Kate Gee and Elliott Fellowes discuss the risks for investors as the popularity of cryptocurrencies continues to rise

By Kate Gee & Elliott Fellowes

Counsel Kate Gee and Associate Elliott Fellowes examine the risks for investors as the popularity of cryptocurrencies continues to rise, in Blockchain Tribune and Global Risk Regulator.

Kate and Elliott’s article was published in Blockchain Tribune on 18 March 2022 here, and in Global Risk Regulator on 5 May 2022, here.

Cryptocurrency continues to dominate global headlines and appeal to all manner of investors, having taken its place in mainstream society in recent years. What was once the cutting edge of technology and finance has now become extremely accessible – proponents of decentralised finance (DeFi) rave about a utopian financial model, free from interference from governments, central banks and other regulators; adverts for crypto trading platforms now adorn London Underground platforms; you can buy, sell and hold cryptocurrencies on PayPal; and there are over 34,000 cryptocurrency ATMs globally which offer instant access to crypto (most are in the US, but the number in mainland Europe is growing).

Market maturity and accessibility

Whilst cryptocurrency is inherently more volatile than other asset classes, there are visible signs – other than its growth – of the market’s maturity.

  • In September last year, El Salvador became the first country to allow consumers to use the cryptocurrency in all transactions, alongside the US dollar.
  • Valereum (a Blockchain company) has announced plans to acquire a 90% interest in the Gibraltar Stock Exchange in an effort to create a trading venue where cryptocurrencies can be used to buy listed securities. The deal is subject to approval by the Gibraltar Financial Services Commission – but illustrates the direction of travel.
  • Binance is a prime example of the rapid growth of crypto-trading platforms. Despite facing continual regulatory scrutiny in the UK, the company is reportedly planning an expansion into new markets by way of a spate of acquisitions. The platform remains comfortably ahead of the crypto-trading pack and handled over $500 billion in trading volume in January alone – over four times more than its closest competitor.
  • Elon Musk announced last year that Tesla would accept bitcoin as a means of payment after previously citing environmental concerns regarding crypto mining.
  • Sports superstars have made headlines for their enthusiastic involvement in cryptocurrency, with footballer Lionel Messi receiving a chunk of his signing bonus in crypto and American Football superstar Odell Beckham Jr’s entire $4.5 million salary being paid in Bitcoin.
  • Ashton Kutcher’s firm Sound Ventures is backing Unikrn, an eSports betting digital platform.

Whilst some of these moves have been considered publicity stunts, they nevertheless highlight how crypto is becoming more publicly visible and accessible by the day.

It has never been easier for a casual investor to participate in the crypto market, with trading platforms and brokers competing for public attention. The average person’s appetite for risk has also dramatically changed during the pandemic, and people are being drawn to investments that, two years ago, would not have caught their eye (see for example the FCA’s comments in its consultation paper on strengthening financial promotion rules). Regulators must contend with the fact that cryptocurrency is considered fashionable and exciting, especially among young investors. That is novel in itself: one would be hard pressed (and surprised!) to find a comparable online buzz surrounding 25-year government bonds or brent crude futures. A young generation of crypto investors, perhaps more familiar with social media than stock markets, may be less likely to heed warnings from authorities that they see as out of touch. Against this background, regulators like the FCA must now adapt their warnings to reach (and resonate with) a younger audience.

Increased scrutiny

As accessibility increases, so too does the pressure on financial authorities to regulate the promotion of, investment in and use of cryptocurrencies and other digital assets.

In some countries, stringent measures have been implemented to crack down on DeFi models: China banned cryptocurrency outright in September last year after months of tightening regulations; Nigeria barred local banks from working with cryptocurrencies; and India imposed a 30% tax on income from virtual assets last month.

Until recently, however, Western attitudes have been more liberal, albeit cautious. UK regulators and politicians have voiced suspicion over cryptocurrencies and digital assets, and many warn of risks of money laundering, terrorist financing or sanctions evasion risks associated with non-traditional assets.

In the UK, the FCA has shown itself to be deeply suspicious of many trading platforms, as evidenced by its frequent spats with crypto trading service Binance over the latter’s British operations. However, such warnings have largely fallen on deaf ears, as both institutional and individual investors have continued to move sums into cryptocurrency and the digital asset space.

Increasingly, authorities in the UK have become more hands-on in their approach to digital asset governance.

  • In the first six months of 2021, the FCA opened 300 probes into unauthorised crypto operators.
  • Sarah Pritchard, Executive Director Markets at the FCA, joined the Advertising Standards Agency (ASA) in expressing concern about the growing crypto-investing market, stating that trading platforms are leading the public to invest in virtual assets without understanding the risks involved.
  • The ASA designated cryptoassets a “red-alert priority issue” over concerns that amateur investors may be duped into depositing their life savings into such a risky asset class, and has resolved to conduct “proactive monitoring and interventions” to ensure that all cryptoassets ads are brought into line with its expectations. It seems that a token “your capital is at risk” statement will no longer wash.
  • Members of parliament in the UK are pushing for increased regulatory oversight of cryptoassets in 2022, in particular in relation to Non-Fungible Tokens (NFTs).

Globally, the Financial Stability Board (FSB), an international body that monitors and advises on the global financial system, has issued warnings over the intersection between crypto markets and the traditional financial system. The FSB has warned of the lack of governance or regulation at a time when the total value of assets locked in DeFi transactions stands at over $100 billion.

Risk management

Despite the public hype around cryptocurrency and cryptoassets, the boasting of successful investors and the cheerful adverts on social media and transport networks, the dark side of cryptocurrency may be more present than ever. Frauds using cryptocurrencies are perpetrated every week – hacking, fake apps, imposter websites, unregulated or fake brokers, wholesale fraudulent exchange platforms and cryptocurrency Ponzi schemes. Clearly, cryptocurrencies themselves are not the only volatile aspect of this new financial system – unregulated and questionably managed crypto-exchanges can themselves pose significant risks to investors, as can the range of scams being operated by bad actors in this space.

  • In December last year two Australian exchanges folded, leaving hundreds of users $50 million out of pocket and forcing investors into lengthy and complex litigation to recover their money.
  • On social media, fake accounts are everywhere – including accounts promoting cryptocurrencies – operated by malicious bots. Fraudsters use well-known brand names and copy high-profile branding to give legitimacy to their scam. Scam accounts are given credibility by other bots, programmed to engage with posts as though they were human users. Fraudsters use social media platforms to advertise “get rich quick” schemes involving mining or trading in cryptocurrencies, such as Bitcoin or Ethereum. The fraudster convinces a victim to open a trading account and make – and then increase – an investment. The fraudster then promptly deactivates the website and disappears with the invested funds.
  • Cryptocurrency ATMs are playing a part in a new take on the common fraud where a victim is convinced to part with money by an impersonator from – for example – HMRC or a utility company, the fraudster directs the victim to withdraw cash and go to a cryptocurrency ATM. There, the fraudster convinces the victim to use the cash to buy cryptocurrency. The fraudster then sends the victim a QR code to scan, which immediately transfers the cryptocurrency to the fraudster’s wallet. The possibilities for crypto-ATM fraud have diminished in the UK, with the FCA recently announcing that none of the firms currently offering crypto-ATMs are registered and therefore all crypto-ATMs are being run illegally and must be shut down.

An investment opportunity or offer that seems too good to be true usually is exactly that – and if a victim parts with cryptocurrency via a suspect platform, recovery is likely to be difficult. Investors must tread with caution and make no assumptions as to the genuineness of a website, advert or social media post. Legitimate organisations will not coerce you into making an investment, so potential investors should feel comfortable taking time to do appropriate research, take advice and make an informed decision. In the event of fraud, where funds move very quickly between crypto and fiat, victims should take urgent legal advice from experts in this area to maximise their chance of recovery. Encouragingly, the English courts are taking an innovative and pro-active approach when being asked to use the tools at their disposal to help protect victims of a crypto scam: with prompt action, claimants have obtained information orders against exchanges and successfully frozen misappropriated cryptocurrency and cryptoassets.

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