Updated on August 15, 2022
Cryptocurrency has become a highly sought-after investment. Its investors range from tech savvy investment professionals to regular people with limited investing experience. The industry has garnered a reputation of high-risk, high-reward investments that make for tempting opportunities for those comfortable with educated gambling. Like gambling, the drawback of crypto investment is the potentially massive losses investors may take due to rapid market fluctuation, scams and fraud.
Cryptocurrency fraud and scamming are steadily increasing, with no peak in sight. In May 2021, the Federal Trade Commission warned that cryptocurrency losses had increased by one thousand percent since October 2020. In September 2021, the Securities and Exchange Commission released an investor alert warning people to take caution when investing in cryptocurrency. The SEC issued the alert due to the high-volume digital asset and cryptocurrency investment scamming. Subsequently, the SEC filed a two-billion-dollar action against cryptocurrency lending platform, BitConnect, for the platform’s alleged fraud.
Typically, those most susceptible to cryptocurrency scams are those investors with limited crypto-investing experience who may get caught up in the hype of a trending currency. These investors lose money by missing blatant warning signs that a token or coin could be fraudulent. Recently, around fifty thousand crypto investors lost money in the scam carried out by the creators of the “Squid” token.
The Squid token was a cryptocurrency created and branded similarly to the Netflix show, Squid Game. The token was supposed to be “play-to-earn” cryptocurrency, meaning that investors would purchase tokens as an entrance fee, then theoretically play Squid Game-themed online games to earn credits. These credits could supposedly be sold or exchanged for other crypto and monetary currencies.
The website launched on October 20, 2021, and the token’s developers advertised the online game’s release in November 2021. The Squid token gained massive popularity by capitalizing on the hype surrounding the television series. Ominously, on October 28, 2021, CNBC published an article stating that Netflix rejected any association with the cryptocurrency as well as its developers. Alas, within the first week of the initial coin offering (“ICO”), the price of the Squid token rocketed from one penny to almost three thousand dollars, attracting tens of thousands of investors during its rise.
By October 29, 2021, the price of the token had increased over two thousand percent from its ICO price. Squid token holders believed they were sitting on massive returns and looked to cash out. However, the most suspect feature of the Squid token was a built-in mechanism in the token’s smart contract that prevented investors from selling or exchanging the token. This technical feature locked in investors who could not cash out on their hopes for substantial gains. Squid token developers disclosed this feature but claimed it was part of an anti-dumping mechanism to limit people from selling off tokens if certain conditions were not met. On November 11, 2021, just three weeks after its launch, the value of the Squid token collapsed. The developers cashed out, leaving investors with valueless tokens.
Because most cryptocurrency is decentralized, unregulated and full of unknowns, scams are inevitable. One of the most nefarious, yet common, types of cryptocurrency scams is the “rug pull” scam. Rug pull scams take place when developers draw in large numbers of investors to buy tokens, restrict their ability to sell and trade their tokens and then sell off all their retained tokens. In doing so, the developer capitalizes on the sale of the token at its highest value, while simultaneously leaving the token essentially valueless for investors who cannot sell. This is the type of scam perpetrated by the developers of Squid token. During the Squid token’s short existence, its developers raised and subsequently stole over three million dollars from investors.
A similarly well-known type of scam in crypto is a “pump-and-dump” scam. In a pump-and-dump scam, the scammer uses fake recommendations to inflate the price of the cryptocurrency. Then, it sells an immense amount of the cryptocurrency at the inflated price. A recent cryptocurrency pump-and-dump happened in March 2021, also using the popularity of a TV show to lure investors. The scammer created a cryptocurrency called Mando, that falsely associated itself with the popular Disney show, The Mandalorian. The cryptocurrency attracted the support of a TikTok influencer, who encouraged over one million followers to invest in the coin’s initial offering. Shortly thereafter, the Mando website disappeared, along with the money it raised.
Unfortunately, because of the anonymous nature of cryptocurrency, most cryptocurrency scam losses are not recoverable. Law enforcement agencies have not devised a way to consistently locate, identify and detain perpetrators of crypto fraud.
The lack of government enforcement leads many scammed investors to file civil suits as an attempt to recover lost funds. Currently, the most promising way to recover losses from cryptocurrency scams is to join or start class action lawsuits against scammers and financial institutions who may have contributed to the fraud. In a more traditional investment environment, the course of action to recover investment fraud losses is to sue the issuing entity for negligence, fraud or misrepresentation. If a cryptocurrency exchange is a centralized exchange, it can be sued in a more traditional way through a court with jurisdiction over the exchange. However, decentralized exchanges like PancakeSwap (on which Squid token was exchanged) are difficult to hold accountable, as the issuing entity is often unknown. It is possible that those who have suffered losses can sue the cryptocurrency sellers for financial fraud, false advertising or misrepresentation, but this is a steep course of action even if the seller’s identity is known.
The crypto regulation landscape is everchanging. Presently, Congress is working on legislation aimed at regulating cryptocurrency exchanges. On November 1, 2021, the President’s Working Group on Financial Markets issued a report on regulatory recommendations of stable coin, a type of cryptocurrency, signaling that more imminent crypto-specific investment regulations may be coming. In the meantime, regulatory agencies like the SEC will focus on enforcing crypto compliance with existing securities laws.
Cryptocurrency investments are relatively high-risk in nature. Accordingly, the burden of due diligence falls solely on the shoulders of the investor, as the exchanges remain largely unregulated. Because of the risk, experts generally suggest that cryptocurrency investments make up a low percentage of an investor’s entire portfolio.
With the risks of crypto investments in mind, there are some distinct warning signs that inexperienced investors should be aware of when vetting a crypto investment. First, cryptocurrencies that claim association with specific trendy brands, TV shows and movies should be carefully evaluated. This is especially true if the brand with which the cryptocurrency is supposedly associated with overtly states that they are not affiliated with the cryptocurrency. For example, Netflix’s denial of association with the Squid token should have tipped off investors.
Another indicia of crypto legitimacy is the cryptocurrency’s whitepaper or lack thereof. Each cryptocurrency should have a whitepaper that details the cryptocurrency’s purpose, as well as the technology used for development. A poorly structured whitepaper is an important red flag that even inexperienced investors can notice. The “whitepaper” in the Squid token scam was littered with grammatical and spelling errors, as well as unvalidated claims about the currency.
Vet a potential cryptocurrency investment by reviewing its’ advocates. Is the cryptocurrency backed by celebrities and influencers? Or are reputable insurers and venture capitalists investing in the cryptocurrency? Lack of support from any reputable investors is often telling of an unsound crypto investment.
Lastly, a warning sign of a cryptocurrency scam is the inability of investors to sell the crypto asset once purchased. In the Squid token scam, the developers distracted from this concern by dubbing it an “anti-dumping” strategy for the sake of the functionality of the game. However, this ended up being the most prevalent issue, and what ultimately led to shareholders losing their entire investment.
Crypto-related scams often involve violations of criminal laws and victims of these schemes should contact their local police department and/or the Federal Bureau of Investigation. The rise in crypto-related scams has also led to the creation of specialized groups within various law enforcement and regulatory agencies to deal specifically with the investigation and prosecution of these crimes. For example, earlier this year, the Department of Justice (DOJ) announced the creation of the National Cryptocurrency Enforcement team, a task force that will identify, investigate, support and pursue the DOJ’s cases involving the criminal use of digital assets, with a particular focus on virtual currency exchanges, mixing and tumbling services, infrastructure providers and other entities that are enabling the misuse of cryptocurrency and related technologies to commit or facilitate criminal activity. In addition to local law enforcement, victims of scams involving digital assets have several government agencies to which they can make a complaint. Here are some helpful links to report fraud and other suspicious activity involving digital assets:.
Investors should carefully vet potential investments, especially ICOs – it is easy to get caught up in the excitement of cryptocurrency and miss signs of a scam. With its high-risk, high-reward market, cryptocurrency has the potential to provide lucrative gains to those who take the time to invest cautiously. As with all high-risk investments, it’s important that prospective investors avoid spending more than they are willing and able to lose. If you think you may have encountered a crypto scam or legal issue with a cryptocurrency transaction, reach out to an experienced attorney who can help you navigate the changing laws regulating the industry.