Cryptocurrency Fraud: Protect Yourself from Digital Currency Scams
Cryptocurrency is a digital asset that uses blockchain technology to record transactions and maintain ledgers, eliminating the need for a central bank or any type of financial middleman. Cryptocurrency does not require your identity to process transactions, although the transactions are not necessarily anonymous. It was developed to work like cash—a straightforward exchange between two individuals.
You have probably heard of various forms of cryptocurrency, like Bitcoin, Ethereum, and Dogecoin. Proponents of cryptocurrency want to de-centralize finance and move away from fiat currency. Fiat currency gets its value from a government backing, whereas cryptocurrency’s value depends on demand from its users.
Because cryptocurrency is a brand-new type of currency—Bitcoin made its debut in 2009—users are still figuring out the pros and the cons. A Wall Street Journal opinion piece highlighted the cryptocurrency market’s lack of regulation and the absence of regal recourse for crypto investors who lose money through no fault of their own. Cryptocurrency investors are taking on significant risks in uncharted territory.
How Do Blockchains Work?
“Blockchains” are digital ledgers. These are secure, encrypted chains of information. That information states how much Bitcoin is stored in your digital wallet, as well as a record of every transaction.
“Blocks” in blockchains contain data about transactions: The sender, the receiver, and the number of bitcoins. It also has a hash, which serves as a unique identifier. Blocks also have information about the previous block, which is what makes it a chain. Each block of the chain relies on complex cryptography.
Blockchains verify transactions using a peer-to-peer network. Each computer in a peer-to-peer network is called a node. When someone adds a new block to the blockchain, every node in the network checks to ensure the new block is legitimate. This is another layer of protection against tampering. If a hacker wanted to attack a blockchain, it would have to simultaneously hack into more than half of the computers in a network.
Cryptocurrency Mining vs. Staking
New blocks of the blockchain form either through “proof-of-work” or “proof-of-stake.” To create proof-of-work, computers must solve complex mathematical equations. This process is called “mining” and it requires a huge amount of power. Bitcoin has drawn substantial criticism for the polluting effects of mining. Proof-of-stake requires investors to agree to pool their coins and allow the blockchain to put them to work. The type of work depends on the cryptocurrency. Both mining and staking offer payment in the form of more cryptocurrency. Staking is more accessible to the average investor since it does not require significant amounts of electricity.
How Can I Use My Cryptocurrency?
As of 2022, only a small number of companies accept cryptocurrency as payment. At this stage, cryptocurrency is a speculative investment. Investors who purchase cryptocurrency are speculating that the price will increase, inspired in part by Bitcoin’s surges in price over the past few years.
Because Bitcoin is not yet widely accepted, investors who have Bitcoin may try to generate value by lending Bitcoin. If investors want a cryptocurrency that they can convert into cash, they may turn to something called a stablecoin. Stablecoin is a cryptocurrency that ties its value to something more stable, like the U.S. dollar. Stablecoins are designed to make it easier to convert Bitcoin to dollars. They hold a reserve of cryptocurrency on hand to back up their value and prevent volatility.
History of Cryptocurrency
Bitcoin followed on the heels of the Financial Crisis of 2008. The Financial Crisis pulled made many Americans question the reliability of the banking system. An anonymous person (or group of anonymous programmers) published a paper called “Bitcoin: A Peer-to-Peer Electronic Cash System.” The anonymous author(s) published the paper under the pseudonym Satoshi Nakamoto on October 31, 2008.
Today, one Bitcoin is currently worth thousands of dollars. Buyers can also purchase fractions of bitcoins—one one-millionth of a BitCoin is called a Satoshi.
Different Types of Cryptocurrency
Bitcoin’s software is open-source, making it easy for others to create their own version of cryptocurrency. Any coin that is not Bitcoin may be referred to as an “altcoin,” simply because it is in alternative to Bitcoin.
Bitcoin is one of the most well-known cryptocurrencies because it is one of the first to emerge, starting in 2009. It is joined by an increasing number of competitors. Ethereum, for instance, is a cryptocurrency that uses proof-of-stake instead of proof-of-work.
Cryptocurrency coins require intensive processes like staking and mining. Tokens—like Dogecoin—are much easier to create, adding another layer of uncertainty regarding their actual worth. The fact that they are easy to create makes them ideal for cryptocurrency scams.
Where Do I Buy Cryptocurrency?
Cryptocurrencies are sold over online-only exchanges. The two most well-known are Coinbase and Gemini. Investors should be wary of purchasing from more obscure exchanges—fake exchanges have been used to perpetrate fraud. There are also online brokers, like Robinhood, that offer cryptocurrency as well as traditional stocks.
Investors who want to speculate on the future price of a cryptocurrency might buy a cryptocurrency future or options contract. Options give investors the right to buy or sell a certain stock at a particular price by a deadline.
Risks of Cryptocurrency
Cryptocurrency comes with a variety of risks.
Digital Wallets May Not Be Secure
Online wallets hold your digital currency. If you forget your password or the exchange goes out of business, you will have lost all your cryptocurrency. There is no way to recover your money under these circumstances. You also cannot cancel cryptocurrency payments as you can with a credit card payment.
To own cryptocurrency, users must create a digital wallet with a secure password. There is no way to access the wallet if the password is lost—there is no company behind Bitcoin, and therefore no system in place to recover passwords.
Cryptocurrency Price Volatility
Cryptocurrency is extremely volatile. Supply and demand drive its fluctuations, and it’s not always clear, especially to the average investor, what drives those fluctuations. Cryptocurrency trades throughout the day, unlike regular stocks, which are limited to trading hours. This contributes to their volatility.
Investors who invest in crypto should be prepared for sudden, sharp drops in prices. For instance, on November 8, 2021, one Bitcoin was worth $67,582.60, but just three months later, on January 22, 2022, the price had plummeted to $35,070.10.
It is possible to lend Bitcoin and earn interest, but the loans are unregulated and it’s not clear how investors could enforce the terms of their loans.
Lack of Regulation
Beyond scams, one of the biggest threats to cryptocurrency investors is the lack of regulation. No regulators have been established to oversee cryptocurrency and no cryptocurrency exchanges have registered with the SEC.
Banks are backed by government insurance—the FDIC. If, for some reason, your bank does not have enough cash in hand to fulfill its obligations, the government will supply the necessary cash. There is no such fail-safe in place for cryptocurrency.
Programmers are involved in the maintenance of cryptocurrencies, so even in the absence of a middleman, human error and dishonesty could still affect investors’ money.
Time reports that scammers stole $14 billion using cryptocurrency scams in 2021 alone. The fact that cryptocurrency transactions are impossible to cancel and anonymous makes them ideal for fraud and criminal activity.
Investors should not invest more in cryptocurrency than they are prepared to lose.
Keep the following warnings from the SEC and FTC before you purchase cryptocurrency:
- According to the Federal Trade Commission, consumers should never pay for anything using cryptocurrency (the same goes for wire transfers or gift cards).
- You might receive a solicitation from a fraudulent investment manager. The FTC reports that individuals have put money into accounts run by cryptocurrency investment managers, only to find that they cannot withdraw their money without paying high fees.
- Hackers can drain accounts, or bad software can delete the record of the loan.
- Fraudsters might set up fake exchanges to siphon away money.
- Ponzi schemes like BitConnect persuade investors that they can enjoy huge returns on their cryptocurrency purchase, only for the manager to keep the money for themselves.
- The SEC has reported that fraudulent websites, online ads, and phony financial newsletters have all swindled crypto-curious investors.
- Social media posts asking you to send cryptocurrency are always posted by scammers. The individual’s account is probably hacked.
- Scammers have been known to create pump-and-dump schemes around a cryptocurrency token, sometimes with the help of social media influencers, only to sell their tokens when the price goes up, leaving their scammed customers with worthless tokens.
What Can I Do to Protect Myself?
If you are buying cryptocurrency, make sure you thoroughly understand how it works before you purchase. Do not give in to the hype. Make sure you obtain your information from a reliable source, instead of a thread on a message board or a social media account.
If your stockbroker or financial advisor recommended you invest in a cryptocurrency stock that lost a significant amount of money, they may have violated FINRA regulations. Even if cryptocurrency is not subject to regulation, your brokerage firm and stockbroker are. Contact Kurta Law today if you were recommended cryptocurrency investments without information about the possibility of losses.