The authors of this article examine ways investors can be on guard against poorly conceived crypto-assets. The UK financial regulator recently moved against elements of this industry, highlighting what is at stake.
A lot has been written about cryptocurrencies such as Bitcoin and how they might change the way people think about money and finance. They remain controversial - volatile price action makes some observers think that they are way off becoming a suitable medium of exchange. But the pace of change has been dramatic. Moves towards negative official interest rates, large-scale central bank quantitative easing, and other market forces, mean that there is an audience for alternative monetary forms.
But what sort of risk do cryptos present, and how should those in the wealth management space think about them? The UK financial regulator recently moved to crack down on the use of such assets by retail investors. To address that and related questions are Christopher LaVigne, litigation and investigations partner in New York, and Harvey Knight, financial regulation partner in London, at Withers, the law firm. Another co-author is Elisa Wahnon.
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On 30 June 2020 the UK Financial Conduct Authority published its consumer research findings regarding the crypto-asset (1) market in the UK and the potential harms presented by this embryonic asset class.
The FCA's research updates its March 2019 research regarding consumer attitudes towards cryptoassets. The regulator’s research shows that consumer interest in crypto-assets is growing. In 2019, 3 per cent of UK consumers had bought crypto-assets and spent on average £200 ($259.8) on such purchases. A year later, and 3.86 per cent of the UK adult population (roughly 1.9 million people) hold crypto-assets and 75 per cent of these consumers have cryptocurrency holdings of £1,000 or less.
This growth has been exacerbated by fear of fiat currency debasement in light of government responses to the COVID-19 pandemic, with UK and US central banks printing and committing to print as much cash as necessary to ease the burden on unemployed workers and to keep the markets moving. Although originating as a form of decentralised digital cash, the FCA research indicates that consumers are increasingly considering crypto-assets as alternative stores of value.
While this market is growing, in many ways it remains unsafe for the unaware purchaser. We have outlined here some of the common perils and pitfalls that investors, especially first-time investors, should beware of when considering a crypto-asset purchase.
At this point, even the newest market entrants should be aware of the price volatility associated with crypto-assets. However, the FCA's research reveals that a significant proportion of people monitor their cryptocurrency holdings infrequently.
Even putting aside "altcoins," which have often suffered from severe volatility, the stalwart Bitcoin has still been extremely volatile in the past year by fiat currency standards. Bitcoin lost about half its value from mid-February to mid-March (falling alongside other currencies as a result of COVID-19), and recently rebounded to a high of almost $12,400 on 17 August, only to drop under the $10,000 mark just a few weeks later.
This volatility has negatively impacted crypto exchanges. Coinbase went offline four times between March and May this year during major Bitcoin price moves, leaving users unable to access their accounts. The popular exchange Robinhood suffered similar crashes, and is currently under investigation by US regulators for its response to a day-long March outage.
Failure to understand this volatility poses a real problem for investors, especially those who do not monitor their cryptocurrency holdings very frequently but may be minded to sell their holdings when a news-worthy price fluctuation occurs.
The FCA found that technical knowledge appeared high amongst most cryptocurrency owners, and the most popular reason for buying crypto-assets was "a gamble that could make or lose money." Increasing investor intelligence is a positive sign for this growing market. However, 11 per cent of consumers thought that they had some form of regulatory protection. This belief is technically correct, and taken alone is unproblematic. But consumers cannot rely on this as a protection against losses, even losses due to fraud.
First and foremost, there is no regulatory protection for crypto-asset investments that lose value in the normal course of business. Second, while the FCA provides some regulatory oversight in the UK (as of January 2020, the FCA has taken over anti-money laundering supervision of crypto-assets), the FCA reports that most (83 per cent) consumers use non-UK based exchanges over which the FCA has no authority. Similarly, while various federal agencies and state banking agencies regulate crypto-assets in the US, there is no guarantee that they will protect against investment losses. At best, it often takes several years for these agencies to recover fraudulently obtained crypto-assets for victims, if those assets are capable of being recovered at all. At worst, regulatory efforts themselves can inadvertently destroy the value of investments. Therefore, investors should not rely on UK or US regulators to backstop investment losses due to fraud.
The FCA's research shows that a third of the survey respondents said an advertisement made them more likely to buy crypto-assets. There has been a high number of cryptoasset investment scams reported in the UK which have been linked to advertisements, and the FCA's research shows that reports of crypto-asset and forex investment scams have more than tripled in the past year, with approximately 1,800 victims losing over £27 million.
According to the FCA, these scams often use social media to advertise “get rich quick” online trading platforms. Coinbase has recently reported that there are more than 1.3 million Instagram posts using #Coinbase, an overwhelming number of which display inauthentic behaviour. These false advertisements attempt to persuade consumers to invest through these platforms and then eventually find their accounts closed with no further contact.
Other scams involving legitimate-seeming businesses have been bolstered by social media ads, including YouTube, which has struggled to regulate misleading content and outright crypto scams advertised on its site. In a particularly harrowing example, a recent scam advertised on YouTube led the Ukrainian government to stage the kidnapping and murder of a whistle-blower in order to foil a murder-for-hire plot against the whistle-blower. A company called Bitsonar advertised itself as a startup that used trading bots to earn high profits on investors’ cryptocurrency.
The company's advertisements appeared on several popular YouTube channels dedicated to crypto trading, and helped the company accumulate $2.5 million in cryptocurrency, more than half of which came from the retail “mom and pop” investors from the US, UK, and throughout Europe who viewed Bitsonar's ads. Eventually the company stopped allowing investors to withdraw funds, and Coindesk has reported that the company's coffers are empty. A former Bitsonar employee purportedly threatened to reveal Bitsonar's fraud to the US Federal Bureau of Investigation (“FBI”) and days later was stuffed into a van on his way home from work and kidnapped.
It was recently revealed that the employee’s kidnapping and murder were staged by the Ukrainian government (complete with photos of fake bullet wounds) after learning that the whistle-blower was the target of a contract killing. While the unsuspecting whistle-blower has reappeared safe and sound, the fate of Bitsonar investors' money remains unknown.
Of course some crypto scams have been far less dramatic and nuanced. July 2020 possibly saw the most high profile crypto scam ever when hackers accessed the Twitter accounts of prominent users such as Barack Obama, Kanye West and Bill Gates. The hackers used the accounts to promote a Bitcoin scam that earned about $120,000.