for the treatment of cryptocurrencies, while many countries are still debating about whether crypto is a payment form or an “investment” type.
For every progressive country, there are some important global economies that are still treating cryptos with excessive mistrust. China has banned all cryptocurrencies from its monetary ecosystem, while India has made several negative pronouncements and has threatened to ban cryptos.
As far as the race, or slow walk, to regulation goes, the US is forging ahead. The country has already installed five important regulatory frameworks that cryptocurrency firms will have to navigate in the future, with some measures being in place already:
• Financial crimes-related regulations, such as the Bank Secrecy Act and others, must encompass cryptocurrencies.
• State banking departments must have input on how cryptocurrency should be regulated in their states.
• The Securities Exchange Act oversight and control measures must encompass cryptocurrencies.
• The Commodity Futures Trading Commission (CFTC) must cater for cryptocurrencies.
• The Internal Revenue Service must finalize how taxation of crypto profits should work.
Clearly, achieving regulation will take concentrated work from many different interest groups, even in smaller economies. However, if we glance at the increasing rates of low-grade crypto crime, as reported by the FTC, never mind the high-profile scams, regulation will be key for the future viability of cryptocurrencies.
How Crypto Scams Affect the Perception of the Asset
Major fraud cases are damaging to the entire industry, leading to drops in the valuation of cryptos and a damaging loss of confidence from would-be investors. Public perception suffers from constant negative media coverage. It influences the idea that crypto is a fad or a scam.
Does this mean that cryptos have no future and will never be adopted? No, it does not. Most qualified observers admit that, by virtue of the technology underpinning blockchain, it is secure. This means that when you have coins locked safely away in an industry-approved storage format, they cannot be or stolen, you also cannot double spend, and your coins will not disappear in a puff of smoke, as many crypto myths contend.
However, the security of the technology is not really what many traders are asking about. Investors want to know that crypto is not used for scams, and money laundering on the mysterious dark Web. The sad truth is that crypto is definitely used for these purposes. Consumers want to know that these cases are in the minority and steps are being taken to close many of the gaps that make the industry vulnerable.
Market commentators expect crypto growth to be stead but not stellar. There are bound to be ups and downs, as we are seeing in the current down cycle. What the currency does not need is to be bedeviled by endless bad press and scandal. This will only complicate and lengthen the road to mainstream acceptance.
How You Can Protect Yourself?
With so much illicit activity taking place, traders need to be armed with as much information as possible. As we have shown, scams can be initiated by illicit hackers and cyber criminals, and they can also be initiated by seemingly ethical CEOs and founders.
Check for a Stable Ecosystem
Cryptocurrencies are not regulated. Therefore, we would encourage you to seek out the next best thing. In all the high-profile examples we listed above, and these were just a few of them, strong regulation would have weeded out many of the bad actors even before they could set up their businesses. However, in the absence of firm regulation, we would encourage you to seek out crypto exchanges that operate in developed markets that function within an overall ecosystem of checks and balances.
To be more specific, you are better off working with highly visible crypto exchanges based in first-world countries that have a track record of success. You can never know the inner workings of a company, but there is comfort to be gained from a long record of trading, a list of happy and profitable customers, and a set of leaders who are visible and active agitators for mainstream crypto adoption.
Be Alert for Common Signs of Scams
Remember, the fraudster could be the CEO of your crypto exchange. As we have shown, in the absence of formal regulation, the next best thing is to work with a crypto exchange that operates out of a country with strong financial oversight. We recognize the irony in this, as Cryptsy, BitConnect, and Endpass Ethereum all operated out of the US, the largest and one of the most regulated economies in the world.
There is comfort in the fact that the perpetrators of crimes in all these cases were indicted or arrested in a highly transparent and public fashion. This could be a deterrent for future criminals, if nothing else. Also, when you work in a market that has a strong culture of whistleblowers and complaint registrations, you are off to a better start.
When you are dealing with a crypto exchange or brokerage, our advice is to clearly understand the value proposition of your crypto partner. Pay attention to reviews and read the fine print that could disclose important details of concern, such as operating terms and conditions that disadvantage you.
In general, whether you are performing trading activities through your crypto exchange or reading an email that could be phishing, understand that whenever a deal is too good to be true, it is probably a scam. The financial world is a notorious place for bad actors preying on your emotional weakness and the powerful human desire to get rich quick. Think of the Squid Game scam, where even experienced investors lost money because they feared losing out.
What to Do if You Think You Have Been Scammed
It may be too late already, but the first item in your playbook is to try to divest from the company if it is still operational. If the company closes overnight, you have no hope of recovering your funds. However, all is not lost. It may be cold comfort, but you should immediately report the matter to the consumer or financial watchdog in your country.
Next, try to find out if there is a charter company for crypto firms that looks after the interests of these companies. You can make a complaint there. Some countries, like the UK, have a service known as the Broker Complaint Alert, a feature that offers practical advice and help to many thousands of disgruntled traders every year.
Some other practical tips on how to rescue the situation could involve you requesting a chargeback from your bank. If you made a recent payment using a major debit card or credit card, your bank could reclaim the money if it is within the appropriate window.
You could also hire a crypto recovery service, which is an emerging product that uses expert industry forensics backed by high computational power to trace stolen coins. These services can track the transactions of the wallet address that received your scammed funds. When scammers transfer funds from the wallet to cryptocurrency exchanges to sell for fiat currency, you can contact the exchange handling this traffic. The most established exchanges employ KYC best practices and try to gather customer names, addresses, and identifying information. If you are in luck, intervening in time could help the exchange report the scammers to the police.
Related to a crypto recovery service, but not quite the same thing, bounty hunters are people in the crypto ecosystem who will charge you for using their blockchain knowledge and experience to investigate theft and try to recover your money. Some sites allow you to post a bounty, which can be taken up by amateur crypto bounty hunters.
Cryptocurrencies are not going anywhere. Many commentators agree that despite the industry’s current challenges, they are here to stay. What the industry needs is to move into a state of regulation so that the most high-profile crypto scams can be vastly reduced in number. This will inspire public confidence and allow the payment form to improve its reputation and grow its legitimacy.
Many analysts predict that when the industry is more stable and legitimate, increased customer demand will reach a critical mass that will invite a rush of investment from traditional financial sector players who will try to get a piece of the action.
Adrian Ashley is a seasoned business and finance writer. With a corporate career spanning over 20 years, he has developed deep experience in such diverse areas as investing, business, finance, technology and macroeconomics.