As cryptocurrencies gain prominence and widespread acceptance, they also become a breeding ground for fraudulent activities. In this article, we discuss various types of cryptocurrency fraud, the risks associated with it, and the role of regulatory authorities in combating these illicit activities.
Introduction to Cryptocurrencies
Cryptocurrencies, also known as virtual currencies or tokens, represent a stark departure from traditional currencies like dollars or euros. Rather than being issued and backed by a central government or bank, these digital assets are secured by cryptography and serve as a medium of exchange. Their validity is typically provided by a blockchain system, which employs an open, distributed ledger to record transactions.
While different forms of cryptocurrencies have existed for years, they became a cultural phenomenon in 2017 when Bitcoin, one of the more established cryptocurrencies, saw its price soar to nearly $20,000—a staggering annual gain of over 2,000%. Although 2018 witnessed the "Great Crypto Crash," cryptocurrencies remain highly popular, with Bitcoin joined by other significant cryptocurrencies like Ethereum, Ripple's XRP, Binance, Tether, and countless others.
Alongside the growth of cryptocurrencies, exchanges have also expanded, providing platforms for customers to trade cryptocurrencies for other assets, including conventional currency and other digital currencies.
The Dark Side of Cryptocurrencies: Fraud and Scams
As with any financial instrument, particularly one that is highly volatile and has captured immense public interest, there are ample opportunities for bad actors to defraud investors. Cryptocurrency fraud has become a dominant topic of discussion for government enforcement attorneys, who are working to address its many forms, the hype versus reality, the numerous ways it can facilitate fraud, and efforts to curb its abuse.
As crypto scams and fraud become more prevalent, it will be increasingly important for whistleblowers to assist the SEC, CFTC, and IRS with their enforcement efforts.
Types of Cryptocurrency Fraud
Cryptocurrency fraud and scams can manifest in various forms, including:
1. Financial Crimes
The instant transactions, portability, and international reach of cryptocurrencies make them a new tool for tax evasion, money laundering, and bribery.
2. Scam Initial Coin Offerings (ICOs)
The first offering of a particular cryptocurrency for sale, called an Initial Coin Offering or ICO, can be a means of preying on the unsophisticated. Many ICOs are completely fabricated, with fake bios of nonexistent team members and technical whitepapers copied from other, legitimate cryptocurrencies.
3. Pump and Dump Schemes
Cryptocurrencies can facilitate a new variation of the classic pump and dump scheme, where owners of a stock drive up the price before selling off their holdings at an artificial peak. In the crypto world, this is common at the ICO stage or even beyond when false claims can generate demand and enable the originators or dominant holders of the cryptocurrency to reap massive phony profits.
4. Market Manipulation
Fraudsters may attempt to manipulate the markets where cryptocurrencies or related derivative products are traded. Improper market manipulation may include spoofing, front-running, churning, and other schemes.
5. Ponzi Schemes
Crypto investments can also serve as the vehicle for a traditional Ponzi scheme, where new adopters are necessary to provide artificial returns to the early adopters. Purported investments in emerging crypto markets can serve as the supposed goal for Ponzi schemes. Given the widespread misunderstanding of cryptocurrencies, they can be the perfect cover for a bogus scheme.
6. Traditional Theft
Cryptocurrencies offer criminals new opportunities for theft. They can hack investors' crypto wallets and steal their currency; set up fake wallets to defraud counterparties; and establish phony crypto exchanges to steal customers' money.
7. Broker/Dealer Fraud
The SEC has examined exchanges and funds investing in cryptocurrencies, which may, depending on the circumstances, need to register as broker-dealers or exchanges.
8. Unscrupulous Promoters
The SEC famously fined Floyd Mayweather and DJ Khaled for failing to disclose payments they received for promoting investments in Initial Coin Offerings (ICOs).
Regulation of Cryptocurrency
The SEC, CFTC, and IRS all assert regulatory control over cryptocurrency under certain circumstances. For the SEC, a given cryptocurrency must qualify as a security, or the "investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others." The SEC developed its application of this test to cryptocurrency in its now-famous report on The DAO, a German crypto ecosystem.
The CFTC also has authority to regulate crypto as a commodity in accordance with the Commodity Exchange Act. The CFTC has recently stated that crypto enforcement is a top priority due to its high risks for investor fraud.
The IRS has taken the position that cryptocurrency investments are assets that should be treated like any other for tax purposes, allowing it to tax returns on crypto investments. Through its Criminal Investigations Division, the IRS can pursue money-laundering crimes committed with cryptocurrency. Enforcement efforts by the SEC, CFTC, and IRS can also extend internationally to schemes that have violated U.S. laws.
The Role of Whistleblowers in Combating Cryptocurrency Fraud
As cryptocurrencies continue to grow in market cap and influence, whistleblowers will be essential in helping the government catch wrongdoers and prevent fraud. Whistleblowers can also take advantage of the various whistleblower reward programs offered by the SEC, CFTC, and IRS, and potentially share in any government recovery.
Conclusion
Cryptocurrency fraud is a complex and evolving issue that poses significant risks to investors and the financial ecosystem. As regulatory authorities work to combat these illicit activities, it is important for the public to be vigilant and report any suspected fraud or scams. By working together, we can help ensure that the world of cryptocurrencies remains a safe and secure domain for all participants.
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