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Cryptocurrency Fraud & Whistleblowers: A Guide

Cryptocurrency or digital assets are a type of virtual currency that can be used in exchange for goods and services or as an investment. Unlike dollars, which are secured by a government or bank, digital assets are secured by a blockchain system with an open ledger recording transactions.

What is cryptocurrency fraud?

As cryptocurrencies have gained popularity and complexity, so too has cryptocurrency fraud. According to the Federal Trade Commission, cryptocurrency scammers have stolen more than $1 billion since 2021. In one example, both the Department of Justice and the U.S. Securities and Exchange Commission (SEC) took action against people for orchestrating a $1.9 billion cryptocurrency pyramid scheme in January 2024. Now scammers are using Non-Fungible Tokens (NFTs) and decentralized finance (DeFi) for their fraud practices.

One reason cryptocurrency is popular with scammers is there is no bank or centralized authority to flag suspicious activity and stop fraud before it happens. Also, cryptocurrency transfers cannot be reversed, so once the money is gone, it is lost. Finally, most people are still unfamiliar with how cryptocurrency works, playing into scammers’ hands.

Types of Cryptocurrency Fraud

Investment Scams

Investment scams start with false promises of easy money paired with people’s limited knowledge and experience with cryptocurrency. Scammers claim quick and easy returns for investors, but the “investment” goes to the scammers’ crypto wallet. The underlying investment changes as the technology evolves. Now, in addition to fraudulent investments in tokens, scammers are luring victims with fake NFTs and more complex DeFi schemes.

Liquidity Mining Scam

Liquidity mining is a popular and often legitimate method for cryptocurrency owners to earn passive income by loaning their tokens to decentralized exchanges. But scammers have made this strategy more dangerous. They exploit owners of cryptocurrency and entice them to participate in liquidity mining by guaranteeing a return on investment. Scammers convince victims to link their cryptocurrency wallet to a fraudulent liquidity mining application and then wipe out the funds without notification or permission from the victim. Since January 2019, according to the FBI’s Internet Crime Complaint Center (IC3) and open source, this scam has been responsible for over $70 million in combined victim losses.

Broker-dealer Fraud

The SEC examines the entities investing in cryptocurrencies that may need to register as broker-dealers or exchanges in some circumstances.

Fake ICOs

When a cryptocurrency is first offered for sale, called the Initial Coin Offering (ICO), it presents the perfect time to scam the uneducated in cryptocurrency. Fraudsters can copy whitepapers and bios of fabricated people associated with the ICO from legitimate cryptocurrencies.

Wallet Theft

Cryptocurrency assets provide another avenue for theft. Criminals can hack crypto wallets and steal digital assets, set up fake wallets, and even set up phony crypto exchanges to steal crypto assets.

Ponzi and Pyramid Schemes

Crypto investments can be a vehicle for pyramid and Ponzi schemes where new people are recruited to give returns to the early investors. In August 2022, the SEC charged 11 individuals in a $300 million cryptocurrency pyramid scheme. The individuals created and promoted Forsage, a fraudulent crypto pyramid and Ponzi scheme that raised more than $300 million from millions of retail investors worldwide. These scams can be run using tokens or NFTs.

Pump and Dump Schemes

This is most common with small-cap cryptocurrencies, pump and dump is a form of securities fraud that involves artificially inflating the price of a cryptocurrency through false and misleading positive statements (pump), to sell the cheaply purchased stock at a higher price (dump). Once the operators of the scheme “dump” (sell) their overvalued shares, the price falls and investors lose their money. In September 2022, the SEC filed charges against Arbitrade Ltd., a Bermudan company, and Cryptobontix Inc., a Canadian company, and their principals, for perpetrating an alleged pump-and-dump scheme involving a crypto asset called “Dignity” or “DIG.”

DeFi Rug Pull Scam

DeFi cryptocurrency scammers can create a new token project and then, after enough investors have pushed the price higher, walk away with all the money in what is called a “rug pull.” These rug pulls can work in different ways. A common method is by programming the token to steal from investors. For example, a fraudster will program a crypto token’s underlying smart contract to make it impossible to sell the token, allowing the scammer to mint unlimited new ones, or charging huge trading fees. Scammers can also steal the liquidity from the new token. They create a liquidity pool, wait for investors to buy in, and then withdraw all of the valuable tokens from the pool.

Exchange Fraud

Scammers will lure investors with the promise of a great cryptocurrency exchange, maybe even promising some additional digital assets. Instead, there is no exchange and the investor doesn’t realize it is fake until after they have lost their deposit.

Regulatory Oversight of Cryptocurrency

The U.S. Department of Justice, the U.S. Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Financial Crimes Enforcement Network (FinCEN), and the Internal Revenue Service (IRS) all have some regulatory control over cryptocurrency.

The SEC, the agency that regulates investment contracts, can require cryptocurrency to register as an investment and regulate it. Under the federal securities laws, a company may not offer or sell securities unless the offering is registered with the SEC or an exemption to registration is available, according to the Commission. These laws require securities broker-dealers, investment advisors, alternative trading systems (ATS), and exchanges to register with the SEC, a state regulator, and or a self-regulatory organization (SRO), such as FINRA. Also, platforms and parties involved in lending or staking crypto assets may be subject to federal securities laws. And the Commission takes its authority very seriously, making cryptocurrency enforcement a top priority over the past few years.

The CFTC also has regulatory authority over some cryptocurrencies as commodities traded under the Commodity Exchange Act. The CFTC has also expressed enforcement of cryptocurrency remains a top enforcement priority because of its high risks for investors. In June 2022, the CFTC ordered Mirror Trading International Proprietary Limited to pay over $1.7 billion in restitution to defrauded victims, the CFTC’s largest fraud scheme involving Bitcoin to date. The company defrauded over 23,000 foreign currency (forex) investors and failed to comply with commodity pool operator regulations.

FinCEN regulates all crypto assets for purposes of anti-money laundering and combating the financing of terrorism. In 2013, FinCEN said that “administrators or exchangers” of virtual currency qualify as money services businesses under the Bank Secrecy Act (BSA) and FinCEN regulations. In the Anti-Money Laundering Act of 2020, Congress made explicit that businesses that exchange or transmit virtual currencies qualify as regulated entities. Money services businesses must register with FinCEN and maintain an anti-money laundering (AML) compliance program.

Finally, the IRS has taken the position that cryptocurrency investments are assets that should be treated like any other asset for tax purposes. The agency can also pursue cryptocurrency used in money-laundering crimes.

As with most frauds, whistleblowers will be integral in helping the SEC, CFT, and IRS enforce securities and commodities rules governing cryptocurrencies.

Protections for Crypto Fraud Whistleblower

Because cryptocurrency can be regulated by various federal agencies, several laws can protect possible cryptocurrency whistleblowers, including providing confidentiality and potential rewards for reporting fraud if money is recovered. It is best to talk to an experienced whistleblower attorney to learn more.

How Do You Become a Cryptocurrency Fraud Whistleblower?

Becoming a whistleblower is one way to make authorities aware of cryptocurrency practices that violate the law or cheat investors.

Before you decide to blow the whistle on cryptocurrency fraud, it is important to talk to an experienced whistleblower attorney about your rights, the risks, and the possible benefits of pursuing a case.  

When choosing a whistleblower lawyer, consider Phillips & Cohen which has represented whistleblowers in qui tam and other government whistleblower reward programs for over 30 years.  We are the most successful whistleblower law firm, with more than $13 billion in recoveries from our cases.   

If you know of wrongdoing or fraud by your employer or another entity, you can take steps to stop it. Talk to experienced whistleblower lawyers and contact us for a free, confidential review of your matter.

Crypto Fraud & Whistleblower FAQs

What evidence should I gather before reporting crypto fraud?

Gather all relevant communications (emails, messages), transaction records, account statements, and any digital footprints that indicate fraudulent activity. Detailed records of dates, amounts, and parties involved will strengthen your case.

What if I only have suspicions and no concrete evidence of crypto fraud?

Report your suspicions with as much detail as possible. Regulatory bodies and investigators can use your information as a starting point for a deeper investigation. It’s important to come forward even if you feel your evidence is not conclusive.

Can I report crypto fraud that occurred internationally?

Yes, you can report international crypto fraud. Many regulatory bodies have mechanisms for dealing with cross-border fraud, and crypto assets often fall under the scrutiny of multiple jurisdictions.

How long does the process of investigating and addressing crypto fraud typically take?

The process can vary greatly, ranging from several months to a few years, depending on the complexity of the fraud, the jurisdictions involved, and the efficiency of the investigative bodies. Patience is key, as thorough investigations take time to gather sufficient evidence for legal action.

Remember, reporting crypto fraud is a significant step in combating illegal activities in the digital finance world. Your actions not only help in potentially recovering lost assets but also protect others from falling victim to similar schemes.

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