Cryptocurrencies rise — so does fraud

The blockchain analysts at Chainalysis have done a valuable service by publishing a preview of their latest Crypto Crime report. It provides a timely reminder that cryptocurrency fraud is alive, well, and growing. Caveat emptor — buyer beware!

Cryptocurrency scams, ransomware and theft in 2021 went up by 79% in Dollar terms: a record $14 billion went into crime-linked crypto wallets last year. But given the anonymity this ‘black’ market understandably craves, how do we know that is the true figure? Might it not be $15 billion, or $10 billion?

Nevertheless $14 billion sounds (and is) a lot. But the report hastens to provide a supposedly comforting context: in 2021 the overall crypto market expanded by 550%, with almost $16 trillion of cryptocurrencies traded, so the report also suggests that “crime is becoming a smaller and smaller part of the cryptocurrency ecosystem.”

In one year the has expanded five times; this has proved rich resource for thefts and scams such as “rugpulls”, where scammers persuade investors to put money into a new token before disappearing. Perhaps the best/worst example in 2021 of a rug pull was the creation in November of a cryptocurrency called Squid Coin, inspired by the popular South Korean Netflix series Squid Game. The coin’s value spiralled by 83,000% over a few days, thanks partly to wide media coverage. Then the coin’s developers quickly cashed out their coins and made off with an estimated $3.38 million stolen from — how should one describe them? The gullible? The greedy? The people who wanted to make an easy fast buck? FOMO ruthless!

but so does fraud. Crypto crime goes up, but relatively slowly (maybe). Three cheers?

What is ‘DeFi’?

DeFi stands for ‘Decentralised Finance’. This contrasts with ‘centralised finance’, where money is held by banks and corporations and other third parties — each one taking a tiny fee on transactions. DeFi is “the next step in the revolution in disruptive financial technology that began 11 years ago with bitcoin.”

DeFi promises to utterly transform the ways we think about and handle monetary value. It’s sometimes referred to as ‘Lego money’ because with DeFi you can join together decentralised apps (dAPPs), which run on a blockchain computer system and operate autonomously, to construct one’s financial life without any centralised agency standing in the middle; dAPPs spell doom for all kinds of middlemen entities. But as most of the computer code used by dAPPS is open source, the scope for criminal hackers is concomitantly widened.

With DeFi, algorithms supposedly handle all transactions; there is no human interaction between parties. This removal of human intermediaries and/or interference is one of DeFi’s main claims to superiority: no human = no human-type flaws such as mistakes or corruption.

DeFi takes control over transactions away from third parties (such as banks) but it does not provide anonymity. Your transactions may not have your name, but they are traceable by the entities that have access to the DeFi computer protocol. These entities might be governments, law enforcement, or other entities that exist to protect people’s financial interests. Sometimes, as reported to be the case in India last December, big companies ask employees to disclose their investments in cryptocurrencies, or risk punishment.

Functionally, DeFi protocols are venues for trading or lending crypto tokens and their derivatives. DeFi protocols are designed without any requirement that users reveal their identities — there’s no ‘know your customer’ (KYC) processes. This anonymity is a double-edged sword; no-one knows what you are doing with your money — but nor do you know what is being done with your money. This is what has encouraged the rise of cryptocurrencies — and also the fraud associated with them.

More than $92 billion of funds are currently locked into DeFi markets; some claim the figure last October was more than $195 billion. , . That $92 billion is a big chunk of change but is tiny compared to the global assets under management, which one source puts at more than $111 trillion now, rising to an expected $145 trillion by 2025.

Goldman Sachs now claims that the cryptocurrency Bitcoin currently has a 20% share of the “store of value” market; Bitcoin in other words can maintain its worth over time with no depreciation.

Astonishing, if true. But is it really true? Not according to Matt Stoller, who blogs about monopolies. He says: “Cryptocurrencies are a social movement based on the belief that markings in a ledger on the internet have intrinsic value. The organisers of these ledgers call these markings Bitcoin, or Dogecoin, or offer other names based on the specific ledger. That’s really all a cryptocurrency is. There’s no magic. It’s not money, though it has money-like properties. It’s not anything except a set of markings. Sure, the technology behind the ledgers and how to create more of these markings is kind of neat. But crypto is a movement based on energetic storytellers who spin fables about the utopian future to come.”

The energetic storytellers (one thinks of Elon Musk for example) might seem to undermine DeFi’s claim to be beyond any individual’s control; so-called ‘whales’, those who hold large amounts of cryptocurrency, “regularly more than $1 million” can by a single social media message have undue influence on cryptocurrency valuations. The whole crypto market is very tightly held, very illiquid, very opaque. How else to explain that Bitcoin between mid-April and mid-July 2020 fell by more than 50% only to double in the subsequent three months? Or to understand how Shiba Inu, another cryptocurrency, built on the Ethereum blockchain, which launched in August 2020 and cost $0.000000000073 per token at the start of 2021 (with a circulating supply of 1 quadrillion tokens) were changing hands at $0.00003305 by the start of this year, meaning Shiba Inu delivered a year-to-date return of 45,273,873%. Suppose you had invested $100 into Shib Inu on 1 January 2021, and held onto that stake throughout the entire year, you’d now be sitting on a a valuation of $45,273,973. Which defies common sense, but which also explains a lot about how cryptocurrencies have captured the imaginations of new and younger investors. Once upon a time cryptocurrencies were touted as challengers to authority, government control over money; they have morphed into get rich quick schemes, and through that temptation have also become honeypots put out by criminals.

Regulating the unregulated

DeFi’s proponents are proud of the fact that they elude much regulatory oversight. Given the terrible job done by regulatory authorities before and during the Great Financial Crash of 2008, one sympathises with the view that regulatory authorities have historically fallen down on the job.

And yet throwing aside the need for regulation of all aspects of the DeFi world would be to throw the baby out with the bathwater. One commentator says that “trying to regulate DeFi is a bit like trying to parent a super-powered 14-year-old who can fly, teleport, and turn invisible at will.” But no-one in their right mind would suggest not trying to parent such a 14 year-old. According to Hunter Horsley, CEO of index fund manager Bitwise Asset Management, “Regulatory uncertainty has been a risk in investors’ minds when it comes to DeFi…regulatory clarity is ultimately what would allow DeFi to get much larger.”

Just before the end of 2020, Singapore’s financial regulator suspended a digital currency exchange, Bitget; the exchange had advertised a digital token, Army Coin, as a way of providing lifetime financial support for fans (known as the BTS Army) of the South Korean music band BTS. According to the Financial Times this coin fluctuated “up to 78 times its value in a day, rising back and forth between $1,000 and $78,000 within minutes.” But given this is probably a token with a tiny profile it’s perhaps understandable that it can be so volatile. Bitcoin, the best-known cryptocurrency, has lost more than 39% of its value since hitting a record high of almost $69,000 on 10 November last year.

DeFi cannot be uncreated. With no single party in charge, it’s nearly impossible for someone to change the rules that govern it. Likewise, even if a government manages to prevent a bunch of computers from supporting cryptocurrencies, these digital assets can continue functioning because other computers on the network retain a full record of transactions and can carry on running the show. When China put a halt to cryptocurrency ‘mining’ last year, the ‘miners’ just upped sticks, moved to other countries, and continued business. Not for nothing did Barron’s christen DeFi the ‘wild West’ of cryptocurrency last October.

Officialdom moves in

In June 2021 headlines by announcing that Bitcoin would be accepted as legal tender. So far it has spent more than $70 million of its official reserves on acquiring 1,391 Bitcoins, which are currently worth $60 million.

Gaining much less media attention was the fact that more than 20 state legislatures in the US updated their banking statutes to accommodate cryptocurrency transactions. The city of Miami last year introduced the ‘MiamiCoin’, which the mayor, Francis Suarez, claims has already earned more than $21 million for the city. Maybe. But the biggest problem for cryptocurrencies is their ambition to become adopted en masse and replace fiat currency. So far that hasn’t happened and some argue that this is “part of the reason why the currency-of-the-future story of bitcoin’s value has given way to the digital-gold story. The latter just needs the price to go up to appear true.”

Central banks will not relinquish their control over what is regarded as legal tender, but they are going to embrace the DeFi world, albeit according to different timetables. While the world awaits a long-promised report from the US about how it plans to work with digital currencies, China will use the imminent Beijing Winter Olympics to roll-out to foreigners its own digital currency, the . If DeFi gains more than its current toe-hold, banks and corporations will find ways to get into the system; if not to control how you access your money, then at least how to make money from the system. Not that every country is set to introduce a digital version of its fiat currency; in the UK the chair of the House of Lords Economic Affairs Committee said this week that “the concept seems to present a lot of risk for very little reward.”

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

Cryptocurrencies may be a new class of financial asset; or they may be a new, grand Ponzi scheme. Their intended mission — to take control over money out of the hands of government and place it in the hands of the people who use it — has hit problems that are inherent to all human enterprises; corruption creeps in. Caveat emptor!



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