Kleptocurrency: ICO Fraud, Regulation, and Red Flags

By Cory Rosenstein-Ford

In recent years, cryptocurrencies have rocketed to the forefront of financial news reporting, and established a significant presence in pop-culture. As of July 2018, the cryptocurrency market consisted of more than 1,500 cryptoassets, up from only 14 in 2013. Crypto has spawned a subculture of young investors and issuers with little interest in the conventional, “lame” investment mediums that populate their parents’ retirement accounts. Vice News recently described the blooming crypto subculture as a “total brofest,” in which silicon valley “tech-bros” tout the lavish spoils of exploiting the thinly regulated crypto market while purporting to disrupt traditional Wall Street investing culture. In short, this new crypto-culture eerily parallels the 1990’s animal-house boiler rooms memorialized by the likes of Wolf of Wall Street and Liar’s Poker.

Just as the 1990’s boiler rooms churned fraudulent stocks, ICOs, have become a hotbed of fraudulent cryptocurrencies. A July 2018 study found that over 80% of ICOs made in 2017 were fraudulent. The most prevalent ICO scam is a simple exit scam, under which a fake ICO purports to be raising capital for an investment project. In exchange for contributions in cash or other forms of cryptocurrency, the fake ICO issues investors a new cryptocurrency that will allegedly grow in value based on the success of the investment project it represents. The fake ICO then pockets the investors’ money and shuts down the ICO platform without a trace. For example, five higher profile ICO exit scams—Shenzhen Puin Blockchain, Cryptokami, NVO, Loopx, and Block Broker—purloined nearly $100 million from investors in 2017 and 2018.

Regulators and law enforcement agencies have not caught up to the recent influx of ICOs. However, the SEC’s position as of June 2018 is that most ICOs using tokens or digital assets are securities offerings and will be regulated accordingly. Over the past few months, the SEC has charged ICO issuers with securities violations.

However, because ICOs often involve international transactions, and the geographical movement of cryptocurrency is harder to trace than conventional money, the SEC warns of heightened risk of fraud. Until regulators and law enforcement authorities catch up to ICO technology, consider the following before investing in ICOs:

  • If the ICO’s advertising looks too good to be true, it likely is. Be wary of supermodel-clad LinkedIn advertisements and celebrity endorsements. One scam even claimed Vladimir Putin’s support.
  • The offering documents should clearly describe the operations and goals of the ICO. Legitimate offering materials won’t simply repeat vague buzzwords. FINRA provides information for investors to consider prior to investing in an ICO.
  • The managers of a legitimate ICO should be easily traceable on LinkedIn and Google.

Even still, some ICO scammers spend tens-of-thousands of dollars developing websites, promotions, and whitepapers that appear legitimate. Buyer beware.

According to CNBC, more than 800 cryptocurrency offerings—many of which involved frauds—had failed by July 2018.