An article by two prominent former DOJ officials currently investigating crypto fraud in the private sector
By Robert Appleton and Ren McEachern**
Losses of investor funds continue to mount in the wake of numerous cryptocurrency company collapses, as well as the recent spate of misuse of investor funds by centralized cryptocurrency exchanges, including the now-infamous implosion of FTX, with initial estimates of 1 million affected creditors and representing a potential shortfall range between $8 to $10 billion. Many fall victim to classic scams updated for the Web3 era: crypto investment schemes promoted by fake influencers or scammers posing as investment advisers. Other new types of piracy, theft or fraud center on the continued increase in decentralized financein which criminals attempt to exploit a decentralized system, block chain either smart contract.
Investor crypto fraud losses resulted in an estimated $680 million in losses last year, and by all accounts, that number will grow exponentially this year. Licensed and unlicensed investment managers soliciting investments in crypto projects and others continue to take advantage of the unsuspecting investor.
Crypto was designed to provide a form of secure direct medium-to-medium exchange. The appeal of cryptocurrencies is obvious and apparent. In addition to previous increases in asset prices, cryptocurrency transfers can be made in minutes with minimal fees. No other third-party intermediaries are needed to transfer crypto assets, and can be done through direct wallet-to-wallet transactions. However, cryptocurrency remains in its infancy, and the FTX disaster and other recent centralized exchange crashes have exposed the immaturity of the industry.
Centralized exchanges continue to undermine the core purpose of cryptocurrency, that investors have a means of transferring assets directly, across borders, without the costs, red tape, and slowdowns of intermediaries and the banking world. The lack of regulatory oversight has resulted in considerable challenges in trying to identify who is orchestrating the fraud and where the ill-gotten proceeds are stored. Unlike some exchanges that
maybe collect "know-your-customer" information, private digital wallets are essentially owned by individuals with no requirements to provide personally identifiable information (PII), which is most often used to properly assess an individual's ultimate beneficial owner (UBO) or entity. Another major current concern, in addition to the lack of a regulatory framework, is that, unlike regulated financial institutions, there is no government or FDIC insurance to compensate innocent investors who have lost funds in custody or crypto assets left behind. in exchanges.
However, there is recourse for victims. Cryptocurrencies are traded and transferred using the blockchain, and as a result, the ability to identify various cryptocurrency movements and volumes is much easier than most people realize. The blockchain is essentially public information and court clearances are not required to fully track cryptocurrency. For comparison, if you wanted to identify traditional wire transfers, you would need to take advantage of a civil subpoena or, if the government were investigating, they could take advantage of grand jury subpoenas and court-authorized search warrants to collect bank information. The purpose of blockchain technologies was to create a permanent, decentralized digital record while maintaining a robust level of transparency for attribution purposes, through an interconnected peer-to-peer network. For this reason, investigations into crypto fraud are becoming more sophisticated and feasible. As in many types of illegal activities, the interaction between the perpetrator and the victim swings like a pendulum. As the scammer's techniques for theft and misuse are used, investigators become more adept at pursuing stolen proceeds.
We have learned a lot in the recent wave of fraud and crises about how stolen and misappropriated assets move. Because the blockchain records every transfer and transaction made, a trace exists. Bad actors have implemented new techniques, using โscramblersโ to try to obfuscate stolen and deleted tokens, sending them to โpooledโ wallets. Similarly, bad actors have traditionally moved stolen cryptocurrency through the use of a single blockchain. Recently, however, bad actors are using chain hopping to disguise the flow of stolen funds. Chain hopping involves the exchange of cryptocurrencies from one token to another, such as in Uniswap, in an effort to cloud the flow and movement of illicitly obtained assets.
With transaction IDs from a victim's assets, the movement of stolen and embezzled funds can be traced. It is determined that many exchanges operate within the jurisdiction of the US, where "Know Your Customer" (KYC) requirements are generally required for exchanges, due to the importance of market share to be gained. In an attempt to be considered "compliant", many non-US exchanges that do not have KYC requirements, and as such are not required to do so, voluntarily collect KYC information and respond to requests for information. As a result, investigations are having more success in tracking down and forcing exchanges to identify account holders, balances, and transactions. In recent investigations carried out by the perpetrators, exchanges have been made with subpoenas and some have indicated their willingness to cooperate.
Victims also have the option of asking law enforcement for help. In 2021, the Department of Justice announced the formation of the National Cryptocurrency Enforcement Team (NCET), to specifically investigate and prosecute the misuse of cryptocurrencies. Similarly, the FBI and other federal investigative agencies have established special units to investigate federal cryptocurrency violations. This increase in government resources and capabilities has resulted in several high-profile indictments, arrests, and successful prosecutions. If the FTX case is any indicator, these investigations will only grow in size and complexity.
Successfully referring a matter to investigative authorities presents numerous challenges due to the complexity and speed of the technology used to steal cryptocurrency. The government will have to carry out its own independent investigation; however, a proper referral using accepted investigative procedures in conjunction with known tracking technologies could expedite a government case. Time is a critical component in these investigations and any opportunity to locate and trace misappropriated assets should be prioritized. The authors have been successful in several recent cases by referring cryptocurrency loss cases to the appropriate law enforcement agencies.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought according to your specific circumstances.
