The pandemic-driven change in investment opportunities led to a lot of investor interest in cryptocurrencies in 2021. But the mania came with its share of pitfalls, as frauds and scams around it have seen a rise too.
While cryptocurrency transactions hit $15.8 trillion (tracked by research firm Chainalysis) in 2021, up 567% from 2020, cryptocurrency based crime also reached an all time high in the same year. Illicit addresses have received nearly $14 billion in cryptocurrencies in 2021, up from $7.8 billion in 2020.
The research also shows that the boom in legitimate adoption of cryptocurrencies has pushed the fraction of illicit transactions as a ratio to all transactions to an all time low: to 0.15% in 2021, 0.62% in 2020 from 3.37% in 2019.
However, this does not negate the risks to investors due to misappropriation and scams, mainly due to scant regulation.
Two brothers, Ameer and Raees Cajee, ran a cryptocurrency investment firm Africrypt based in South Africa. In April last year, the brothers said that their firm was hacked and that they had lost all their clients' money. However, they were sued, and the lawyers representing the aggrieved investors pegged the losses at $3.6 billion, in what is deemed to be the largest crypto heist till date. The whereabouts of the Cajee brothers is also unknown.
Poly Networks, a decentralised finance (DeFi) platform, was robbed of $600 million after a hacker discovered a flaw. However, the hacker reached out to the firm and returned the money for a reward of $500,000, claiming to be a 'white hat' hacker (a hacker without nefarious intentions, who hacks targets to expose flaw before it can be exploited for malicious purposes).
Closer in India, a Kerala-based individual, Nishad K, who is now absconding, pulled of a scam valued at nearly ₹1,200 crores. The scam was based on a promise of giving ₹270 daily for 300 days on an investment of at least ₹15,000 in a new cryptocurrency called 'Morris Coin', which eventually turned out to be non-existent.
The cryptocurrency industry has many verticals, and each has paved the way for its own variety of scams.
A non-fungible token represents something unique that exists exclusively digitally. It could be a piece of artwork, a video snippet, a URL or a collector's item; all of which has been authenticated using blockchain, the technology powering cryptocurrencies.
The diverse and open-ended nature has let many celebrities and illustrious personalities put snippets of their own work and make collectors' token to interact better with their followers. However, the art crimes and theft have found their way to this space too.
In fact, in the first half of the first month of 2022, a major NFT scam has already occurred.
Frosties is a series of artwork NFTs available on NFT marketplace Openseas.io. While all the Frosties NFTs were sold within an hour, the investors in these tokens, instead of getting their NFTs, discovered that its developers have deactivated all communication channels, and are absconding with nearly $1.3 million.
Such a modus operandi in the cryptocurrency space is called a 'rug pull'. It means that developers of a crypto-related project hype it up on social media to inflate the product's value, but then immediately abandon it, making its value drop to zero.
The Securities and Exchange Commission, the securities market watchdog in the United States, in a report to the US Congress last year, acknowledged that there is little regulation concerning NFTs, though tokens that generate commission or royalty for their minters could be treated as a security and regulated under existing law. A petition for introducing NFT specific regulation has been placed before it.
Openseas.io has some tips in place for safety in NFT transactions. It encourages due diligence before purchase, seeing the sellers and their history, as blockchain purchases are irreversible. It also encourages users to use hardware cryptocurrency wallets to prevent both crypto and NFT theft.
It can be read here.
ICOs, or initial coin offering, is when the issuer of a new cryptocurrency solicits investment in fiat currency or other cryptocurrencies for this purpose.
Consider them to be equivalents to IPOs, or initial public offerings, in the equity space.
The Morris Coin scam that took place in India is an example of an ICO-related scam, where it sought money from investors for a coin that was never launched.
A more prominent 'rug pull' also took place last year, in a coin related to popular television series Squid Games, called 'Squid Coin'. The model of this coin was play-to-earn, where subscribers of the coin, in theory could:
- Buy coins using traditional currency
- Use the said coin to play games that was scheduled to be launched in November 2021, which in this case, was based on the show Squid Games
- Win additional coins through these games which could be en-cashed for traditional currency
However, the coin went from valuable to zero in the course of just a week. On October 26, the coin cost around one cent, which went up to $2,856 a week later, only for it to lose 99.99% of its value overnight, as its users were unable to trade and sell these coins. The website promoting the coin and affiliated social media handles also vanished. Experts had warned that the website had several red flags of a fraudulent website, including spelling and grammatical errors.
However, the SEC does have a few pointers when it comes to ICOs. For example, a coin could be classified as a regulated security regardless of what it is called. It also poses high risks, and can cause loss to investments. The SEC advises caution, research, and to not go in for any promises that sounds too good to be true. In an advisory to exchanges, the SEC has asked to vet if their ICOs are regulated, and to know when an exchange needs to be registered with it.
It can be read here.