Article written by Elani Vogel, Candidate Attorney and Dave Loxton, checked and released by Dave Loxton, Partner at Schindlers Attorneys
30 August 2021
As the popularity of cryptocurrency (“crypto”) has grown in the past year, so have concerns about its risks and increased use by criminals. The USA alone reported more than 80 00 crypto frauds in 2020. This has led to a recent spike of regulators around the world focusing on crypto and its regulation. The rise of crypto and related services has no doubt induced financial innovation, efficiency, and inclusion. It provides a powerful mechanism to empower financially marginalized people in developing countries. On the flipside, technology with such potential inevitably also creates new opportunities for criminals and terrorists to launder their proceeds or finance their activities. It can also assist tax evaders in their efforts to avoid their tax obligations.
In this article, we will discuss why crypto may seem appealing for use in criminal activities as well as recent trends in and scope for crypto fraud.
Why is crypto appealing to fraudsters?
Crypto provides a higher degree of anonymity than traditional transactions. However, crypto (particularly Bitcoin – the most popular cryptocurrency in terms of market capitalization) has been described as pseudonymous. While this means that crypto transactions are not completely anonymous, it can be identified only by using a blockchain address, viewable on the public ledger. These addresses do not reveal any identifiable personal details; however, they do provide a vantage point for further investigation. Anonymous, but not private, is the bottom line.
Crypto further provides ease of transaction. It eliminates intermediaries such as banks. By way of peer-to-peer transactions, users are able to send and receive payments to or from anyone on the crypto network around the world. Unless you are sending or receiving crypto from a regulated exchange or institution, the parties to a transaction do not require approval from an external source or authority.
Trends in crypto fraud
South Africa is a member of the Financial Action Task Force (“the FATF”), an intergovernmental organization that sets international standards to combat money laundering and terrorist financing. The FATF recently provided direction on the treatment of crypto assets and now requires jurisdictions to regulate crypto assets and crypto assets service providers for anti-money laundering and counter-terrorism financing (AML/CFT).
In its 12-month Review of the Revised FATF Standards of Virtual Assets and Virtual Assets Service Providers, dated June 2020 (“the FATF review”), it explains that “the value of virtual assets involved in most ML/TF cases detected to date has been relatively small so far compared to cases using more traditional financial services and products, although there needs to be ongoing monitoring for any potential changes”.
It explains that most detected cases involved the use of one type of virtual asset only. In cases where criminals did make use of more than one type of virtual asset, such use was primarily for the ‘layering’ of illicit proceeds (‘layering’ is the second stage in the money laundering process, after ‘placement’ whereby the ‘dirty’ money enters the financial system. At the ‘layering’ stage, the illicit money is blended with legitimate money or placed in constant motion from one account to another).
According to the FATF review, the use of virtual assets as a way of ‘layering’ is the most prominent use by criminals, possibly due to the ease of rapid transfer (for example, updating public addresses and fast exchanges across borders). Professional ML networks have also appeared to start exploiting this vulnerability and use virtual assets as one of their means to launder illicit proceeds.
Scope for fraud
As explained above, crypto seems to appeal to fraudsters mostly due to its perceived anonymity and rapid transfer. The FATF warns that these qualities have led to an influx in fraudulent activities in recent years, which will probably increase as exploitation techniques become more sophisticated. Some of the techniques already include:
i. registering internet domain names through proxies: A proxy server acts as a gateway between a person’s browser and the internet. When you use a proxy server, your internet traffic is sent to the proxy before going on to the website or address you requested. As an intermediary, a proxy server ensures that you’re never in direct contact with sites you visit on the web;
ii. the use of tumblers and mixers: A tumbler service functions like a Virtual Private Network (VPN), which hides the sending address from the receiving party. The crypto is sent to the tumbler service, and the service relays the transaction hiding the sender’s address;
iii. anonymity-enhanced cryptocurrencies or privacy coins: Privacy coins are cryptocurrencies which power private and anonymous blockchain transactions by obscuring their origin and destination. To effectively preserve anonymity, privacy coins employ a variety of different strategies, the most popular of which includes the use of stealth addresses. Stealth addresses require a sender to generate a new address for every transaction sent to avoid being linked to a receiver;
iv. using decentralised exchanges and applications: a decentralised cryptocurrency exchange allows for direct peer-to-peer cryptocurrency transactions. As explained above, peer-to-peer transactions are concluded between users without an intermediary or central authority, such as a bank;
v. chain-hopping and atomic swapping exchanges allow the exchange of one type of cryptocurrency to another without going through an exchange, often in rapid succession; and
vi. dusting, which is the transfer of tiny amounts of virtual assets to random wallets, making it more difficult to track and trace the transaction trail.
Further to the above, investment scams, swindling, blackmail, and extortion relating to crypto are prevalent in South Africa. One need only look at recent scams such as Mirror Trading International (MTI) and Africrypt to realise that people are particularly vulnerable when it comes to unlawful investment schemes. These scams are in no way limited to crypto, but its recent popularity and its get-rich-quick type of advertising have made people more susceptible to falling victim to these types of scams.
Through refinement and implementation of FATF recommendations, development of domestic regulation and education on sound investment practices, the scope for fraudulent activities may be limited.
Schindlers Attorneys has numerous legal specialists should you require any assistance with fraud investigation. Should you require any such assistance, please do not hesitate to contact us.
This article explains why crypto may seem appealing for use in criminal activities as well as recent trends in and scope for crypto fraud.
Please note our articles are meant for information purposes and do not constitute legal advice.