Crypto Fraud is Real - How Practitioners Can Help Prevent It

By Dr. Sean Stein Smith, CPA, DBA, CMA, CGMA, CFE, City University of New York-Lehman College – April 22, 2022

Blockchain and cryptoassets are increasingly part of mainstream financial markets and accounting conversations. Decentralized finance (DeFi), non-fungible tokens (NFTs), the rapid proliferation of stablecoins and the continued research around central bank digital currencies (CBDCs) are just a handful of the major topics that have burst into mainstream conversation in the past year.

Alongside this innovation and creativity, however, has been an uptick in fraud risks for investors and clients. There have been several recent high-profile examples of fraud that should catch the attention of practitioners. It is also worth noting that the crypto sector has incurred nearly $2.5 billion in fines since inception. Consider the following:

Fraud and theft related to DeFi activities (a red hot area) totaled $10.5 billion during 2021.
Social media platforms, including YouTube and Twitter, have been used to spread dozens, if not hundreds, of crypto-related scams.
Hit shows like Squid Game on Netflix can be leveraged to defraud investors out of millions.
Investors are investing millions into NFTs and the metaverse (virtual/augmented reality) without truly understanding the implications of doing so.

As individuals and institutions further integrate blockchain and crypto into operations, the factors that practitioners and advisors should keep in mind will only increase.

Review the Details and Fine Print

Blockchain and crypto might be relatively new topics and technologies, but that does not mean that the fundamentals for investing and due diligence are any different. Many of the fraud, scams and unethical activities that have occurred in this space are a result of investors and customers thinking that, because blockchain and crypto are new, the regular rules of risk and return do not apply.

Promises of overly consistent or outsized returns, free money or promises that are too good to be true are red flags that would usually be caught but can easily attract non-crypto experts. Practitioners should always encourage clients to perform their own research and due diligence, as well as assisting by performing independent research as their own.

Have a Crypto Payment Strategy

As increasing numbers of firms integrate blockchain and crypto into core operations or seek to attract and advise clients who are doing so, the need for a defined crypto payment strategy will only become more necessary. The following questions should be asked:

What type of crypto will be accepted for payment? This makes sense from an operational perspective, and it highlights (yet again) the importance of conducting due diligence on specific cryptoassets.
Will the firm hold onto cryptoassets used for payment purposes or immediately convert them back to fiat? Both aspects have exposure to scams, which are discussed in more detail below.
How well does the crypto technology stack interoperate with other technology tools? While most third-party service providers are ethical actors, some are not. This can expose the organization to scams and other crypto risk.

Safeguard Crypto

Managing the risk around crypto scams and other ethical activities is not simply a matter of understanding the specific crypto in question but also understanding what happens when crypto has been purchased or received. Much has been written about hot wallets (applications that enable real-time and web-based access to crypto holdings) and cold wallets (specialized hardware that is not as easy to access or hack since it is offline), but that misses the wider point.

Third-party service providers can have all the appearances of being legitimate but may, in fact, simply be a funnel to direct investors and clients to unethical actors or scam artists. Granting access to crypto should be treated with exactly the same seriousness as allowing access to bank accounts, brokerage accounts or other financial assets. No matter which option is selected or pivoted to over time, the evaluation and research performed on any third-party provider should be the same.

Blockchain and cryptoassets have grown incredibly fast, continue to attract billions in investments, and garner the attention of policymakers, regulators and potential clients. As quickly as this has occurred, however, the risks of fraud and other unethical activities has increased nearly as quickly. Fortunately, there are several common-sense steps that can be implemented today to minimize firm and client exposure to crypto scams and fraud. The marketplace will, as it always does, reward proactive market actors willing to embrace new opportunities.

Sean D. Stein Smith

Dr. Sean Stein Smith, CPA, DBA, CMA, CGMA, CFE, is a professor at the City University of New York – Lehman College. He is a member of the NJCPA Board of Trustees, a New Jersey CPA Political Action Committee Trustee and participates on several interest groups. He can be reached at sean.steinsmith@lehman.cuny.edu.

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