Compliance

Cryptocurrencies: What Type Of Gamble Are They?

Christopher LaVigne and Harvey Knight, 30 October 2020

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Recent Regulatory Developments
Both UK and US regulatory and law enforcement agencies have taken action to combat cryptocurrency-related fraud schemes. For example, the FBI warned in April 2020 that "[f]raudsters are leveraging increased fear and uncertainty during the COVID-19 pandemic to steal your money and launder it through the complex cryptocurrency ecosystem." The FBI reiterated that many of these schemes rely on tried and true fraudulent tactics, including blackmail attempts, charitable donation scams, solicitation of payments for non-existent treatments or equipment, and "too good to be true" investment scams.  

The US National Counterintelligence and Security Center (“NCSC”) has launched a "Cyber Aware" campaign to help consumers mitigate cyber security threats. This campaign revealed that as of April 2020 the NCSC had disrupted and removed more than 2,000 such scams. Similarly, the US Department of Justice (“DOJ”) announced in April 2020 that it had disrupted "hundreds" of COVID-19-related cyber scams. In a recent example, the DOJ charged a California-based lawyer with conspiracy to commit money laundering and bank fraud for running an alleged Ponzi scheme ring in which "memberships" in a cryptocurrency mining and trading firm, called AirBit Club, were marketed to investors with the promise of guaranteed profits, though no Bitcoin mining or trading ever took place and the defendants spent the victims’ money on luxury expenses instead.  

While these regulatory and law enforcement efforts are laudable, investors must realise that they cannot rely on these efforts to make them whole. First, though government agencies have become more adept at tracing and securing stolen crypto-assets, there is still no guarantee that stolen crypto-assets will be located and secured for victim restitution. In the US, some government agencies have announced partnerships with private exchanges like Coinbase and Chainanalysis to use those companies' blockchain analytics tools to trace cryptocurrencies used for illicit activity such as fraud, extortion, and money laundering. Other US agencies have developed their own analytics programmes. 

Similarly, in January 2020, Her Majesty's Revenue and Customs (“HMRC”) offered £100,000 to any developer that could build software capable of detecting when cryptocurrencies are being used to avoid paying taxes. These efforts are paying off: for example, on 27 August 2020, the US DOJ filed a forfeiture action involving two North Korean actors who stole over $250 million worth of alternative cryptocurrencies. The money was laundered over several months through multiple intermediary addresses and other virtual currency exchanges in a process known as “chain-hopping,” converting it into Bitcoin, Tether, or other forms of cryptocurrency which are more difficult to trace.  Despite the sophisticated laundering techniques used, the DOJ was able to trace the illicit transactions.   

Despite this, scammers are able to conceal stolen cryptocurrencies by breaking down those currencies into small denominations and transferring them over hundreds or thousands of transactions, through unregulated foreign exchanges, and through dozens of wallets. As the Wall Street Journal recently aptly put it, tracking stolen cryptocurrencies movement across an entire blockchain is "daunting" and victims may never see their stolen cryptocurrency again.  

Second, regulatory and law enforcement efforts are often lengthy endeavours.  For example, the US Secret Service (“USSS”) seized roughly $6.5 million worth of cryptocurrency from an alleged Ponzi scheme in which an administrator of "Banana.Fund," believed to be a British national, solicited cryptocurrency investments from retail investors and used the funds for personal expenses, including purchasing a house. While such prosecutions are promising, the legal maxim "justice delayed is justice denied" is appropriate: US prosecutors filed this action on 29 July 2020, but one of the victims complained to Coindesk that he had been pushing the USSS to investigate Banana.Fund since May 2018. 

Third, regulatory and law enforcement efforts may inadvertently cost investors money. The US Securities and Exchange Commission’s (“SEC”) recent lawsuit against Telegram provides a cautionary tale. The SEC sued Telegram, a private messaging app, for failing to register its marketing and sale of tokens to investors. The US court hearing the lawsuit agreed with the SEC. Telegram appealed the court's decision, but ultimately decided to abandon its distribution of the tokens. As part of its settlement with the SEC, Telegram offered US investors a refund of only 72 per cent of their investment, and offered non-US investors the choice of receiving an immediate 72 per cent refund or treating their investment as a loan in exchange for 110 per cent return in a year.  

Similarly, the SEC recently announced a $6.1 million settlement with online gaming and gambling platform Unikrn for conducting an unregistered initial coin offering. The SEC stated that the settlement accounts for substantially all of the company's assets. The settlement forced the company to publicly defend its ability to continue to doing business, and provoked a dissenting public statement from SEC Commissioner Hester M Peirce, also known as “Crypto Mom,” that she does not agree with the enforcement efforts or the settlement amount, which will “effectively forc[e] the company to cease operations.” 

These are only two examples, but they illustrate that while government regulations are designed to root out fraud and protect investors, the results and costs of enforcement efforts may destroy investors' ability to recoup the value of their investments. 

Be diligent
Outside of government actions, there are a number of legal remedies available to victims of crypto-asset fraud through the English and American courts. Victims can file civil actions for fraud (among other causes of action) and seek to seize stolen funds.  Recent court decisions have issued rulings to make such efforts easier for victims. For example, in a decision earlier this year (AA v Persons Unknown [2019] EWHC 3556 Comm) the UK High Court confirmed that cryptocurrencies are 'property' under English law, allowing victims to obtain proprietary injunctions to, e.g., prevent the transfer of stolen assets. The decision was influenced by a legal statement produced by the UK Jurisdiction Taskforce, which clarified that crypto-assets have legal status as property (consistent with how HMRC has treated these assets).  

However, civil lawsuits are often complicated and lengthy endeavours. Infamously, civil litigation stemming from Mt. Gox’s loss of approximately 850,000 Bitcions has been ongoing since 2014 and has been tied up with multiple bankruptcy proceedings in the US and Japan.

Investors’ best bet is not to rely on advertisements and to conduct their own independent and thorough research regarding whatever crypto-asset investment they are contemplating. The FBI has issued a non-exhaustive list of tips that investors should consider when making any crypto-asset investment:

-- Any charities, investment platforms, and e-commerce sites that pressure investors to pay with virtual currency should be considered a significant red flag, and investors should verify that a vendor or charity is legitimate before donating or sending cryptocurrency;
-- Conduct extensive research on potential investment opportunities;
-- Do not use personal bank accounts for work-from-home business-related activity or provide your bank account information to someone who is not named on the account; and
-- Contact law enforcement before paying out blackmail and/or extortion attempts and before converting your money into cryptocurrency to pay racketeers.

These are just a few things that investors should be aware of to avoid poor crypto-asset investments. In light of the risks outlined above, investors should conduct serious due diligence before investing their money in crypto-assets. Failing to do so is a gamble and investors may find themselves gambling with litigation - either on their own or in connection with government regulatory efforts - in order to recoup their losses or to protect themselves.  

Footnote:
1,  The FCA's preference is to use the term "crypto-asset" rather than "crypto-currency" though it acknowledges crypto-currency is the more widely used term in the public domain. The terms are used interchangeably here.

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