What is a Digital Asset?
A digital asset is anything that is created and stored digitally, is identifiable and discoverable, and has or provides value. Common types of digital assets are cryptocurrencies, non-fungible tokens (NFTs), audio files, videos, logos, graphic art, social media accounts, and websites. Below, we explain two of the most common types, cryptocurrency and non-fungible tokens.
What is Cryptocurrency?
Cryptocurrencies (crypto) are also called virtual currencies or digital tokens. Cryptocurrency is not backed by physical assets or tangible securities. Unlike government-issued “fiat money” such as U.S. dollars, British pounds, and Euros, crypto is not issued or backed by any government or central bank. Investors often use fiat money to purchase crypto and/or trade or sell their crypto holdings in exchange for fiat money.
There are hundreds of cryptocurrencies – some of the most well-known are Bitcoin, Ethereum (Ether), and Tether. Investors store, access, and manage their crypto holdings in a digital wallet. A hot digital wallet is internet-enabled and online, while a cold digital wallet is offline in the form of a physical device, such as a USB stick or thumb drive.
Crypto is tracked on distributed digital ledgers or databases called the blockchain. Blockchain is meant to be a secure and decentralized record of all crypto transactions. Blockchain is designed to be immutable, meaning it cannot be altered.
Crypto is typically traded on cryptocurrency exchanges. Because crypto is only worth what other people are willing to pay, the values can and do change quickly. Crypto exchanges can be quite volatile. The collapse of the FTX exchange and the LUNA StableCoin crash provide two examples of the risk and uncertainty of crypto exchanges.
What are Non-Fungible Tokens?
Non-Fungible Tokens (NFTs) are digital items stored on the blockchain. When you purchase an NFT, you are buying a unique piece of code that represents ownership of something digital. This could be artwork, a video, music, or even a tweet. Each NFT is created and sold by someone. NFTs are usually bought and sold using digital currencies like Bitcoin.
NFTs share a few important qualities:
- Uniqueness: Each NFT is one-of-a-kind. Unlike fiat currency or Bitcoin, one NFT cannot be swapped for another NFT. An NFT is more like a unique piece of art. Each one has its own intrinsic value and cannot be replaced by another seemingly identical NFT.
- Provable Control and Provenance: NFTs provide a way to prove that you own a digital item. Each NFT is traceable back to its creator. Even if copies of the digital item are floating around online, the original one tied to the NFT is considered the true version. When you buy an NFT, you are also buying ownership of that digital item. You may not get the copyright to it however.
- Linked Smart Contracts: Sometimes, NFTs come with “smart contracts” attached to them. Smart Contracts lay out the specific rules or conditions for how the NFT can be used. For example, a smart contract might ensure that the original creator gets a percentage of any future sales of the NFT.
Who Regulates Crypto Transactions?
It depends. The U.S. Securities and Exchange Commission (SEC) and the U.S. Commodity Futures Trading Commission (CFTC) have both been quite active in the digital assets space, particularly in cases involving market manipulation, misleading reporting, or investor fraud.
Additional U.S. regulatory agencies potentially wielding authority over cryptocurrencies, depending on their specific application, include the U.S. Department of Justice, the Financial Crimes Enforcement Network (FinCEN), the Internal Revenue Service (IRS), the Federal Trade Commission (FTC), and the Office of the Comptroller of the Currency (OCC), among others.
Common Types of Crypto Fraud
Money Laundering – New Book, Same Story
The instantaneous transactions, perceived anonymity, global accessibility, and ease of transfer associated with cryptocurrencies have made them a favorite tool of criminals. Individuals involved in illegal activity may use crypto and other digital assets to commit tax evasion, money laundering, pr bribery, among other crimes. To prevent money-laundering, crypto exchanges and many digital asset businesses are required to have anti-money laundering (AML) and know your customer (KYC) programs. Failure to comply with those regulations can lead to severe financial and criminal penalties.
Deceptive Initial Coin Offerings (ICOs)
The launch of a new cryptocurrency through an Initial Coin Offering (ICO) presents an opportunity for exploitation, particularly targeting inexperienced investors. Some ICOs are fraudulent, featuring fictitious team members and plagiarized technical documents from legitimate projects.
Pump and Dump Schemes
Cryptocurrencies are susceptible to manipulation akin to traditional pump and dump schemes. A pump and dump scheme refers to a situation when the value of something is artificially inflated before insiders sell off their crypto or shares. Illegal actors often misuse social media to create a buying frenzy to drive up value. Once the insiders have sold off their positions, the value of the remaining crypto or shares plummet. This tactic is often deployed during ICOs or later stages when false claims artificially inflate demand, enabling creators or major holders to reap substantial, illegitimate gains.
Market Manipulation
Fraudsters may engage in various forms of market manipulation within cryptocurrency markets. Some examples of market manipulation are spoofing, front-running, and churning. These activities artificially influence prices and deceive investors.
Ponzi Schemes
Cryptocurrency investments are vulnerable to Ponzi schemes. In a Ponzi scheme, there is little or no actual business activity that produces revenue. Rather, the original investors and the perpetrators of the fraud are paid with funds provided by the later investors. Ponzi schemes often masquerade as investments in emerging crypto markets, exploiting the lack of understanding surrounding cryptocurrencies.
Cyber Theft
The digital nature of cryptocurrencies opens avenues for cybercriminals to steal funds. For example, bad actors may hack investors’ wallets, create fake wallets to defraud counterparties, or establish fraudulent exchanges to swindle customers. Criminals sometimes create fake profiles and use dating apps, texts, and romance scams to identify and mislead victims into buying and transferring digital assets. The scams often start with offers to make small, ‘risk free,’ investments. Once the criminals establish trust, they pressure their victim to take out loans, liquidate retirement savings, or mortgage a home. The practice is so widespread it has become known by the crude name ‘pig butchering,’
Misleading Promotion
Celebrity endorsements of various digital assets without proper disclosure of compensation is a growing problem in the cryptocurrency space. In recent years, the SEC has initiated several enforcement actions against celebrities for this type of conduct.
How to Report Crypto and Digital Asset Fraud?
Depending on the circumstances of the transaction, one or more whistleblower programs such as those by the CFTC, SEC, FinCEN, or IRS, may apply. If you are considering reporting crypto or digital asset fraud, or if you know of a crypto business or exchange which is failing to meet its anti-money laundering or its know your customer obligations, we urge you to contact us for a free, confidential consultation to discuss the appropriate whistleblower program for your situation.
Whistleblower Law Collaborative LLC, based in Boston, devotes its practice entirely to representing clients nationwide in bringing actions under various whistleblower programs. We have assisted many whistleblowers bring successful cases under the auspices of these programs, including obtaining a $17 million SEC whistleblower reward for one of our clients.