In 2017, thousands of investors in more than 175 countries found their pockets empty after investing nearly $4 billion in a cryptocurrency called “OneCoin”. The mastermind behind the project, Ruja Ignatova, went missing with an amount believed to be missing.
This news item struck a nerve in the cryptocurrency world. The BBC even provides the podcast. And while this case is one of large-scale fraud, the fact remains that fraud schemes often exist in the world of crypto-assets, which include cryptocurrencies (such as Bitcoin) and non-fungible tokens (NFT). Owning this token gives investors rights that can take various forms (either access to a good – like a work of art – service or something they own shares).
The number of scams is alarming
A 2018 report from a crypto-asset company estimated that nearly 80 percent of all initial coin offerings (ICOs) launched in 2017 — such as the issuance of new cryptocurrencies — were scams. Of course, it is impossible to accurately measure the number of frauds that occur each year, not least because they are not reported to the relevant authorities. However, this alarming figure should still ask potential investors how to manage the risks they are taking.
It should be noted that crypto-assets are subject to little or no regulation worldwide. Regulatory bodies have been working on this for some time, but regulation in certain areas still lags behind. One of the reasons for this is the decentralized and unlimited nature of investment, which makes the development and enforcement of laws and regulations particularly difficult.
Traditional indicators of fraud
Investing in crypto-assets belongs to the field of financial technology, commonly called FinTech. Tools to invest in FinTech very different from traditional finance. Investors in FinTech are often driven by the search for quick profits, bordering on speculation.
The fact remains that fraud signals – which have long existed in traditional finance, such as stock market investments – are also present in FinTech. One only has to think of the promise of extraordinary returns, far beyond what the regulated market produces. Or the pressure of some promoters of financial products for investors to act quickly, which makes investors put money without taking time to think about their decision.
This speed is felt especially by the investors when the promoters play because they fear that they will not lose an extraordinary investment opportunity, thus encouraging them to put money quickly to beat others. A parallel can be drawn with the promotion of a product in a store that sells it at a discounted price, while stating that the quantity is limited. However, in the case of investments, this often turns out to be a fraudulent scheme rather than an attractive opportunity.
An explanatory document, not a regulatory document
The technological aspect of crypto-assets means that new fraud indicators have emerged. Because this is different from what investors usually hear from people responsible for informing them about risk – including investment advisers – it is important that investors pay attention to the projects they are considering.
Indeed, the absence (or almost absence) of regulation means that, for now, investors are solely responsible for protecting themselves from the fraud schemes that abound in the industry. Some investment funds offer cryptocurrency exchange funds. But the fact remains that these investments have the risk of volatility.
As in the case of traditional investments, the team behind the ICO publishes a so-called “white paper”. Like a prospectus for a public offering – when a company raises additional funds through a stock offering, for example – this document provides potential investors with a wealth of information about the proposed project. Among other things, it explains how the project works and who the team is behind it.
However, the similarity with the prospectus ends there because, unlike the latter, the white paper is not regulated. Issuers can show what they want, and vice versa, omit information that could be useful to potential investors.
It is important to note that for most projects, anyone can issue a white paper. But the regulator strongly recommends that these entities be registered, not only to build trust with potential investors, but more importantly, to ensure that the rules are followed.
A new signal of fraud
There are new signals of fraud that are unique to crypto-assets. We have seen white papers containing elements that contradict each other, incongruities or even errors in the name of the company behind the project. Some white papers are copied from other projects and revised quickly, leaving typos behind. It should be noted that as a general rule, ICOs are unique projects and copies usually signal fraudulent projects.
Another indicator of potential fraud is a white paper where certain sections are too complicated to read. This should prompt potential investors to question the seriousness of the project. The main purpose of the white paper is to inform the investors, so that abstruse language cannot be used for projects presented as coherent.
What’s more, given the complexity of the technology involved, the team behind the project is particularly important to its success. So, if the project documentation does not include a description of the team, whether in a white paper or on the website, none of this should raise questions in the investor’s mind.
For that matter, it is usually quite easy to get in touch with the team behind the ICO in order to ask questions or get additional information about the project, which is not available in traditional finance. If potential investors can’t get in touch with the team, again, there is reason to question the seriousness of the project.
Finding one of the scam signals discussed above does not mean the project is a scam. However, recognizing these signals will make investors better prepared to manage the fraud-related investment risks that are particularly prevalent in the crypto-asset ecosystem.
(This article is syndicated by PTI from The Conversation)