Recovering crypto losses is very challenging but not impossible

Online cryptocurrency scams cause significant financial losses to several consumers every month. US-based victims have already lost more than $4 billion to complex criminal networks and hackers in the past year.

Sophisticated, usually overseas-based networks host fictitious trading platforms that appear legitimate but are programmed to portray false trading profits and fraudulently route consumer funds.

The platforms look so authentic that the average user cannot distinguish a scam crypto site from a legitimate one.

It is widely believed that once a victim’s cryptocurrency is transferred from the wallet, usually held on a centralized exchange, to a decentralized exchange or private wallet, the coins are lost forever.

Law enforcement route

Referral to law enforcement is often considered the only avenue available for any chance of recovering stolen funds and identifying bad actors. But decentralized wallets and private platforms are even beyond the reach of US law enforcement in most cases.

The law enforcement option is also rapidly becoming less available to victims who complete the Federal Bureau of Investigation’s online iC3 loss form. In most cases, local authorities lack the training, resources and ability to investigate cross-border criminals or recover cryptocurrency coins from private offshore wallets.

The FBI and Justice Department crypto task forces, in cooperation with other federal agencies, remain the best route for investigation. But the challenge is to persuade the appropriate authorities to accept and then investigate a crypto case.

The massive explosion in the number of frauds has produced a corresponding explosion in the number of referrals. Consequently, a long waiting list of complaints accumulates, and federal authorities are unlikely to be able to handle all the cases.

Threshold loss amounts for investigation and prosecution have increased. Losses under millions of dollars may not be a priority. Federal authorities are more likely to accept a case that is investigated by a competent professional they know and who has done a lot of doctoring in support of the referral.

Tracking fund

This leaves victims in very challenging circumstances. Private investigation and prosecution of these cases may be an option. In some cases, teams with the right mix of forensic investigation and tracking capabilities, combined with an asset recovery attorney experienced in cryptocurrency investigations and law, can sometimes help locate lost coins and identify bad actors.

While recovering stolen crypto from a fraudster’s private wallet is challenging, blockchain provides significant useful information and evidence and presents avenues for possible recovery.

Unlike traditional money transfers with financial institutions, each the blockchain transaction is publicly recorded and available to those who know how to search for it. Every transfer is traceable, and significant information about the transfer is remembered on the blockchain.

Captured data includes the wallet address to which the stolen crypto was sent. The recipient’s address is available for identification by a trained specialist through the tracing process, which can reveal the stolen funds sitting in the criminal’s wallet.

Other useful information is available on the movement of the funds and the activity of the recipient’s wallets.

The heavy lifting is recovering tokens.

Tokens – or coins – held on private wallet platforms are difficult to seize. Circumstances, however, may present some opportunities. To transfer crypto back to fiat currency, a criminal must initially use an account on a legitimate, centralized cryptocurrency exchange.

To do this, an account holder must present proof of identity and know your customer identification, usually a valid driver’s license or passport.

Credible exchanges increase the requirements even further. In some cases, criminals have transferred stolen coins to an account on an exchange and then left the coins sitting for an extended period of time.

Where courts can help

A civil court order served on an exchange in the jurisdiction can retrieve this information. Other civil legal processes may be available to freeze and eventually recover the coins.

Exchanges outside the jurisdiction have in some cases been willing to honor subpoenas. US-based entities must respond to a court order or validly issued civil subpoena. But entities that host private wallets typically won’t honor either a criminal or civil subpoena.

With proper monitoring, tracking, investigations and the use of subpoenas, stolen funds that have been carelessly stored on an exchange have the potential to be recovered.

The challenge is that often once a case has been referred to a firm, fraudsters have transferred the coins multiple times, often into pooling accounts – similar to cocaine drug laundering cartels in the 1980s.

This can be done to hide and clean the coins. The difference, however, is that subpoena power is not required to see the transfers and where the coins have gone.

Recovery remains challenging and quite difficult in many cases. The benefits of digital currency platforms are also its curse. Peer-to-peer transactions and near-instant transfers across the ecosystem and the world eliminate intermediaries and financial institutions.

In this case, there is no bank involved, and no FDIC or other government insurance for lost funds. Crypto accounts on exchanges and wallets are not insured. And securing stolen funds from a bad actor’s private wallet is nearly impossible.

The key is to react early, along with some luck that criminals have carelessly left stolen tokens on an exchange, or transferred the coins there to exchange for fiat currency.

Given that we can now track the movement of coins in wallets through the blockchain, it is not certain that all hope is lost. The old saying, “You can run, but you can’t hide” may remain in the crypto ecosystem.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Robert Appleton is a partner at Olshan Frome Wolosky and former senior US federal prosecutor specializing in international white-collar and cross-border financial transactions and due diligence.