Since the emergence of cryptocurrencies, they have been linked with fraud and crime, the anonymous nature of accounts has enabled criminals to use them to transfer funds and launder their profits.
I interviewed Richard Kay, CCO Officer at EXMO UK, to highlight the risks involved but more importantly to look at what you can do to protect yourself and also what exchanges, governments and other forms are doing to mitigate the risks involved.
Risks of Trading Virtual Assets
There are five main types of financial risks. These are similar to trading most assets and I will briefly cover.
- Credit Risk - the probability of the crypto project failing to fulfil their due obligations and become worthless.
- Legal Risk refers to the probability of a negative event occurring with respect to regulatory rules. For instance, a ban on cryptocurrency trading.
- Liquidity Risk in respect to crypto trading refers to the chance of a trader being unable to convert their holdings to fiat currencies (USD, YEN, GBP).
- Market Risk refers to the chance of coin prices moving up or down.
- Operational Risk is the chance that a trader is unable to trade, deposit, or even withdraw money in their crypto wallets.
One of the main areas the authorities are looking at is Money Laundering and the risk that virtual assets are being used by criminals. As a trader, you need to understand that all movements of virtual assets are available and that the authorities can trace your assets to see how they were obtained and who they were obtained from so you need to know yourself!
Direct Fraud – How to avoid being involved.
By Direct Fraud, one means fraud that you are actively being involved in and can look to prevent by taking the necessary actions, these usually are simple, and involve ensuring you understand what you are doing and the risk that are out there. They are similar to all use of the internet, use trusted sites, do your research, ensure you have the correct security.
You would not just open a bank account online and transfer your money. You would want to know who the bank was, where it's based and how you are protected. So do the same with your Crypto account!
What frauds are out there? Here are some examples:
- Hacking
- Theft and exit scams
- Phishing Fake ICOs (initial coin offerings)
- ‘Overnight’ exchanges
- Fraudulent wallets
- Pyramid/Ponzi schemes
How to avoid these!
Firstly, do your research and fully understand the risks involved. You need to ask yourself:
- What am I buying?
- Where am I buying it form?
- Where am I storing it?
- Where can I sell it?
This is the same for all assets whether virtual or not. The old adage “if it seems to good to be true it probably is” should be always considered in any investment.
The easiest way to avoid the frauds I listed is to go directly to a trusted exchange, they will offer you the security and advice you require.
What are you looking for with an exchange?
1. KYC/AML Policy
Ensure the exchange has a Know Your Customer (KYC) and Anti-Money Laundering (AML) practices, requiring participants to submit personal information about themselves during account creation. You should have to prove:
- Who you are?
- Where you live?
- What the source of your funds is?
These practices and requirements vary from exchange to exchange. Some platforms require KYC and AML to withdraw funds or lift certain limitations, obligating customers to provide copies of photo identification and sometimes a proof or residence. Other platforms require such customer verification during the process of account creation.
These checks are there to protect you from handling criminal funds. The more they ask you the better!
2. Reputation
Since the cryptocurrency space is still largely a new industry, it is important to be aware of the reputation of each exchange, again do your research. Many exchanges have been involved in nefarious activities, hacks and exit scams, leaving users in a less than ideal situation.
3. Security
Each exchange has its own chosen methods of security. Ensure the exchange offers two-factor authentication (2FA). This should be a minimum requirement.
- Where to store your Crypto?
- You have two choices Hot or Cold.
- Hot wallet or cold wallet?
There's no simple answer to this question. Every cryptocurrency user needs to evaluate their requirements. If you are going to only hold, cold storage is the way to go. If you are planning to execute big trades in the near future, consider a hot wallet. If you are going to do a bit of both, or if you want to trade but mitigate risk, store funds in both hot and cold storage.
Storing crypto in a hot wallet doesn’t necessarily mean it’s unsafe, it just means your funds are more at risk to hacking.
For any cryptocurrency assets that you don’t need instant access to, it’s best to store them offline in a cold wallet. Maintaining high levels of security is key in crypto.
There are different choices of cold wallets, such as a hardware wallet or a paper wallet.
A hardware wallet is an external device that stores your private keys. You must push a button to complete a transaction, so hackers cannot take control. Hardware wallet access is locked behind a password or pin. In general, the funds stored on a hardware wallet are fairly accessible, as long as you have access to the wallet.
A paper wallet is a print out of the private key and pubic address on a sheet of paper or another material. This is generally regarded as a risky form of cold storage because you can lose the paper or someone could easily find it and access your funds.
Where to store? Again, do your research and understand the risks and functions of each option.
Indirect Fraud - What is out there to protect you.
By Indirect Fraud, I mean fraud that you are not actively involved in. This concerns the risk of you being involved in fraud even though you have no knowledge of it. The key part here is handling crypto which was obtained illegally, as I stated earlier you need to know, what you are buying and where you are buying it from.
You don’t want the authorities coming after you for your crypto or them closing your exchange as it's involved in money laundering!
Onboarding
All the trustworthy exchanges usually conduct enhanced due diligence on clients. This means the exchanges do the following:
- Require a government issued photo ID
- Ask the customer to provide a selfie showing the ID and the date
- Require a proof of address dated within 3 months
- Monitor the IP address the client use
- Check all customers against Global Sanctions lists
The exchange is protecting you by ensuring that it knows the people trading on the exchange.
Deposits and Withdrawals
The exchange needs to understand where funds come from and where they go to, this is fundamental to preventing money laundering, whether it is fiat or Crypto.
The first part of this is fiat currencies, usually, the exchange has in place full Source of Funds policy and procedures to check the legitimacy of any money that is deposited or withdrawn. This includes taking evidence of bank statements, cards to ensure that we understand where the money is coming from, that it is legitimate and also that we are returning it to the customer.
The second part is cryptocurrencies, the exchange needs again to understand that any wallets are owned by the customers and that they have obtained these from a legal source.
All transactions of Crypto are recorded and you can look where any crypto has been received from or sent to if you have a Blockchain Analytics Cryptocurrency Intelligence Tool.
There are different instruments that allow monitoring all transactions and check to see if any connected wallets are high risk and linked to Money Laundering, we can then close any accounts we feel are receiving fund from criminals or sending them to criminals.
The exchange is protecting you by ensuring that it knows the source of funds on the exchange.
Trading
The exchange usually has algorithms / triggers and patterns to monitor all transactions. The firm understands how customers to trade and when anything happens that falls outside this the firm system triggers an alert as “suspicious” or “abnormal” behaviour. All transactions that fall under either are carefully checked by our specialists and if necessary, accounts blocked or additional data requested.
To prevent this type of fraud, you need to suppress it at the beginning - at the stage of registration or the first user deposit. As a rule, the behaviour of such accounts is very similar and basically, the same groups work. If such cases are identified it is also necessary to report to the appropriate authorities.
The exchange is protecting you by ensuring that it understands the trading on the exchange.
Summary
The increasing number of fraud cases has put a security issue on the agenda of crypto exchanges. More and more platforms are now taking radical steps to prevent fraud and criminal actions and ensure the required level of protection for their users. But exchange hack isn’t the only fraud type the industry is facing that results in a financial loss. To shed some light on the problem of fraud-fighting and teach you how to keep your assets safe, we’ve prepared answers to the following questions.
Along with the explosion of interest in digital currency and all of its implications for both new and traditional businesses, there is a growing need for clarity regarding the legal implications of these new technologies and currencies. As governments around the world, regulatory agencies, central banks, and other financial institutions are working to understand the nature and meaning of digital currencies, individual investors can make a great deal of money investing in this new space. On the other hand, investors assume certain legal risks when they buy and sell cryptocurrencies.