As crypto assets and associated products continue to make their way and gain ground in the traditional finance (TradFi) sector, scams and frauds related to cryptocurrencies continue to pose a significant challenge for even broader adoption. According to a report published by the FBI, Americans lost over $5.6 billion due to cryptocurrency scams in 2023. These losses represent approximately 50% of total investor losses due to financial fraud and a 45% increase in cryptocurrency scams compared to 2022. It is noteworthy that the dollar figure associated with these scams and frauds is due both to the uptick in incidents and the recovery in cryptocurrency prices, which has driven much of the market narrative in 2023-2024. The fact that frauds and scams remain so frequent, and have even increased year over year, is a fact that all members of the crypto community must take into account.
The details of scams related to cryptocurrencies included some of the methods more traditionally associated with the sector, such as pump and dump tactics, but also included other tactics. These include, among others, the establishment of complete call centers from which to direct fraudulent organizations, scammers impersonating government agents, and the use of online dating sites to scam cryptocurrency investors. While the FBI report focused on investors, and not specifically on institutions, there are several important lessons that entrepreneurs and institutions looking to integrate or expand their operations with cryptocurrencies should keep in mind.
Counterparty risk is real
For entrepreneurs or even larger institutions looking to use cryptocurrencies for payroll, treasury management, or vendor payments, it is unlikely that the organization will self-custody crypto assets. As the use of cryptocurrencies has expanded, it is practically certain that fraudulent custodians will enter the market, especially given the price recovery that has already occurred in 2024, along with optimistic forecasts centered around the U.S. presidential elections. Given the rapid evolution of the cryptocurrency sector, few custodians or external service providers will have a long track record, but there are aspects that institutions should consider when evaluating a counterparty to collaborate with.
These items include but are not limited to inquiring about regulatory licenses and compliance records, completed third-party audits or at least attestations, cold storage procedures and controls, insurance coverage and limits, and evidence of client asset segregation. As the collapse of FTX demonstrated these items, among others, should not be assumed but rather should be investigated prior to entrusting funds to a third party.
Clear Reporting Is Needed
Building on the first point it is difficult to overstate the importance of clear and standardized reporting, and consistent channels of communication. Every investor benefits from better reporting, but the institutional and entrepreneurial investors stand to benefit even more than individual investors. In addition to providing better information for business decision-making, providing on-demand reporting and analytics can also help these same investors avoid projects that are either unable or unwilling to provide the necessary information.
For example, even if the concept of proof-of-reserves is still very much a work in progress this is something that any investor seeking to integrate crypto into operations should be aware of. For stablecoin issuers, or any other token that is offered to the marketplace, one of the first things that should be provided to potential partners and investors is some sort of report on the status of tokens and reserve assets. Since institutional and entrepreneurial users of crypto are concerned with liquidity and transparency, better accounting and reporting is a must have.
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Scam Risks Will Not Go Away
The unfortunate reality is that as the crypto market continues to mature, expand, and increase in value the cybercriminals and other unethical actors across the globe will continue to take advantage of loopholes in security and internal controls. Especially as institutions seek to integrate crypto payment options – in the form of stablecoins or other tokenized assets – this will provide another avenue for bad actors to gain access to these financial transactions and other data within the organization. Appropriate controls, employee training, and periodically updating policies around how crypto integration occurs will only become more important going forward.
Crypto crime is back on the rise, and investors need to take proactive steps to avoid falling victim.
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