Partner Richard Cannon examines the rise of investment fraud and white collar crime in the digital asset market.

Richard’s article was published in Cointelegraph, 6 December 2022, and can be read here.

News involving crypto and fraud is ubiquitous in the white-collar crime sphere, and perhaps more worryingly these fraudulent activities in the crypto sector are not limited to a single type of crime.

Diverse and distinct yet with one common thread, crypto investors are the victims and these crimes involve real money. Many people have placed their life savings into crypto and on a larger scale private equities, pension schemes and even nation states are principal investors and losers.

There are con artists who will try and entice their targets to invest in a get rich scheme which turns out to be a Ponzi. On 21st November, it was announced that two Estonian citizens were arrested in a $575m cryptocurrency fraud and money laundering scheme.[1] Additionally, in September, US authorities announced that the “Head Trader” of global cryptocurrency Ponzi scheme EmpiresX had pleaded guilty to conspiracy to commit securities fraud in connection with a fraud that stole $100 million from investors. The unravelling of major frauds such as EmpiresX has become frequent in the crypto market, as fraudsters cash in on the bountiful opportunities for scams in the digital assets market.

Then we have the institutional risk – the exchanges and platforms that present as being mainstream and stable but then collapse due to holes in their balance sheets where customer deposits should be[2]. The spectacular recent collapse of FTX has sent shockwaves through the sector, which was already reeling from the effect of the ‘Crypto Winter’ that saw coin prices plunge across the board. According to a filing in a US bankruptcy court, FTX owes its 50 biggest creditors almost $3.1bn, though the true cost of FTX’s demise is far higher in terms of the ripple effect tearing through the industry.

The role of regulators in FTX’s ability to fraudulently operate on such a vast scale will face much scrutiny moving forward. In fairness to the FCA they did issue a warning in September 2022 that they believed FTX may be providing financial services or products in the UK without their authorisation. But the notice was confined to their website and does not appear to have been put on Twitter or disseminated much further. One must ask what the point is of making such a warning without doing much more to try and make sure it reaches the target audience. The collapse of FTX is huge, but it will certainly not be the last of its kind.

In the wake of FTX’s demise, a deputy governor of the Bank of England called for the sector to be brought within the regulatory framework, warning that the continued growth of the crypto market meant action should be taken now, before an even greater shock than the FTX implosion occurs.

While this call to arms is welcome, it is not just about having rules, it is how they are policed and enforced that impacts bad behaviour and improves market confidence.

Proponents of the sector seek to draw in breathless crowds by playing on the ‘disruptive’ and ‘Wild West’ nature of the crypto space, but it is precisely that feature which makes it so attractive to con artists and thieves. Cryptocurrency remains largely beyond the reach of both domestic and global financial regulation, making it a haven for criminals and leaving investors dangerously exposed, with almost no recourse for redress if they are the victim of crime.

Banks are turning away from, rather than towards the market. Starling Bank recently announced they were imposing restrictions on customers’ crypto activity which is likely to push crypto investors towards less safe avenues to complete transactions.

Crypto and blockchains have recently been labelled as disruptive tech that operates in a decentralized space. In these parameters, it seems perhaps unwise to complain about the traditional financial system’s process which many perpetrators have tried to evade.

There is a need for external education but also self-control from users. As a commentator said on Twitter in November: “Everyone keeps asking me HOW we missed the FTX scam. It’s simple: Greed. We were all making money, all of us, that we didn’t think about proper due diligence. We all followed each other, like sheep, trying not to be the idiot that misses out. We’re now paying our dues.”

Crypto trading should not be seen as little more than an extension of online gaming, rather as a serious financial choice with real and risky consequences The gamification of crypto has been made possible by the viral spread of crypto and NFTs across social media, with celebrity endorsements and influencer promotion normalising the culture with scant regard for the possible downsides of investing. Young investors are bombarded with tall tales of how their peers made eye-watering returns from small stakes investments, and are easily tricked into throwing money at the next get-rich-quick scheme being dangled in front of them.

Currency speculation, once the preserve of banking institutions, governments and funds, has been repackaged and sold to the masses as casino entertainment, and its rapid growth demonstrates just how successful the revamp has been. The perfect storm has been created, harnessing brash social media broadcasting, the fog of little-understood crypto technology, and the type of wild price volatility that allows investors to dare to dream. The combination of greed, technology advances and lack of regulation remains destructive. Fraud is currently the price of doing business in crypto and there is a long way to go to prevent history continuing to repeat itself.

If exchanges are handling customer funds, then they must be regulated and operate like banks to protect consumers, with guarantees in place and deposits properly siloed and protected.

Cryptocurrency should be subject to some form of centralised certification process so that investors can be well informed of the risk in investing in different crypto currencies. There will need to be minimum standards and assurances for a token to be certified. Consumers will then have clear vision and can make informed choices.

The issuing of coins/tokens also needs to be looked at and for regulation to mean something, then minimum standards comparable to IPO’s are a requirement.

Valuation remains a problem. Companies are issuing tokens where the value is based on the prospects/value of the company and therefore are included in the value of its own shares. FTX value was supported by the market value of its token FTT, and the value of FTT was itself based on the valuation of FTX. The circularity here is dangerous.

The crypto sector is now at a crossroads. The counterculture that sets it at odds with centralised regulation will only lead to more scandal, volatility and loss of confidence.

[1] https://www.justice.gov/opa/pr/two-estonian-citizens-arrested-575-million-cryptocurrency-fraud-and-money-laundering-scheme

[2] https://www.theguardian.com/technology/2022/nov/21/crypto-exchange-ftx-creditors-cryptocurrency

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