Investigating Cryptocurrency Fraud

Avi Kamath, Senior Associate at nagel + associates, is pleased to be delivering a virtual presentation on March 16, 2022 for the CalCPA 2022 Fraud and Forensic Accounting Virtual Conference on the topic of:

“Investigating Cryptocurrency Fraud”

In this session, participants will explore the basics of investigating cryptocurrency fraud, covering the range of different frauds that are commonly encountered and the tools available to assist in these investigations. The session will address how participants can assess and develop a plan of action for different types of cryptocurrency frauds and consider future trends in the digital asset landscape.

Session Topics to be Covered:

• Background of cryptocurrency types, their traceability and level of privacy offered.
• How cryptocurrencies are stored and how these assets can be frozen and/or recovered.
• The cryptocurrency fraud landscape, including the types of commonly encountered cryptocurrency fraud schemes.
• How to assess and plan for cryptocurrency investigations, including resources to assist with tracing and recovery.
• Future trends in terms of ‘Big Tech’ and cryptocurrencies and how to stay on top of a rapidly evolving digital asset landscape.

Session Learning Objectives:

• Understand the basics of cryptocurrency ownership, storage, privacy and traceability.
• Identify the most common types of cryptocurrency frauds and develop an investigation work plan relating thereto.
• Recognize future trends in the digital asset landscape.

Click here for more information about Avi’s session on Investigating Cryptocurrency Fraud.

Municipal Internal Auditors Association

Edward Nagel, Principal of nagel + associates is pleased to be speaking on April 22, 2021 at the Municipal Internal Auditors Association’s 2021 Spring Workshop Webinar.  Edward will be speaking on the topic of:

“Procurement Fraud in Municipalities”

The procurement process provides countless opportunities for employees to collude with vendors, or vendors to collude amongst themselves, in order to extract illicit financial benefits from the organizations with whom they deal. However, when armed with the tools and skills to know what to look out for, municipalities can protect themselves to prevent/detect these kinds of schemes from occurring, thereby mitigating this risk.

Led by a seasoned forensic accountant and citing real-life cases, this engaging session will explore the profile of a typical fraudster and what drives people to cross ethical boundaries. It will consider the types of procurement fraud schemes that commonly victimize municipalities, the ‘red flags’ or indicators for internal auditors to watch out for, the role of technology in today’s business environment and recent trends & best practices in fraud prevention, detection and investigation.

The session will address the impact on fraud risks emanating from the Covid-19 pandemic, as many people have shifted from physical to remote work environments—a trend that is likely to continue in some capacity, even once Canadians are fully vaccinated.

Click here for a full agenda of the MIAA’s 2021 Spring Workshop.

Airdrops: Billions of Dollars of ‘Free Money’ – Uniswap

Over the past several months, the entire crypto community has been buzzing with excitement. Since March 2020, several billion dollars’ worth of cryptocurrency has been freely distributed to ‘people in the know’ through what is commonly referred to as airdrops. Where did these billions of dollars of free money come from? More importantly, how can you get your share of this free money?

Even though everyone has heard the old adage, ‘If it sounds too good to be true, it probably is’, the promise of free money can compromise the judgement of even the most reasonable and sensible among us. As a result, airdrop events are prime targets for fraudsters. In fact, there are numerous recent examples of people losing substantial amounts of crypto assets in an effort to get some of this ‘free money’.

What is an ‘Airdrop’?

To get started, what exactly is an airdrop? In simple terms, an airdrop is a free distribution of any crypto asset. While established crypto assets (like Bitcoin and Ether) can be airdropped, it is far more common to see new assets that have no or negligible established market values be distributed for free. Given how easy it is becoming for anyone to issue and distribute their own crypto assets, many airdrops will remain valueless. However, increasingly, even legitimate well established companies developing in this space are making use of these free distributions.

Why, you may ask, would these organizations offer free distributions of their crypto assets?  There are many benefits to these crypto companies providing the airdrops, the most notable of which is market exposure. Crypto companies use airdrops as a way of connecting with new users and growing the underlying user base for their platform by leveraging the word-of mouth recommendations and media attention such events generate.

There are several different types of airdrops, each requiring a different set of actions in order to receive the ‘free crypto asset’. The most common types of airdrops used today are:

(i) Airdrops for using a company’s platform or service;
(ii) Airdrops in exchange for completing simple tasks, such as sharing a referral link on one of your social media platforms (e.g., Facebook, Twitter, etc.);
(iii) Airdrops for signing up to a newsletter, by providing your email;
(iv) Airdrops for individuals who hold certain specified tokens (for example, Ether) in their various crypto wallets as of a specific date, the purpose of which is to quickly attract a tech-savvy userbase (in this example, Ether holders) to their platform or service; and
(v) Airdrops for VIP/loyalty members who contribute to a specific project or community.

With that basic understanding of airdrops, let’s introduce the three airdrops that we will be profiling over this three-part article series:

(i) Part 1 (Uniswap airdrop) – Intro to airdrops and associated fraudulent schemes;
(ii) Part 2 (Yearn Finance airdrop) – Decentralized finance (DeFi) and associated risks; and
(iii) Part 3 (Reddit ‘community points’ airdrop) – Big Tech is airdropping! What’s the catch?

In part 1 of this article series, we will be examining the Uniswap airdrop of UNI tokens (the “UNI Airdrop”), some common fraudulent schemes that have been associated with it, and the specific conditions that one needs to meet in order to qualify to receive it.

UNI Airdrop

The UNI Airdrop is a great place to start, as its qualification requirements were extremely simple. In order for an individual to be eligible to claim the 400 free UNI tokens offered by the UNI Airdrop, they simply had to use the decentralized crypto asset exchange platform Uniswap, prior to September 1, 2020. That’s it.

So, your first question right now is probably, ‘how many UNI tokens got distributed and how much were they worth?’. However, before we get into that, let’s take a step back and quickly unpack what exactly Uniswap is. While the majority of crypto assets are traded on centralized exchanges (i.e., an exchange run by a particular company that is based out of a specified location), people are increasingly using trustless alternatives called decentralized exchanges. Decentralized exchanges, such as Uniswap, are considered trustless as they require no middlemen or custodians to facilitate trading.

The mechanics underlying Uniswap can quickly become very complicated and are beyond the scope of this article. However, let’s address some of the key characteristics that make Uniswap unique. Unlike most exchanges, Uniswap doesn’t have an ‘order book’, nor does it take custody of any assets in order to facilitate trading. Instead, it allows certain users (referred to as “liquidity providers”) to put crypto assets into liquidity pools, against which other users (referred to as “traders”) can directly swap their crypto assets. The unintuitive part is that the crypto assets held in these liquidity pools are secured by computer code rather than an institution like your bank or a centralized exchange.

We will discuss liquidity provision and its associated risks in greater detail in part 2 of this article series.  But continuing on with the UNI Airdrop, the only requirement needed to enjoy this Airdrop of 400 UNI tokens was to be a Uniswap user (liquidity provider or trader) prior to September 1, 2020[1]. Of the 150 million UNI tokens marked for the UNI Airdrop, over 126 million (84%) have been claimed to date[2]. Between September 16, 2020 (the date of the UNI Airdrop) and December 8, 2020 (the date this article was published), the value of the UNI token reached a high of $8.44 USD[3].  That means each user’s UNI Airdrop of 400 UNI tokens was potentially worth in excess of $3,300 USD, which translates to over 1 billion dollars being distributed for free, from this one airdrop!  Not bad for free money!

So, what’s the catch? There’s always a catch, right? As expected, this unannounced and valuable airdrop created quite the media buzz. While there was no time limit for claiming the UNI Airdrop, given how volatile crypto prices are, there was a ‘mad rush’ to claim and sell these free tokens, which had an approximate value of $1,375 USD (400 UNI Tokens X $3.44 USD) on September 17, 2020, the day after the UNI Airdrop became available to be claimed[4].

This chaotic ‘mad rush’ to claim the free UNI tokens offered by the UNI Airdrop didn’t go unnoticed by scammers and fraudsters alike.  Even in a ‘simple’ airdrop such as the UNI Airdrop, countless things could and often do go wrong.  Let’s look at two real-world examples of fraud schemes that targeted the UNI Airdrop.

Fraud Example 1: “Verify Your Address” Scam

One of the most common types of crypto fraud schemes we’ve seen over the lifespan of cryptocurrencies is essentially an advance fee scheme, whereby the victim is persuaded to pay a small sum of money up front with the promise of a much larger repayment in return.

Image No. 1

Image No. 1 shows a ‘UNI Airdrop’ scam, which gives the impression that 10 million UNI tokens are being given away, as indicated by the red/black bar at the bottom of the picture.  This visual depiction conveys a sense of urgency as it implies that a majority of the finite available UNI tokens have been claimed.

In order to ‘claim’ these purported UNI tokens, users were required to ‘verify their address’ by sending between 40 and 4,000 UNI to the address 0x1f5b…613ad, and in return, they would be sent back between 400 and 40,000 UNI. The fraudulent promotion states, “1. To make a transaction, you can use any wallet or exchange that supports UNI. 2. Send a small amount you want multiplied by the promotion from your wallet. For example, to get 3000 UNI, send 300 UNI. You can use any wallet or exchange of choice to send UNI. 3. Once we receive your identifying transaction, we will immediately send the requested amount back to you.”

These scammers even go as far as to show you the purported transaction history of the 0x1f5b…613ad address on the Ethereum network (depicted in Image No. 2), which falsely shows that they have returned 10x to other users as promised, thereby giving a degree of comfort to the victim.

Image No. 2

As we can see from Image No. 2, address 0x1f5b…613ad appears to have received 338.893 UNI tokens and then immediately sent back 3,388.93 UNI tokens, giving the impression that the scammer is sending the user back 10x the amount they originally sent. It is noteworthy that the other transactions in this transaction history reflect this same ratio (i.e., immediately sending back 10x the UNI tokens received).

However, if you were to actually look up the address 0x1f5b…613ad on a blockchain explorer (a basic due diligence step you should always do), you would see a very different picture painted:

Image No. 3

Image No. 3 tells the real story – the account in question has a total of five transactions, none of which match the transactions displayed on the scammer’s website. This should leave no doubt in your mind that someone is trying to defraud you out of your crypto assets.

If this scam sounds somewhat familiar, it is because a variation of it was in the news recently, when we saw a host of celebrities (including Jeff Bezos, Bill Gates, Eric Schmidt, Steve Wozniak, Daymond John and Elon Musk) peculiarly appear to promote what turned out to be fake BTC (Bitcoin) giveaways that required users to first send some BTC in order to receive a larger amount back.

For example, the ‘Elon Musk bitcoin giveaway’ asked people to send BTC to an ‘Elon Musk’ address provided by the scammers and promised to return twice as much BTC immediately. Needless to say, no BTC was returned to the victims and the scammers made off with at least 214 BTC, which, as of the writing of this article, is worth in excess of $4,000,000 USD[5]. The mechanics of this scheme are almost identical to the UNI scheme outlined above.

While most seasoned crypto users would have immediately recognized this ‘advance fee scheme’ as one of the most common forms of crypto fraud, there were many other more complicated scams relating to the UNI Airdrop that savvy fraudsters perpetrated, one of which is described below.

Fraud Example 2: “Phishing” Scam

On September 16, 2020, most people who received the UNI Airdrop were looking to claim and sell their UNI tokens quickly as these tokens were trading for considerable value.  As crypto users – both novices and seasoned users alike – rushed to claim and sell their UNI tokens, the price of “gas” (the transaction fees required to complete a transaction on the Ethereum network) skyrocketed. This steep rise in gas, coupled with  the inherent price volatility of crypto assets in general, further perpetuated the sense of urgency.

In fact, this rush to claim and sell the UNI tokens had a quantifiable impact on the Ethereum network, resulting in an increase in transaction costs by a factor of almost 5. This is due to how priority is given to transactions on the Ethereum network.  Since transactions are prioritized by the amount of gas the user is willing to pay per transaction, users looking to have their transactions processed quickly can rapidly bid up the transaction costs for all users. Image No. 4 below demonstrates the fluctuation in gas prices between June and September 2020.

Image No. 4: Source: Dune Analytics

Volatile token prices and transaction fees create the perfect conditions for even hardened crypto users to make errors that could cost them far more than the free money they hoped to gain.

An extremely common malicious tactic used by criminals is to set up ‘phishing’ websites that request your seed or private key (if you don’t know what a seed or private key is and you are interested in learning more, click here to be directed to Nagel Academy’s Introduction to Cryptocurrency course).

For example, take a look at the series of screenshots below. Series 1 is taken directly from the Uniswap website and Series 2 from a fraudulent site trying to pass itself off as Uniswap.

Series 1:

Series 2:

Could you have identified which one is legitimate and which one is not?  The two series look almost identical, from the branding to the website’s user experience. The only real difference is that upon trying to connect with the malicious website, users are prompted with an error message as follows:

Image No. 5

As shown in Image No. 5, the malicious website prompts the user to enter either their private key or mnemonic phrase – a telltale sign of a scam.  Often times, users are requested to submit transactions (for example, to prove that they used a given platform) in order to claim airdrops. An inexperienced user – or an experienced user given certain market conditions – could quite easily be duped into submitting their private key along with other requested information, by a malicious website such as this.  Doing so would likely have catastrophic consequences, including compromising all of the user’s funds that are associated with that private key.

How can nagel + associates help?

The nagel team can assist in providing due diligence on any crypto related offers you may have received, in order to help you avoid ones with malicious intent.  We can also provide you with a safe a reliable service that will allow you to securely claim any non-malicious airdrop you may have been awarded.

The nagel team can offer various crypto-related services, including:

a) Conducting due diligence to explain risks and help avoid malicious offers;
b) Confirming or dispelling allegations relating to investment fraud;
c) Identifying unreported crypto assets;
d) Tracing and recovery of crypto funds;
e) Providing consultation services on token implementation;
f) Providing consultation services on policy making and/or policy compliance;
g) Reviewing security, privacy, and asset safeguarding protocols and methodologies;
h) Assisting in locking/unlocking assets into liquidity pools;
i) Assisting in staking/unstaking liquidity provision tokens (yield farming); and
j) Assisting in securely claiming all entitled airdrops.

While nobody can be sure what the future holds for crypto, past experience and current trends would appear to suggest that this is only the beginning…

Stay tuned for part 2 of 3 of this article series, where we will address the Yearn Finance Airdrop, decentralized finance (DeFi) and associated risks.

Sources:
[1] Source: uniswap.org
[2] Source: duneanalytics.com
[3] Source: coingecko.com
[4] Source: coingecko.com
[5] Source: bitcoin.com

Fraud Trends Stemming from the COVID-19 Pandemic

In a memorable scene from the esteemed HBO crime drama The Sopranos, mob boss Tony Soprano is angry with his captains about their dwindling earnings, claiming that the recession is no excuse for poor financial results in their line of work.  He rhetorically asks his consigliere, Silvio Dante, “…what two businesses have traditionally been recession-proof since time immemorial?”.  Silvio responds, “Certain aspects of show business, and our thing[1]

While the developments of the last several months – a global pandemic, government-ordered closures, mass unemployment, civil unrest – have presented problems far more formidable than those of a typical recession for enterprises both criminal and legitimate, they have also provided fertile ground for fraud and other wrongdoing.  Despite some underworld revenue streams being disrupted or completely drying up[2], such as sports gambling (due to professional leagues suspending their seasons), protection rackets (due to mandated business closures), and the drug trade (due to border restrictions), other opportunities have presented themselves for those willing and able to exploit them, suggesting that Silvio’s argument holds true even in these extraordinary times.

This article addresses some of the recent fraud trends that have emerged over the past several months in Canada as well as in other parts of the world, because of COVID-19.

A Confluence of Circumstances

The coronavirus pandemic has created waves that have touched virtually all corners of the globe, giving rise to a convergence of many, often mutually exacerbating, developments, including:

    • Death and illness of loved ones;
    • Widespread layoffs;
    • Physical distancing requirements;
    • Remote work arrangements;
    • stock market volatility;
    • Mandated business and school closures;
    • Closed borders/ other travel restrictions; and
    • Critical shortages of certain goods.

Collectively, these circumstances have created widespread uncertainty, fear, anxiety, instability, isolation, and desperation – precisely the sorts of conditions that opportunistic ‘bad actors’ can readily exploit[3]

According to the Canadian Anti-Fraud Centre (CAFC), Canadians reported losing $1.8 million to frauds related to COVID-19 between March 6 and May 25, 2020[4].  Like many attempts to quantify the pervasiveness of fraud, this figure is almost certainly understated, as frauds often go undetected, and even those that are detected often go unreported.  Indeed, the CAFC acknowledges that what gets reported to them is “typically the tip of the iceberg”[5]. Notwithstanding, the extent and variety of frauds reported to date to the CAFC (and to other authorities) suggest a pervasive problem.  In general, many of these frauds fall into one of five categories: product scams, investment scams, cybercrime scams, impersonation scams, and government scams.

Product Scams

Product scams include the sale of test kits, medicines, medical supplies, and other goods/services that are fake, substandard, exorbitantly priced, and/or never delivered.  Organized crime groups are believed to be heavily involved in these types of scams[6].

According to the CAFC, reported frauds of this nature have included fraudsters posing as cleaning or heating companies selling decontamination services, duct cleaning, or air filters that purportedly protect against the coronavirus.  The CAFC has also received reports of questionable testing kits or remedies that in many cases are ineffective[7].

In British Columbia, an investigation by the RCMP and Health Canada resulted in over 1,500 illegal COVID-19 testing kits being seized[8], while Toronto Police made an arrest following an investigation conducted alongside American authorities, in connection with prohibited COVID-19 testing kits being shipped across the Canada-U.S. border[9].

Product scams appear to be a worldwide concern amid the pandemic.  For example, a Europol report on how COVID-19 will affect European crime trends cites “…the trade in counterfeit and substandard goods” as one of the most prominent developments that they have observed[10].  Moreover, it is a trend that they anticipate to continue in the medium term (with an expected proliferation of counterfeit vaccines) as well as the long term (with an expected recession-spurred increase in demand for cheaper products)[11].

Mitigating the Risk of Product Scams:

    • Purchase only from reliable sources
    • Assess price against the price of comparable goods or services
    • Be skeptical of claims about products that seem too good to be true
    • Perform online searches for customer reviews of companies and products before making purchases

Investment Scams

Investment fraud and other financial services schemes have also been a widespread problem during the current crisis.

In April, the Ontario Securities Commission (OSC) and the RCMP’s Integrated Market Enforcement Team (IMET) issued a joint warning about pandemic-related investment scams, including cases in which investors have been approached by companies claiming to offer methods of preventing, detecting, or curing COVID-19.  They also warned about aggressive stock promotions and ‘pump and dump’ schemes in which false or misleading information (including about potential cures, remedies, or tests) may be disseminated to artificially inflate stock prices[12].

Similarly, the CAFC has issued a warning about fraudsters posing as financial services companies or financial advisors and offering loans or debt consolidation or promoting certain investments[13].

According to Torys LLP, both Canadian and American securities regulators are actively pursuing companies that have made inaccurate disclosures relating to COVID-19-related goods/services such as therapeutics, vaccines, or personal protective equipment, as well as companies that have attempted to hide existing financial problems by falsely representing them to be related to the pandemic[14].

Mitigating the Risk of Investment Scams:

    • Perform due diligence before making investment decisions
    • Make sure the business you are dealing with is regulated and/or licensed
    • Be wary of businesses based overseas
    • Be skeptical of those who aggressively promote certain investments

Cybercrime Scams

Cybercrime is another area that has been – and is expected to continue to be – an area of focus for the criminal element looking to take advantage of the pandemic.Cybercrime can be carried out through various means, including emails, text messages, and illegitimate websites, usually for the purpose of obtaining money, personal information, or both[15].

Victims of such schemes have been induced to open email attachments, click on links in text messages, visit websites, or perform other similar actions by fraudulent communications relating to the pandemic.  These include ‘phishing’ emails and other messages indicating that recipients have been exposed to a person who tested positive or instructing them to click on a link or provide personal information in order to collect government benefits[16].

Mitigating the Risk of Cybercrime Scams:

    • Do not open attachments or click on links from texts or emails unless you are certain that they are from a trusted source
    • Check the sender’s email address
    • Check email content for spelling and grammar errors
    • Be leery of any requests for personal information – do not respond unless there is a legitimate reason why the information os required AND you trust the entity to which you are providing the information

Impersonation Scams

There have also been numerous reports of fraudsters pretending to be charities, government agencies, or other authorities, in order to obtain funds and/or personal information from unsuspecting victims.  Such impersonations may be part of the types of cybercrime-related schemes described above, or they may be a unique category of schemes altogether.

The CAFC has received reports[17] of fraudsters posing as:

    • public health authorities offering fake information relating to infections in a given neighbourhood or personal test results, and then soliciting personal information;
    • charities seeking donations under false pretenses;
    • utility companies threatening to disconnect services if payments are not made; and
    • government departments asking for personal information.

In addition to the above, there have been reports of ‘job scams’ in which criminals pose as employers offering work-from-home employment – an enticing proposition for many, given the prevalent unemployment and stay-at-home orders – and request money or personal information as part of the purported job application[18].

The OSC has also warned about similar types of impersonation schemes, including ones in which fraudsters are posing as banks, financial advisors, prospective employers, or government departments/agencies, in an attempt to obtain financial or personal details[19].

Mitigating the Risk of Impersonation Scams:

    • Verify the identity of parties representing themselves to be agents of the governments or other authorities, and corroborate claims that they make
    • Be skeptical of any requests for personal information or payments

Government Scams

In the wake of the pandemic, governments have been hurrying to provide financial support to people and businesses, as well as trying to procure the necessary testing kits, medical supplies, and personal protective equipment. While both measures are much-needed, they also create areas that crooks can abuse, including by claiming financial relief or other benefits to which they are not entitled, and by setting up companies to source and re-sell needed supplies and equipment at excessive mark-ups.  For example, a Virginia man was recently charged with submitting fraudulent loan applications to take advantage of emergency financial relief provided by the CARES Act[20].

In response to concerns about support programs being abused, the Canada Revenue Agency recently opened up a ‘snitch line’, which provides a mechanism for people to report information relating to individuals who are receiving the CERB or CESB despite not being eligible, or businesses that are misusing the wage subsidy program[21].

 Possible Future Trends

As governments continue to ease restrictions and businesses and institutions begin to open up again, many of the aforementioned problems will persist, and several others will likely present themselves.

Financial difficulties are likely to continue for many individuals and businesses, as continued mandatory closures, concerns about subsequent ‘waves’ of the coronavirus, strained financial resources, and other factors will cause some employers to be slow to rehire and reopen.  Many customers and tenants that have been able to defer or reduce credit card, loan or rent payments temporarily, or that have only been able to meet such obligations with funds from government support programs, will find it difficult to make ends meet when such concessions or support programs are phased out.  These problems will only be exacerbated when landlords begin to evict and lenders begin to call loans with greater frequency and zeal than they have in the last few months. All of which is to say that financially speaking, the worst of this crisis may not be behind us.

Such ongoing financial difficulties may give rise to a number of conditions that criminals and other unscrupulous opportunists can take advantage of.  For example, struggling companies may feel compelled to scale back or eliminate certain ‘non-revenue-generating’ activities, such as internal audit, control, and compliance functions, thereby leaving themselves vulnerable to fraud at a time when bad actors, both internal and external, may be looking to defraud them.

These types of cost-cutting measures can lead to shortcuts being taken, standard procedures being bypassed, and financial information being misrepresented[22], all of which create risks for the organization. The trend of working from home, which is expected to continue for many office workers, may also make some of these negative outcomes more likely.

Recent economic conditions may also lead to more risk aversion, both for individual investors as well as financial institutions[23].  This may make it more difficult for businesses to obtain financing through traditional avenues, which may lead them to turn to other financing sources, including those looking to exploit them.  Such sources include criminal groups, which may be looking to buy or lend money to struggling businesses[24], given that legitimate businesses offer organized crime groups a means of laundering proceeds of crime, demonstrating legitimate earnings, and carrying out further criminal activity.

In fact, Italian police recently arrested 91 suspected mobsters who were allegedly involved in laundering proceeds of their extortion and drug trafficking operations by purchasing failing businesses affected by the COVID-19 lockdown[25].

Desperation may also lead otherwise honest employees and businesses to carry out fraud against their employers, vendors, customers, or insurers, which could lead to increases in payroll fraud, procurement fraud, expense report fraud, benefits fraud, financial reporting fraud, and insurance fraud.

Another trend that is expected to continue in the near future is ongoing growth in online retail transactions, contactless purchases, and digital wallets.  Stores and restaurants that were a short time ago primarily or exclusively physical businesses are rapidly adapting to offer online ordering[26].  These changes in how consumers are making purchases are expected to give rise to upticks in chargeback fraud (in which customers claim goods were not received and request refunds through their credit card company) and account takeover (in which a customer’s online account is taken over by someone else)[27].

While nobody can be sure what the future holds, past experience and current trends would appear to suggest that crooks will continue to look for ways to use worldwide uncertainty and instability to their advantage.  

About Our Firm

nagel + associates is a Toronto-based boutique forensic accounting firm that focuses exclusively on Forensic Accounting, Investigations and Disputes, Anti-Fraud Training, Anti-Fraud Consulting and Crypto Advisory. For more information about our services, please click here.

Sources:
[1]  Source: “For All Debts Public and Private.”  The Sopranos. (Season 4, Episode 1).  HBO.  Television.
[2] Source: cbc.ca
[3] Source: cbc.ca 
[4] Source: antifraudcentre.ca 
[5] Source: www.cbc.ca
[6] Source: Ibid.
[7] Source: antifraudcentre.ca 
[8] Source: citynews1130.com 
[9] Source: torontosun.com 
[10] Source: europol.europa.eu 
[11] Source: Ibid.
[12] Source: osc.gov.on.ca 
[13] Source: antifraudcentre.ca 
[14]Source: torys.com
[15] Source: cbc.ca
[16] Source: cbc.ca
[17]Source:  antifraudcentre.ca
[18] Source: cbc.ca 
[19] Source: osc.gov.on.ca
[20] Source: justice.gov 
[21] Source: canada.ca
[22] Source: corporatecomplianceinsights.com 
[23] Source: cbc.ca 
[24] Source: cbc.ca
[25] Source: cbc.ca
[26] Source: oliverwyman.com
[27] Source: forbes.com

Tether: The (Un)stable Cryptocurrency

Having both a personal and professional curiosity about cryptocurrencies, I am often asked, “Should I buy Cryptocurrency ‘X’?”, or more broadly, “Should Cryptocurrencies be a part of my investment portfolio?”. I have always been reluctant to answer for a litany of reasons, and today I will explain my rationale.

If you had to guess which cryptocurrency accounted for the highest 24-hour trading volume in April 2020, I suspect many of you would guess Bitcoin. However, despite representing greater than 60% of the total value of all cryptocurrencies, Bitcoin’s volumes have been surpassed by another, lesser-known, cryptocurrency for quite some time now: Tether.

Source: coinmarketcap.com – April 15, 2020

So what is Tether? Tether is the most widely used example of a ‘stablecoin’. Stablecoins are cryptocurrencies or cryptocurrency tokens that attempt to minimize price volatility – a major criticism of ‘traditional’ cryptocurrencies – through pegs or reserves.

When Tether launched, the principle was relatively simple: For each US Dollar they held in reserve, they would issue a Tether token, thus maintaining a 1-to-1 peg. Therefore, while Bitcoin’s supply is predetermined and released algorithmically, Tether’s reserve-based supply requires an entity to manage and be a custodian of the reserve US dollars. In theory, stablecoins such as Tether could become critical to the cryptocurrency ecosystem as they can limit exposure to volatility. With that said, let’s briefly review some of the major red flags that have emerged to date with respect to Tether.

One of the key features of cryptocurrencies that sparks excitement and curiosity is their ability to function without the coordination of a central entity. However, this feature does not apply to Tether. As noted above, Tether’s reserve-based structure necessitates such an entity. A cryptocurrency that requires a middleman defeats the whole value proposition of decentralized currencies. Why would a crypto investor avoid government powers only to trust a tech company?

Now let’s take look at who actually controls Tether. Tether tokens are issued by a Hong Kong-based private company whose proprietors also own the cryptocurrency exchange Bitfinex. While in and of itself this may not be an issue, the ownership structure could raise potential conflicts of interest.

In fact, in April 2019, New York’s Attorney General filed a suit accusing Bitfinex of comingling corporate and client deposits with Tether’s reserves. Specifically, it is alleged that Bitfinex lost access to $850 million, when their makeshift banking partner (a Panamanian payment processor) absconded with the funds. In order to cover this loss and remain solvent, it is alleged that cash from Tether’s reserves was transferred over to Bitfinex in exchange for a bogus receivable.

New York’s Attorney General stated that in effect, Bitfinex executives “fraudulently shifted most or all of Bitfinex’s risk of loss of several hundred million dollars onto Tether’s balance sheet, but continued to represent to the market that Tethers were fully ‘backed’ by U.S. dollars sitting safely in a bank account. They were not.” [1]

Tether’s lack of transparency as it relates to its reserves has been a source of controversy from inception. Even with allegations of unaccounted funds, to date, Tether has been unable to produce a single audit report to confirm their stated reserves and financial position.

In fact, the closest Tether has come to an ‘audit’ is a June 2018 report by the law firm Freeh, Sporkin & Sullivan LLP (FSS), which appeared to confirm that the issued Tether tokens were fully backed by dollars. However, FSS stated, “FSS is not an accounting firm and did not perform the above review and confirmations using Generally Accepted Accounting Principles” and “The above confirmation of bank and tether balances should not be construed as the results of an audit and were not conducted in accordance with Generally Accepted Auditing Standards.” [2]

According to their website, Tether’s reserve and transparency claims have also evolved over time. As noted in the website excerpts below, Tether originally claimed to hold traditional currencies in reserves on a 1-to-1 basis, with their issued Tether tokens subject to ‘frequent’ audits. In response to growing criticism over the lack of formal audits, all claims referencing external reviews were removed. Finally, even the 1-to-1 US dollar backing claim was revised to include other assets and receivables arising from loans made by Tether to third parties, as illustrated by the following:

Source: web.archive.org – Jan 26, 2018


Source: web.archive.org – Jan 1, 2019


Source: tether.to – April 15, 2020

It is also alleged that Tether was involved in price manipulation of cryptocurrencies. Independent research conducted found that half of the increase in Bitcoin’s price in 2017 could be traced to the hours immediately after Tether flowed to Bitfinex and a handful of other exchanges, generally when the price was declining [3].

It is noteworthy that in 2017, Bitcoin’s price went from under $1K to its all-time high of just under $20K. During this same period, Tether’s circulating supply increased from under 10 million tokens to approximately 1.4 billion tokens [4].

Tether’s supply has continued to steadily increase and as of the date of this article, there are currently in excess of 6.4 billion Tether tokens circulating. In fact, more than 1.5 billion tokens were issued since March 2020 [5], following Bitcoin’s rapid decrease in price from $9K to $4K.

Given how illiquid cryptocurrency markets are, it is fair to assume this injection of Tether has helped support the subsequent price recovery of Bitcoin, which raises some obvious questions. How much of this value was created out of thin air versus being properly reserved? What impact will there be on the entire crypto-sphere if Tether, the number 4 cryptocurrency by market cap, goes bust? These are the questions that keep me – and invariably other crypto investors – up at night…

By now it should be abundantly clear why I am reluctant to respond to the loaded question, ‘should I invest’. However, as an enthusiast and a forensic accounting professional, I encourage everyone to acquire a base level literacy on cryptocurrencies and distributed ledger technologies.

Cryptocurrencies have become more accessible and mainstream over time, including gaining widespread use in the world of white collar crime.  It is for this very reason that we added a diverse range of crypto advisory services as one of the core areas of our forensic practice.

Check out our website for our Introduction to Cryptocurrency webinar (under ‘Upcoming Training’).   Note: This webinar will take approximately one hour to complete, and may be eligible for continuing professional development (CPD) credit.  Be sure to check the specific CPD requirements that apply to your industry or designation. Upon successful completion of this webinar and a brief quiz, you will receive a certificate of completion.

About Our Firm

nagel + associates is a Toronto-based boutique forensic accounting firm that focuses exclusively on Forensic Accounting, Investigations and Disputes, Anti-Fraud Training, Anti-Fraud Consulting and Crypto Advisory. For more information about our services, please click here

Sources:
[1] Source: www.bloomberg.com
[2] Source: tether.to
[3] Source: www.nytimes.com
[4] Source: coinmarketcap.com
[5] Source: coinmetrics.substack.com

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