In 2017, thousands of investors in over 175 countries found themselves empty-pocketed after investing nearly $4 billion in a cryptocurrency called OneCoin. The mastermind behind the project, Ruja Ignatova, disappeared, with the entire crowd believed to be missing.
This news struck a chord in the cryptocurrency world. The BBC even dedicated a podcast to him. And while this case was a large-scale scam, the fact remains that fraudulent schemes are common in the world of crypto assets, which includes cryptocurrencies (like Bitcoin) and non-fungible tokens (NFTs). Owning these tokens grants investors rights that can take different forms (either access to an asset – like a work of art – a service, or something similar like owning a share).
I have been interested in fraud studies for many years, first in my professional practice as a chartered accountant and forensic accountant, then as a researcher. I am particularly interested in the factors that lead to fraud and the indicators and effects of fraud. More recently, my interest has focused on crypto-asset related scams, as these new technologies bring new risks and limitations that both users/investors and regulators face.
A frightening amount of fraud
A 2018 report by a crypto-asset company estimated that nearly 80 percent of all initial coin offerings (ICOs) launched in 2017 — like new cryptocurrency issuance — were fraudulent. Of course, it’s not possible to accurately measure the number of fraud cases that occur each year, not least because most go unreported to the proper authorities. However, this alarming number should still ask potential investors how to manage the risks they are taking.
It should be noted that crypto assets are subject to little or no regulation around the world. Regulators such as the Autorité des Marchés Financiers in Québec and the Security and Exchange Commission in the United States have been working on this issue for some time, but regulation is lagging behind in certain areas. One reason for this is the decentralized and borderless nature of these investments, which makes developing and enforcing laws and regulations particularly difficult.
Traditional indicators of fraud
Investing in crypto assets falls under the field of financial technology, commonly referred to as FinTech. The tools for investing in FinTech differ significantly from those used in traditional finance. Investors in FinTech are often driven by the quest for quick profits that border on speculation.
The fact is that fraudulent signals, which have existed in traditional finance for a very long time, such as stock market investments, are also present in FinTech. Just think of incredible promises of returns that go far beyond what regulated markets generate. Or the pressure that some marketers of financial products put on investors to act quickly, pushing investors to place their money without taking the time to consider their decision.
This urgency is particularly felt by investors when a promoter plays on their fears of missing out on an incredible investment opportunity, encouraging them to put their money down quickly to outpace others. A parallel could be drawn with in-store promotions of products sold at reduced prices while claiming that quantities are limited. However, in the case of investments, this often proves to be more of a fraudulent scheme than an attractive opportunity.
Explanatory documents, not regulatory documents
The technological aspect of crypto assets has led to the emergence of new fraud indicators. Because these differ from what investors are used to hearing from those who inform them about risks – including investment advisers – it is very important that investors pay close attention to the projects in which they intend to invest.
Indeed, the absence (or near absence) of regulation means that for now, investors alone are responsible for protecting themselves against the fraudulent schemes rife in the industry. Some mutual funds offer cryptocurrency exchange-traded funds. The fact remains, however, that these investments carry a risk of volatility.
As with a traditional investment, the teams behind the ICO publish a so-called “white paper”. Similar to a prospectus for a public offering – such as when a company raises additional funds through a stock offering – this document provides the potential investor with a wealth of information about the proposed project. It explains, among other things, how the project works and who the team is behind it.
However, that is where the similarities with prospectuses end, because unlike the latter, white papers are not regulated. An issuer can therefore show what it wants and, conversely, omit information that could prove useful to a potential investor.
It’s important to note that for most projects, anyone can edit a white paper. However, regulators strongly recommend that the company in question be registered, not only to build trust with potential investors but more importantly to ensure compliance with applicable regulations.
New fraud signals
There are new scam signals unique to crypto assets. We’ve seen white papers that contain conflicting elements, inconsistencies, or even errors on behalf of a company behind a project. Some whitepapers are copied from other projects and quickly revised, leaving typos behind. It should be noted that an ICO is usually a unique project and a copy usually signals a fraudulent project.
Another indicator of potential fraud is a white paper in which certain passages are too complex to read easily. This should cause the potential investor to question the seriousness of the project. The main purpose of a white paper is to inform an investor, so abstruse language should never be used for projects that are presented as coherent.
In addition, due to the technological complexity of the work, the team behind the project is particularly important for its success. So, if the project documentation doesn’t include a description of the team, whether it’s in the white paper or on their website, this absence should raise questions for an investor.
Incidentally, it is usually quite easy to get in touch with the team behind an ICO to ask questions or get additional information about the project, which is not the case with traditional finance. If a potential investor cannot get in touch with the team, there is again reason to question the seriousness of the project.
The occurrence of any of the fraud signals described above does not necessarily mean that a project is fraudulent. However, recognizing these signals will better position an investor to manage the scam-related investment risks that are particularly pervasive in the crypto-asset ecosystem.