Fraudulent payments – where people are tricked into sending money to criminals – cost consumers £460 million in England and Wales last year. To give consumers more protection, the UK government now plans to give banks 72 hours to delay completion of potentially fraudulent transfers.
The growth of the decentralised finance sector – including cryptocurrencies and the platforms that facilitate their trade – offers an alternative to mainstream finance. But as well as new opportunities, the growth of DeFi (as it’s known) has brought serious risks of financial crime and scams.
On the one hand, the blockchain technology used in cryptocurrencies has been heralded as a means of increasing transparency and efficiency for banks and other corporations. On the other hand, DeFi presents a longstanding problem of criminal use – anonymising and masking illicit transactions and facilitating the global movement of crime proceeds.
The grooming processes that fraudsters use to gain the trust of victims can be sophisticated, with slick websites, pseudo-expertise, or promises of gain or a long-term relationship (whether romantic or business).
Once they’ve struck, the criminals convert traditional currencies into digital assets like cryptocurrencies. This enables large volumes of money to move quickly and undeclared across borders. The blockchain technologies that make this possible are celebrated as the cutting edge in financial technology, but they also pose risks by serving as avenues for money laundering, scams and other illegal activities, from narcotics trafficking to funding terrorism.
The scale is difficult to gauge, but published figures vary from about 1% to 3% of global transactions, a range of US$24 billion (£19 billion) to US$72 billion – just Bitcoin – annually.
The speed and sophistication of the evolution of scams against businesses and consumers has made it difficult for regulators to keep pace. Phone calls and phishing emails have mutated into deepfaked boardroom meetings, with AI voiceovers, targeting those with financial sign-off powers and causing companies to fall victim too.
DeFi specialist lawyers can instigate proceedings and tracing if they are informed before the money leaves their jurisdiction. However, the risk increases over time and in less robust legal systems. It very quickly becomes difficult to trace or retrieve funds thanks to crypto wallets, offshore accounts and cryptocurrencies that offer total anonymity, like Monero.
The crypto millionaires
Despite the dark side of DeFi, the global demand remains high. For example, fintech firm Revolut (which was only established in 2015) was valued at US$45 billion in the latest funding round. This rivals traditional banks like Barclays (around US$47 billion), demonstrating their potential for rapid growth.
More than 172,000 crypto millionaires exist in a market worth US$2.3 trillion. This is 54 times more than the number of ISA millionaires (which are government-backed, tax efficient and generally safer).
In short, crypto millionaires have become rich fast. Bitcoin has rocketed to all-time highs since Donald Trump’s landslide victory in the US presidential election.
At US$88,000, just one Bitcoin is worth 33.8 times the price of an ounce of physical gold – US$2,600 – despite gold’s momentous rally over the past year. Around 85% of crypto asset owners are gen X, gen Z and millennials.
The news is not all bad. Scamming and stolen funds were actually down year-on-year and the planned UK legislation demonstrates a commitment to stopping the scams.
Challengers to traditional banking, like Binance, Coinbase, Kraken and Revolut have thrived. They offer digital wallets, lending and transactions into and out of blockchain products like cryptocurrencies.
The combination of technological advances, privacy, accessibility, innovation and long-term plans for adoption boost momentum among speculators. Ultimately, investors and the industry itself anticipate very long-term demand for their services.
How can we explain the positive sentiment alongside such high volumes of scamming and crime? Behavioural finance speaks of irrational exuberance (where investors’ enthusiasm drives prices higher than they merit), over-optimism bias, fear of missing out, envy or greed and resultant “herding” behaviour, which can spark both speculative bubbles and volatility.
According to loss aversion theory, consumers tend to be more upset by losses than they are happy with equivalent gains. But on the other hand, the average consumer is overconfident of their financial knowledge and capability.
So criminals can use psychological vulnerabilities combined with technology to persuade potential victims, winning their trust and compliance. Promoting financial literacy, as well as healthy scepticism of offers that seem too good to be true, are key to helping people avoid scams. The emotional and financial harms to vulnerable people of falling prey to scammers can be profound and long lasting.
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If you experience fraud, you should report it immediately to the police’s Action Fraud service and the Financial Conduct Authority. Speedy reporting can make all the difference when it comes to recovering assets.
Regulation and consumer education will be crucial to mitigating risks and reducing DeFi’s potential for harm to consumers and companies. However, these are nuanced and difficult problems. For example, compensation schemes for fraud victims have themselves opened the door to fresh scams.
Governments should collaborate with industry and researchers on traceable blockchains and protocols that enable accounts to be frozen, while nudging individual and corporate users away from those that do not (so-called privacy coins).
This will mean a serious reckoning with the technological and economic benefits of deregulated finance and the malevolent forces that seek to exploit it.
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