How the FTX debacle sparked a wave of crypto scams

The demise of a cryptocurrency exchange offers a useful case study of the vicious cycles that can occur in online fraud. When a major stock market collapses, bad actors trying to recoup their own losses suddenly have many new potential victims in the same boat, to whom they can offer “help” to save their accounts.

The latest high-profile example is provided by the ill-fated FTX exchange, which filed for bankruptcy protection in November 2022 with $8 billion (£6.7 billion) of investors’ money missing and more than $400 million identified as stolen by hackers. While the founder, Sam Bankman-Fried, has pleaded not guilty to charges of fraud and other crimes, this is just the latest in a series of cases where a combination of reckless mismanagement, deliberate fraud and inadequate regulation have cost unwary investors dearly.

In fact, the problems extend far beyond FTX. According to data obtained by FT from the police’s Action Fraud unit, financial losses to crypto fraud in the UK totaled £226m in the 12 months to October 2022 – up by almost a third on the previous year. Across the Atlantic, a report published by the Federal Trade Commission in June 2022 estimated that losses to crypto fraud in the United States since the start of 2021 had topped $1 billion.

Why the worst is yet to come

Cautious investors may assume that such cases will deter all but the most foolhardy from taking big risks in the crypto markets, leading to a natural decline in fraud. But experts like Lewis Duke, a senior specialist in SecOps risk and threat intelligence at cybersecurity software firm Trend Micro, disagree.

He predicts an increase in crypto fraud in the short to medium term because both criminals and honest investors will be highly motivated to chase losses caused by the FTX debacle. The impact of the stock market collapse is also putting downward pressure on the values ​​of the main cryptocurrencies, which are already worth far less than they were a year ago. One bitcoin, for example, was trading at around the $44,000 mark in early March 2022. Twelve months later, it was worth around $24,800.

“Scammers will exploit uncertainty and target those trying to recover lost investments through fake exchanges and scams involving initial coin offerings,” says Duke. “For the threat actors, there is the added motivation of the reduced monetary value of the digital currency, as well as the potential for large financial losses if an exchange or currency goes offline.”

Daniel Seely, an associate specializing in crypto issues at law firm Freeths, agrees. He explains that while there is always some level of fraud in this field, it tends to increase when an exchange fails, because it gives criminals an additional way to defraud distressed investors.

“When a website is known to be down – even temporarily – fraudsters will take it as an opportunity to impersonate their employees and contact affected customers,” he says. “They will often approach victims with an offer to help ‘solve problems with their account’, which they claim was caused by the outage, and use this as a pretext to obtain information such as passwords, encryption codes and other sensitive data.”

Could the FTX scandal be a turning point?

A potential silver lining from the FTX scandal and its predecessors is that legitimate exchanges are cooperating more proactively with investigators trying to recover users’ funds. That’s according to Josh Chinn, co-founder and director of Wealth Recovery Solicitors.

Getting help used to be a long and expensive process for fraud victims, but the exchanges – very aware of the sector’s Wild West image – have become more willing to offer assistance, he explains.

“Since the FTX scandal, we’ve seen a big shift in the way exchanges and endpoints deal with us,” reports Chinn. “In the past, endpoints typically would not cooperate until our customers had incurred fees to obtain court orders requiring them to do so. The exchanges are cooperating more, providing disclosures and helping us work to recover lost assets.”

The rise of crypto regulation

The other positive development concerns regulation. The UK’s proposed regulations for crypto providers are particularly strict. The FTX case is almost certain to build support for this stricter set of rules to be adopted as quickly as possible.

Andrew Parsons, a partner at law firm Womble Bond Dickinson, believes the UK could emerge as a leader in legitimate cryptocurrency transactions as a result. Obtaining a registration with the Financial Conduct Authority (FCA), which oversees the UK’s anti-money laundering rules, represents a high regulatory hurdle for crypto providers to clear. Their reward for overcoming that could be winning the trust — and business — of the many investors who don’t deal with unregulated entities, he says.

“Becoming authorized by the FCA is a long and complex process, while ensuring compliance is always onerous,” says Parsons. “As more unregulated crypto exchanges collapse, it is possible that more people may see the benefits of regulating exchanges as the UK is proposing. There are definitely opportunities for exchanges willing to put in the time, effort and money to secure FCA authorisation.”

That doesn’t improve matters much in the short to medium term, of course. Nor does the new level of cooperation with investigators, which only applies when an investor has been defrauded.

Unfortunately, the experts’ warnings are likely to be accurate. The criminals are using this particularly turbulent period in the crypto markets to redouble their efforts to defraud people who have already made large losses and are in a vulnerable state. The best advice to the distressed investors may therefore well be: trust no one – least of all the ‘helping hand’ that comes out of the blue and offers to get their money back.