Cryptocurrencies, often referred to as virtual currencies or tokens, are quite different from typical currencies such as dollars or euros. For instance, they live online and are not backed by a government or central bank. While different forms of cryptocurrencies have been around for years, they became a cultural phenomenon in 2017 when the price of Bitcoin, one of the more established cryptocurrencies, skyrocketed to nearly $20,000. At the time of its apex, Bitcoin had an annual gain of over 2000%. Such returns are almost unheard of in any traditional investing context. While 2018 saw the “Great Crypto Crash,” considerable interest in the next crypto rags-to-riches story will certainly continue.
But as with any financial vehicle, particularly one that is highly volatile and has garnered incredible public interest, there are opportunities for bad actors to defraud investors. Cryptocurrency fraud has become a dominant topic of discussion for government enforcement attorneys, with numerous prominent conference panels and agency bulletins addressing its various forms, the hype versus the reality, the many ways it can facilitate fraud, and efforts to rein in its abuse. As crypto fraud becomes more common, it will continue to be crucial for whistleblowers to help the SEC, CFTC, and IRS with their enforcement efforts.
Cryptocurrency fraud can come in many forms, including:
- Financial Crimes: Crypto’s instant transactions, portability, and international reach mean it can be used as a new tool for the furtherance of tax avoidance, money-laundering, and bribery.
- Scam Initial Coin Offerings: The first offering of a particular cryptocurrency for sale, called an Initial Coin Offering or ICO, can be a means of preying on the unsophisticated. Many ICOs are completely fabricated, with phony bios of nonexistent team members and technical whitepapers copied from other, legitimate cryptocurrencies.
- Pump and Dump Schemes: Crypto can provide a new variation of the classic pump and dump scheme, where owners of a stock try to drive the price up before selling off their holdings at an artificial peak. In the crypto world, this is common at the ICO stage, or even beyond, whenever false claims can hype up demand and permit the originators or dominant holders of the cryptocurrency to earn massive phony profits.
- Market Manipulation: Fraudsters can attempt to manipulate the markets where cryptocurrencies or related derivative products are traded. Improper market manipulation may include spoofing, front-running, churning, and other schemes.
- Ponzi Schemes: Crypto investments can also be used as the vehicle for a traditional Ponzi scheme, where new adopters are necessary to give artificial returns to the early adopters. Purported investments in emerging crypto markets can also serve as the supposed goal for Ponzi schemes. Given that crypto is widely misunderstood, it can be the perfect cover for a bogus scheme.
- Traditional Theft: Crypto also provides criminals new opportunities for theft. They can hack investors’ crypto wallets and steal their currency; they can set up fake wallets to bilk counterparties; and they can set up phony crypto exchanges to steal customers’ money.
- Broker/Dealer Fraud: The SEC has examined exchanges and funds investing in cryptocurrencies, which may, depending on the circumstances, need to register as broker-dealers or exchanges.
- Unscrupulous Promotors: The SEC famously fined Floyd Mayweather and DJ Khaled for failing to disclose payments they received for promoting investments in Initial Coin Offerings (ICOs).
Thankfully, regulators have taken notice and are beginning to find their feet in enforcing the law in this new arena. The SEC, CFTC, and IRS all assert regulatory control over cryptocurrency under certain circumstances. For the SEC, a given cryptocurrency must qualify as a security, or the “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.” The SEC developed its application of this test to cryptocurrency in its now-famous report on The DAO, a German crypto ecosystem.
The CFTC also has authority to regulate crypto as a commodity in accordance with the Commodity Exchange Act. The CFTC has recently stated that crypto enforcement is a top priority because of its high risks for investor fraud. The IRS has also taken the position that cryptocurrency investments are assets that should be treated like any other for tax purposes, permitting it to tax returns on crypto investments. And through its Criminal Investigations Division, the IRS can pursue money-laundering crimes committed with cryptocurrency. Enforcement efforts by the SEC, CFTC, and IRS can also extend internationally to schemes that have violated U.S. laws.
As cryptocurrencies continue to grow in market cap and influence, whistleblowers will be essential in helping the government catch wrongdoers and prevent fraud. Whistleblowers can also take advantage of the various whistleblower reward programs offered by the SEC, CFTC, and IRS and potentially share in any government recovery.