The demise of a cryptocurrency exchange offers a useful case study of the vicious cycles that can arise in online fraud. When a large exchange collapses, bad actors seeking to recoup their own losses suddenly have many new potential victims in the same boat, whom they can offer ‘help’ to rescue their accounts.
The most recent high-profile example is provided by the ill-fated FTX exchange, which filed for bankruptcy protection in November 2022 with $8bn (£6.7bn) of investors’ money missing and more than $400m identified as having been stolen by hackers. While its founder, Sam Bankman-Fried, has pleaded not guilty to charges of fraud and other crimes, this is merely the latest in a string of cases where a combination of reckless mismanagement, deliberate fraud and inadequate regulation has cost unwary investors dearly.
Indeed, the problems extend well beyond FTX. According to data obtained by the FT from police unit Action Fraud, financial losses to crypto fraud in the UK totalled £226m in the 12 months to October 2022 – up by nearly a third on the previous year. Across the Atlantic, a report published by the Federal Trade Commission in June 2022 estimated that losses to crypto fraud in the US since the start of 2021 had topped $1bn.
Why the worst is yet to come
Prudent investors might presume that such cases would deter all but the foolhardiest from taking big risks in the crypto markets, leading to a natural decline in fraud. But experts such as Lewis Duke, a senior specialist in SecOps risk and threat intelligence at cybersecurity software firm Trend Micro, disagree.
Fraudsters will exploit uncertainty and target those trying to recover lost investments
He predicts an upsurge in crypto fraud in the short to medium term because both criminals and honest investors will be highly motivated to chase losses caused by the FTX debacle. The impact of the exchange’s collapse is also putting downward pressure on the values of the main cryptocurrencies, which are already worth far less than they were a year ago. One bitcoin, for instance, was trading at around the $44,000 mark at the start of March 2022. Twelve months on, it was worth about $24,800.
“Fraudsters will exploit uncertainty and target those trying to recover lost investments through fake exchanges and scams involving initial coin offerings,” Duke says. “For the threat actors, there is the extra motivation of the reduced monetary value of the digital currency, as well as the potential for large financial losses should an exchange or currency go offline.”
Daniel Seely, an associate specialising in crypto matters at law firm Freeths, agrees. He explains that, while there’s always a certain level of fraud in this field, it tends to rise when an exchange fails, because it offers criminals an extra way to swindle distressed investors.
“Once a site is known to have gone down – even temporarily – fraudsters will take it as an opportunity to impersonate its staff and contact affected customers,” he says. “They’ll often approach victims with an offer to help ‘resolve problems with their account’, which they claim arose from the outage, and use this as a pretext to obtain information such as passwords, encryption codes and other sensitive data.”
Could the FTX scandal be an inflection point?
One potential silver lining from the FTX scandal and its predecessors is that legitimate exchanges are cooperating more proactively with investigators trying to recover users’ funds. That’s the view of Josh Chinn, co-founder and director of Wealth Recovery Solicitors.
Getting help used to be a long and costly process for fraud victims, but the exchanges – acutely aware of their sector’s Wild West image – have become more willing to offer assistance, he explains.
“Since the FTX scandal, we’ve seen a huge shift in the way exchanges and end points deal with us,” Chinn reports. “In the past, end points usually wouldn’t cooperate until our clients had incurred fees to obtain court orders requiring them to do so. Exchanges are being more cooperative, providing disclosures and helping us to work towards recovering lost assets.”
The rise of crypto regulation
The other positive development concerns regulation. The UK’s proposed regulatory framework for crypto providers is particularly rigorous. The FTX case is almost certain to build support for this more stringent set of rules to be enacted as quickly as possible.
Andrew Parsons, a partner at law firm Womble Bond Dickinson, believes that the UK could emerge as a leader in legitimate cryptocurrency transactions as a result. Obtaining a registration with the Financial Conduct Authority (FCA), which oversees the UK’s anti-money-laundering rules, represents a high regulatory hurdle for crypto providers to clear. Their reward for surmounting it could be winning the confidence – and business – of the many investors who don’t deal with unregulated entities, he says.
“Getting authorised by FCA is a long and complex process, while ensuring compliance is always burdensome,” Parsons says. “As more unregulated crypto exchanges collapse, it’s possible that more people may see the benefits of regulating exchanges in the way the UK is proposing. There are definitely opportunities for exchanges that are willing to put in the time, effort and money to secure FCA authorisation.”
That doesn’t improve matters much in the short to medium term, of course. Neither does the new level of cooperation with investigators, which applies only once an investor has been conned.
Sadly, then, the experts’ warnings are likely to be accurate. The criminals are using this particularly turbulent period in the crypto markets to redouble their efforts to defraud people who’ve already made big losses and are in a vulnerable state. The best advice for those distressed investors, therefore, may well be: trust no one – least of all the ‘helping hand’ who arrives out of the blue offering to recover their money.
