With the increase in popularity of crypto-assets comes the increased risk of fraudulent schemes. In June and July 2018 alone Action Fraud UK reported over 200 complaints from individuals and businesses defrauded by alleged cryptocurrency providers and platforms, with an average of £10,000 claimed per complaint.
What is a crypto-asset?
Crypto-assets, also known as cryptocurrencies, were designed as an alternative, secure, payment system. Cash is exchanged for units of cryptocurrency, which may be backed by whatever the creator of the cryptocurrency chooses, although it doesn't necessarily have to be backed at all. The cryptocurrency can then be used as a form of payment or traded across a trading platform. The idea behind cryptocurrency is that large sums can be transferred without the need of banks, thereby allowing the parties to avoid processing fees.
Encryptions are used to regulate the generation of new units of the cryptocurrency, and technology known as blockchain is used to store an online ledger of all transactions conducted using the respective cryptocurrency. This ledger is copied across all computers using a cryptocurrency's respective software, with the result that it is incredibly difficult to forge a transaction.
Crypto-assets are launched via Initial Coin Offerings (ICOs) where interested investors buy in to the offering, either with fiat currency or with pre-existing digital tokens. In exchange for their support, investors receive a new cryptocurrency token specific to the ICO.
Potential for fraud
The key risk for consumers is that the crypto-asset itself is a fraud or scam to begin with, or it fails in the early stages due to it being part of an inadequate business proposal. There are a number of websites listing coins which are reported to be the subject of scams or those that have been abandoned. Website www.deadcoins.com lists 182 Crypto-assets which it reports to be scam coins.
A further risk for consumers is that the bitcoins custodian's platform is hacked. Crypto-assets can either be held on a custodial or non-custodial basis. In non-custodial cases it is the consumer who is responsible for the security of their crypto-assets. Where the crypto-assets are held on a custodial basis and one provider holds a number of consumers crypto-assets, there is a greater potential for their accounts to be hacked and for the crypto-assets to be stolen. It was reported last year in Japan that bitcoin 'NEM' to the value of $534m was stolen from a cryptocurrency exchange.
Crypto-asset related activity is not clearly regulated in the UK. Whether a particular ICO is regulated is dependent on what the ICO token represents, making the position difficult for consumers to understand.
The House of Commons Treasury Committee published a report on 12 September 2018, recommending that UK government brings forward legislation for the regulation of crypto-assets as a priority by incorporating crypto-assets into the Regulated Activities Order 2001, which would see greater control and regulation over the companies offering Crypto-assets and their advertising.
Although victims of a crypto-asset fraud have access to civil remedies such as a claim for fraudulent misrepresentation, but difficulties may currently lie in identifying the fraudster and in tracing the proceeds of the fraud and the intention is that the new regulations will provide additional protection for consumers.
How to protect yourself from crypto-fraud
- If you are considering investing in an ICO, always perform background research on the company behind the offering. Have they got a track record of other enterprises that have performed well? Who are the directors? Are they experienced in the market?
- An ICO is an investment opportunity. It's entirely possible that an investor's entire stake will be lost for reasons beyond the control of the enterprise operator, whether it may be through the crypto-assets being stolen through a hack, or through the asset losing its value due to price volatility.
- Consider insurance – some policy providers are offering policies to cover theft of crypto-asset investments.
Contact details: For more information please contact Alice Daniels, Senior Associate.
This article is for general information only and does not and is not intended to amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.