Crypto Scams: An Advanced Guide to Cryptocurrencies

Many scams and phony cryptocurrency schemes have scared investors. Here’s a deep dive into crypto scams and how to avoid them.

Shankar Iyer - Author

Jan. 3 2020, Published 11:58 a.m. ET

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News of Facebook (FB) creating a new crypto coin, Libra, broke in June 2019. CNBC reported that Facebook and 27 other organizations were working together on the project. However, since the news release, the project has faced its fair share of woes, from Zuckerberg’s testimony in Congress to members distancing themselves from the project. Many regulators have had issues with Zuckerberg’s crypto project, and according to WIRED contributor Molly Wood,”this guy is still right on plan for global domination.”

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An intro to cryptos

In one of my earlier posts, Cryptocurrency in 2020: A Beginner’s Guide to Trading, I talked about crypto markets’ fundamentals and stock market experts’ perception of bitcoin (BTC). The post also touched upon some crypto fundamentals, such as crypto exchanges, ICOs (initial coin offerings), and blockchain tech. In this article, the second part of the series, I’ll provide insights into scams that plague the crypto community. Such scams have highlighted the need to implement regulations and streamline crypto investments and trading activities. Many of the past scams have built a learning curve for investors and regulators.

Unlike stock markets, the virtual currency domain has a lot of grey areas, particularly in the dissemination of material public information. And this lack of transparency makes investors more susceptible to scams. The risk of scams is something all crypto investors should keep in mind.

A word of advice for crypto investors

Cryptocurrencies use blockchain networks to power transactions and maintain records. All activities are encrypted and spread across the blockchain in a distributed ledger. In simple terms, all virtual currencies are decentralized, and there is no federal regulator to safeguard crypto investors. There have been many scams and phony cryptocurrency schemes in the past that have scared investors. This post will educate investors on crypto scams and how to avoid them.

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Mt. Gox security breach in 2011

One initial setback in the crypto domain was the closure of Mt. Gox in 2014. Mt. Gox was a well-known Japanese crypto exchange that operated from 2010 to 2014. According to Blockonomi, the trading platform was so popular that it hosted almost 70% of all bitcoin transactions at the start of 2014. With that kind of momentum, it could have become the market leader for all crypto transactions by 2019. But something went wrong. The exchange filed for bankruptcy in its home country and then in the US in February 2014.

The Mt. Gox episode gained steam after the news of a massive theft was made public in 2014. The breach had taken place long before it made news. Blockonomi reports that in 2011, hackers breached the platform through compromised credentials and manipulated bitcoin’s price in the exchange portal. The attackers made deals at the manipulated price and transferred around 2,000 bitcoins from customer’s accounts to their wallets, according to Cointelegraph. Mt. Gox reported that the hackers had gained access to customers’ hot wallets (or online wallets). Despite the hack and coin transfers, Mt. Gox continued to operate and even became the world’s largest bitcoin exchange in 2013, according to Blockonomi.

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Mt. Gox files for bankruptcy in 2014

The hack went unnoticed for years. However, early signs were visible in 2013, when traders started facing issues while withdrawing funds from their Mt. Gox accounts. Partners and associates of the exchange filed lawsuits citing a breach of contract. Finally, in February 2014, Mt. Gox filed for bankruptcy and, by the end of the month, halted trading activities.

Mt. Gox claimed that 850,000 bitcoins were missing from the exchange’s wallets, according to Cointelegraph. Of the total loot that disappeared, 100,000 bitcoins belonged to Mt. Gox, and the remaining 750,000 belonged to customers. Cointelegraph valued the missing bitcoins at $473 million at the time of the theft. Regulators started investigating the incident. Before getting arrested, former Mt. Gox CEO Mark Kerpeles claimed to have recovered around 200,000 bitcoins from an offline wallet (or cold wallet), reports Cointelegraph.

Mt. Gox was way ahead of the game in the crypto realm. Unfortunately, the cyberattacks exposed its lack of security and poor governance model. The exchange has been held responsible for not taking preventive security measures.

A key takeaway from Mt. Gox

From the Mt. Gox incident, we learned that an exchange is vulnerable to hacking if it doesn’t update its security regularly. Cybercriminals are always on the lookout for network weaknesses. Investors should look for exchanges that implement new security features or regularly upgrade them to stay ahead of such threats. If your crypto exchange has not seen any innovations or upgrades in six months, you should be concerned and consider another exchange.

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Failed IPOs and fraudulent ICOs

Remember the WeWork fiasco and its failed IPO? Just before the WeWork IPO, cracks began to emerge in its business model. WeWork CEO Adam Neumann was said to be creating a conflict of interest for the company, whose $47 billion valuation turned out to be a colossal mistake. OTC (over-the-counter) investors began to turn away from the company. The news hurt the reputation of WeWork’s primary backer, Softbank CEO Masayoshi Son. One of his successful ventures was Chinese e-commerce giant Alibaba.

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Now, hypothetically, what if WeWork had issued cryptocurrency instead of stocks? A lack of regulation and incorrect business valuation are genuine risks for ICO investors. Many investors may have believed WeWork’s hype and followed Son based on his previous track record as a venture capitalist. All the grey areas and conflicts of interest would have come to light only after the ICO and fundraising were over. And such cash-grab fundraising scams do happen—let’s look at a specific case in the crypto sphere.

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The Chinese PlusToken scam

Chainalysis, a software company established in 2014, recently released an excerpt from its 2020 report on crypto crime. The excerpt, published in December, talked about PlusToken, a Chinese cryptocurrency scam where scammers got hold of high-value cryptos through a fake ICO and cashed them through OTC crypto traders anonymously. The report explained PlusToken scammers duped many investors and got hold of around 180,000 bitcoins, 6.4 million ethereum, and approximately 111,000 tethers. Collectively, this amounted to over $3 billion at the time of the ICO fundraising, according to Chainalysis.

In the excerpt, Chainalysis explained that investors subscribing to the token launch received the company’s in-house crypto coins, PLUS tokens. To make the cryptocurrency seem genuine, the scammers listed PLUS in some Chinese crypto exchanges, reports Chainalysis. The cryptocurrency did so well that it touched $350 on some Chinese exchanges. But in the end, it turned out to be another “Ponzi scheme,” according to Chainalysis experts.

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Even though law enforcement officers in China have caught some of the criminals involved, the stolen cryptocurrency is still missing. According to the Chainalysis excerpt, a significant portion of bitcoins was dumped and cashed on Huobi, a crypto exchange with minimum KYC (know-your-customer) requirements. Chainalysis also discussed how OTC crypto brokers might have aided in laundering. These brokers have maintained anonymity.

Key takeaways from PlusToken

The PlusToken scam happened because blockchain networks assure all participants anonymity. This assurance shouldn’t be used as an excuse by exchanges to adopt minimal KYC requirements. The PlusToken scam teaches us that investors should stick to trading exchanges with a proven track record. They should have a high KYC benchmark and conduct background checks. Investors should also carefully research companies they are investing in.

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Another indicator of potential problems could be the government’s approach to crypto exchanges in the exchange’s host country. For instance, as Asia Times reports, the People’s Bank of China has been cracking down on crypto exchanges. Although Chinese president Xi Jinping is strictly against crypto trading, he has encouraged the adoption of blockchain tech in the country. According to CNBC, Jinping aims for China to become the world leader in blockchain technology. Given this momentum, a Chinese company could make a breakthrough with blockchain tech. However, I would suggest investors exercise caution when engaging with startups launching ICOs through Chinese crypto exchanges.

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Types of crypto scams from 2014 to 2019

In addition to Mt. Gox and PlusToken, there have been many other crypto scams over the last five years. Some have involved fake ICOs and Ponzi schemes, whereas others have involved hackers breaking into exchanges to steal cryptos from customer accounts. Let’s look at some of the common types of scams investors should watch for.

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Individual hacking

In some incidents, scammers have targeted crypto investors through phishing attempts on social media. They then gain access to these investors’ private keys for their crypto wallets. Some scammers have created fake online wallets and stolen private unsuspecting investors’ keys as they log in.

Crypto scams and fraudulent ICOs

Scammers have also cheated investors through fraudulent ICOs, as we saw with PlusToken. Most scammers who launch an ICO keep their identity anonymous or use fake handles. They use flashy marketing and promises of exponential gains to lure investors. These scammers copy other token’s whitepapers and pass them off as their own. They also hasten the ICO process to avoid investors’ questions about their startup, its vision, its management, and the services backed by the token.

Another fraudulent ICO was that of Benebit. In January 2018, detailed the scam, which reportedly made $2.7 million.

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Crypto pyramid schemes

Multilevel marketing schemes, or pyramid schemes, may also be used to defraud crypto investors. Such startups promise large returns on investment within a short period, and typically deploy other members to rope in new participants. Once the member list becomes substantial and the fraudsters get a sizeable deposit, they vanish, leaving all investors fuming. The best way to identify such schemes is to look at the project’s background. Such projects tend to avoid any recognized companies or bureaus and have very little verifiable background information.

The classic pump-and-dump for cryptos

Another form of crypto fraud is the pump-and-dump scheme of price rigging. Once common in stock markets, price rigging faded after the SEC stepped in. However, this strategy is still in practice in crypto trading. Some OTC crypto brokers tend to manipulate prices for altcoins. Cointelegraph published a report in December 2018 about pump-and-dump groups active on messaging apps. Quoting Bloomberg estimates, Cointelegraph reported that over 4,800 separate attempts were made to manipulate prices between January and July 2018.

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Virtual currency fraud is a pervasive problem. However, the entire crypto domain isn’t a scam. There are many good startups around the globe with innovative business models that are worth investing in. These entrepreneurs rely on crowd sales through ICOs to raise funds. They ensure that all investors receive timely responses to queries. You can get details about their operations or business model on websites such as Top ICO List and TokenMarket, which compare new and active ICOs.

In many ways, digital assets represent a new era of investing and trading. However, their decentralized, global model is difficult for federal governments to tame. In my opinion, the crypto space needs some actionable guidelines and a comprehensive approach. The US has taken some measures to regulate the crypto space, such as drafting the Cryptocurrency Act of 2020 and approving the launch of Bakkt, the first regulated exchange for bitcoin futures. How other nations react to these regulations will determine the fate of cryptos in 2020.


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