Imagine that you could invest legally in an unregulated market and make a huge, tax-free profit, perhaps overnight. Would you do it? For some people, the answer is a resounding “yes.”
Welcome to the world of cryptocurrency, the digital asset that some consider the future of money. But thanks to cryptocurrency scams, it’s also an area rife with fraud.
“Cryptocurrency such as bitcoin has become all the rage,” according to Mark Grabowski, author of “Cryptocurrencies: A Primer on Digital Money” and an associate professor at Adelphi University, where he teaches a course on bitcoin and blockchain.
“Many historians see it as the latest phase in the evolution of money. Many technologists are intrigued by the potential of its innovative blockchain technology. For some entrepreneurs, especially early adopters, cryptocurrency represents a once-in-a-generation wealth opportunity,” Grabowski added. “However, it’s also suffered numerous cybercrimes and market crashes, resulting in a chorus of critics warning that it’s risky and perhaps a pyramid scheme.”
Long story short, the “crypto” markets are ripe with opportunity but also fraught with risk. If you’re interested in getting involved, how can you identify crypto scams and protect your investment?
First, learn what crypto is all about.
What is cryptocurrency?
“A cryptocurrency is a digital currency. It was created to transact on the blockchain, a technology enabling highly secured and fast peer-to-peer online payments using digital contracts,” said Caroline Hoffmann, the head of public relations and communications at MarketOrders in London.
“There are different types of cryptocurrency, which are either called a coin, if it operates on its own blockchain, like bitcoin or ethereum, or a token, if it operates on an existing blockchain,” Hoffmann continued. “Cryptocurrencies are stored in a digital wallet and can be exchanged for other cryptocurrencies or fiat currencies such as dollars, euros or pounds.”
Investors can purchase crypto by buying them directly on an exchange, by participating in a public offering similar to the stock market or by “mining” them, Hoffmann said. Investors who “mine” earn cryptocurrency by validating other cryptocurrency transactions on the blockchain.
“The most immediate way to understand how cryptocurrencies work is to compare them with the national currencies we are used to, such as euros, dollars or pounds,” said Jonathan Swerdlow of Enigma Securities. “In fact, just like the latter, crypto can be used to make online purchases or carry out different types of investments, very similar to what happens in foreign exchange, commodities and stocks.”
In short, cryptocurrency is a catch-all term for a digital currency that’s traded on exchanges and encrypted for internet security. It can be purchased using traditional currency or earned by mining (if you have strong coding skills). And just as you can purchase crypto with “regular” money, you can also exchange it back— but the similarities end there.
That’s because unlike other types of money, such as the dollar, crypto is not backed by the U.S. government—or any government, anywhere in the world. It doesn’t come in paper or coin form. Most importantly, unlike other types of digital transactions such as those made with credit cards, crypto owners can buy and sell to other crypto owners anonymously.
Because markets are unregulated and transactions are anonymous—“With cryptocurrency, you are free to spend your money the way you want, without everyone knowing it,” Swerdlow said—there’s a lot of room for cyberscammers to operate. From illicit drug deals going down on the dark web to honest investors getting taken advantage of by tech-savvy cheats, cryptocurrency scams are bold and expensive, with investors losing billions every year.
How to spot cryptocurrency scams
In 2019, cyber thieves stole $4.26 billion from cryptocurrency exchanges and owners, according to the Cryptocurrency Anti-Money Laundering Report issued by CipherTrace. Hackers claim more than their fair share of the pie by breaking into exchange systems and stealing sensitive data. And while there is little that the average investor can do to prevent hacks from occurring, anyone can learn how to try and avoid becoming a victim of an online fraudster.
Every expert echoed the same advice: If you’re considering investing in crypto, the best way to spot a potential scam is by investigating the reputation of the people behind the currency or exchange.
“Check out who the developers are. Make sure that the people on the team have [an] established history in the crypto industry and no past history of fraud,” said Michael Jones, chief marketing officer of Ivy McLemore & Associates, a blockchain marketing and public relations firm. “Beware of claims for celebrity endorsements. Instead, stick to those who are well-known in cryptocurrency and have backed previously successful projects,” he added.
Other things to watch for:
- Guarantees of any kind: Just like stocks and bonds, crypto values change on a daily basis. Losing your entire investment is possible, and there are no sure things. If someone you don’t know promises easy money, and you can’t verify that person’s identity and reputation, stay away.
- Problems with your mobile phone or digital device: Is your device operating more slowly than usual? Have you installed any new applications or software? Does your battery run down fast? If so, a “cryptojacker” might have downloaded malware onto your device.
- Invitations to invest delivered through casual online forums such as Reddit: Scammers use these forums to gather personal information and find an entry point. In one recent phishing scam, two brothers, Assaf and Eli Gigi, lured people from online forums such as Reddit onto websites that resembled well-known exchanges, according to Business Insider. The take? More than $100 million in crypto stolen over a three-year period.
- Typosquatting scams: Typosquatting, which involves creating a fake crypto exchange for the purpose of gaining access to investors' digital crypto wallets, is another effective method. Global authorities recently arrested six people for creating a fake cryptocurrency exchange that ensnared 4,000 people and yielded $27 million in stolen funds.
Here’s how digital currency pros recommend proceeding when considering a crypto investment opportunity:
- Before you invest, take the time to understand how the technology works. “Knowledge is power,” Hoffmann stresses. “The first thing I would do before investing in cryptocurrency is take time to understand the basics of the technology, the ecosystem and the industry.”
- Stick to big, well-known exchanges. “There are dozens of cryptocurrency exchanges and new ones opening each week,” Grabowski said. “Not all of them are reliable and trustworthy. Avoid shady exchanges, and only use well-known exchanges that provide good security and easy liquidity.”
- Try to assess the pros who created the marketplace. “Do your due diligence,” said Michael Yuan, technologist, founder of Second State and chief scientist at CyberMiles. “If a particular cryptocurrency is not backed by a strong, bonafide team and a solid business proposition, then that can be a red flag.”
What to do if you’ve been scammed
Unfortunately, crypto fraud is surprisingly common. Nearly 20% of surveyed crypto investors reported hacking, and 15% said they were victims of fraud, according to security company Kaspersky. And the lack of regulation means you’ll need to act fast.
First, get in touch with the exchange and request a freeze on your account. If you know the identity of the person or entity that stole your currency, that may increase the chance of recovering your funds. In many recent cases, crypto exchanges returned stolen funds to investors.
You can also consider getting in touch with a company that specializes in tracing crypto transactions, such as Chainalysis. Hiring an attorney to sue the exchange where your crypto eventually lands is another possibility. Neither solution, which are sometimes used in concert, is cheap; you can expect to pay thousands of dollars and spend years getting your crypto back.
You should also report suspicious activity to the Federal Trade Commission, the Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission. Although crypto markets aren’t regulated by these entities, they do track fraudulent activity.
The take-away? Only invest what you can afford to lose
Unregulated crypto markets mean investors have few, if any, legal protections. Their volatile nature means prices can fluctuate wildly and even go to zero. And because it can take thousands of dollars and many years to recover lost funds, crypto investing is really only appropriate for people who can afford to lose their entire investment—no matter the potential upside.
“It takes a special investor who can deal with the extreme price fluctuations, prevalent scams, uncertain legal future and other risks associated with cryptocurrency,” Grabowski said. “It also takes luck. Yes, there’s potential to make a lot of money quickly. But there’s also a good chance you could lose everything you invest.”