With the rise in popularity of digital assets, many fraudsters have emerged to lure retail investors into financially devastating scams. This often leads investors to suffer debilitating losses, as the money they invest is never recovered from these fraudsters. It is important to remind investors to watch out for these new investment schemes. Digital assets include cryptocurrencies, non-crypto digital coins, and crypto-tokens such as those offered in so-called initial coin offerings (ICOs). These digital assets are regulated by, in part, the Security Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the US Treasury Department. Which agency has regulatory authority depends on the structure of the digital asset. The key question to making a determination about which agency has regulatory authority is analyzing whether a cryptocurrency product or technology is a security, which would make it regulated by the SEC, or a derivative, which would make it regulated by the CFTC, or whether it is a currency, which would make it regulated by the Treasury Department. Whistleblowers can play an important role in helping expose fraudsters who use cryptocurrencies and blockchain technology to violate laws and/ or who steal from the public. A whistleblower may even be entitled to a reward if their information about cryptocurrency fraud leads to a successful prosecution and recovery of monies by the SEC or CFTC or, if applicable, under another whistleblower rewards program. 

What is a Cryptocurrency?

As defined by the IRS, a ‘cryptocurrency’ is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, known as a blockchain. A transaction involving a cryptocurrency recorded on a distributed ledger is referred to as an “on-chain” transaction; a transaction that is not recorded on the distributed ledger is referred to as an “off-chain” transaction. Cryptocurrencies can be mined or purchased from cryptocurrency exchanges. 

The skyrocketing value of cryptocurrencies has made them popular as trading instruments. Blockchain technology’s impact is often compared to the rise of the internet and serves multiple industries, like the supply chain, legal, accounting, crowdfunding, and housing industries, among many others. Blockchain has the potential to impact virtually every sector of the economy. 

A defining feature of cryptocurrencies is that they are generally not issued by any central authority, this way rendering them theoretically immune to government interference or manipulation. This decentralized structure of cryptocurrencies has unfortunately made them popular among criminals who want to make their transactions difficult to trace. This abuse of use includes offshore financial crimes like tax avoidance, bribery, and money laundering.

We are going to see more and more adoption of blockchain technology and cryptocurrencies by financial institutions such as JPMorgan Chase & Co, which is testing for possible uses of blockchain technology to lower transaction costs. Meta (the parent company of Facebook) recently attempted to create a new cryptocurrency called Libra. Governments around the world are contemplating implementing blockchain-based cryptocurrencies. 

Types of Cryptocurrency Frauds

The rapid rate of adoption of cryptocurrencies over the past several years has caught the attention of all kinds of investors. It has also caught the attention of a lot of fraudsters. 

The most common types of crypto frauds include:

• Financial Crimes – As mentioned before, cryptocurrencies’ instantaneous transactions, portability, and international reach mean that these digital objects can be used as a new tool for the furtherance of tax avoidance, money-laundering, and bribery. According to the Federal Trade Commission (“FTC”) Consumer Sentinel, from October 2020 through March 31, 2021, reports of crypto-related scams skyrocketed to nearly 7,000 people reporting losses of more than $80 million. 
• Scam Initial Coin Offerings – 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. Some ICOs are completely fabricated, with phony bios of nonexistent team members and technical whitepapers copied from other, legitimate cryptocurrencies.
• Pump and Dump Schemes – Crypto can provide a new variation of the classic pump and dump scheme, where owners of stock try to drive the price up before selling off their holdings at an artificial peak. In the crypto world, this is common at the ICO stage, or even beyond, whenever false claims can hype up demand and permit the originators or dominant holders of the cryptocurrency to earn massive phony profits. 
• Ponzi Schemes – Crypto investments can also be used as the vehicle for a traditional Ponzi scheme, where new adopters are necessary to give artificial returns to early adopters. Given that crypto is widely misunderstood, it can be the perfect cover for a bogus scheme.
• Traditional Theft – Crypto also provides criminals new opportunities for theft. They can hack investors’ crypto wallets and steal their currency, they can set up fake wallets to bilk counterparties, and they can set up phony crypto exchanges to steal customers’ money.
• Fake celebrity endorsements: Scammers hijack celebrity social media accounts or create fake accounts, encouraging followers to invest in fake schemes like the ones above.
• Fake exchanges: Scammers send emails or post messages on social media promising access to virtual money stored on a cryptocurrency exchange. The only drawback is that the user usually has to pay a small fee first. The exchange never exists and your money is lost forever.
• Fake apps: Cybercriminals create fake but legitimate-looking cryptocurrency apps and upload them to app stores. When installed, these apps can trick people into giving their personal and financial data or plant malware on users’ devices. Others may trick users into paying for nonexistent services or try to steal logins from a cryptocurrency wallet.

What Regulatory Frameworks Exist to Protect Investors and Consumers Against Fraud?

The legal status of cryptocurrencies has implications for their use in daily transactions and trading. For example, in June 2019, the Financial Action Task Force (“FATF”) recommended that wire transfers of cryptocurrencies should be subject to the requirements of its Travel Rule, which requires Anti-Money Laundering compliance. 

Similarly, during a recent speech from Gary Gensler, the new Chairman of the Security Exchange Act (“SEC”), Gensler made some remarks about the test to determine whether a crypto asset is a security or not: “The test is clear” he said, but he also urges for the need for additional Congressional authorities to prevent transactions, products, and platforms from falling between the regulatory cracks. The SEC Chairman made clear that these platforms where people can trade or lend cryptocurrencies can implicate securities laws. Some platforms’ transactions and types of crypto-based financial assets can also implicate commodities laws and banking laws as well. 

How Regulators can Pay Rewards to Whistleblowers with Information about Cryptocurrency Fraud?

Government agencies generally want whistleblowers to come forward. Whistleblowers can also take advantage of various whistleblower reward programs administered by the SEC, CFTC, and IRS and potentially share in a government recovery. For example, the SEC and the CFTC whistleblowers reward programs incentivize people to provide information about cryptocurrency fraud if securities or commodity futures are involved. Under these programs, whistleblowers are eligible for rewards of between 10 to 30% of the monetary sanctions collected by the government. Since 2012, the SEC and the CFTC have paid over $1 billion to whistleblowers. 

Some uses of cryptocurrencies may lead to taxable events. For instance, holding these crypto assets as an investment and then selling them for a profit generally has tax consequences that could result in tax liability. The IRS offers rewards of between 15 to 30% if the information provided by the whistleblower helps the IRS collect over $2 million dollars. The Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) has also implemented ways to incentivize blowing the whistle on cryptocurrencies being used to launder money. This new program provides potential rewards to whistleblowers who blow the whistle on violations of the Bank Secrecy Act (BSA), where the information leads to a successful government enforcement action. The reward could be up to 30% of monetary sanctions over $1,000,000. This program comes into play when cryptocurrencies have been used to launder money by criminals.