It’s time to crack down on cryptocurrency scams

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If there’s a lesson to be learned from the demise of cryptocurrency exchange QuadrigaCX, it’s that fraudsters aren’t afraid of our securities regulators.

Revelations from the Ontario Securities Commission (OSC) that Quadriga collapsed in 2019 because its late founder, Gerald Cotten, operated the company like a Ponzi scheme highlight how easy it is to run crypto scams. It’s as if fraudsters know there’s little chance of getting caught.

Cotten, who died in late 2018, was the poster boy for digital grifters. He misappropriated client money to fund his posh lifestyle, engaged in fraudulent trading and, in doing so, racked up steep losses, according to the OSC’s investigative report. Those findings, though, offer cold comfort to the more than 76,000 clients who are collectively owed $215-million.

Considering that Quadriga’s bankruptcy trustee, Ernst & Young, has recovered only $46-million, and the OSC has now determined that much of the remaining $169-million shortfall stems from Mr. Cotten’s fraudulent trading activities, swindled customers will be lucky if they get back a fraction of what they’re owed.

While securities regulators can’t nab all the bad guys, they clearly need a bigger stick to crack down on crypto fraud, which is poised to proliferate during these uncertain times. Not only do securities regulators require more tech-savvy staff for fraud detection and enforcement, they also need more money to educate investors about crypto market risks.

Although it defies logic to invest one’s hard-earned money in something as opaque as cryptocurrencies, securities regulators have nonetheless recognized them as a legitimate – albeit risky – form of investing, if done legally. Trouble is, not all crypto promoters are on the up-and-up.

As Quadriga customers found out the hard way, there’s no federal deposit insurance on cryptocurrencies. Many crypto-trading businesses, meanwhile, openly flout rules requiring them to register with securities regulators if they deal in securities and derivatives, the OSC says. It seems these so-called entrepreneurs think they’re above the law, even though it’s obvious they hold and control crypto assets traded on their platforms.

In addition to contacting securities regulators to ensure they’re operating in compliance with the law, the OSC advises that “platforms should ensure that they have systems and controls in place to manage risks," and “should disclose key information to clients” about their businesses.

“Providing clients with accurate information about key aspects of their operations – such as asset custody and storage practices, fees, reported volumes, platform security measures, internal controls, and conflicts of interest – will facilitate informed decisions by investors and promote investor confidence in the platform,” the OSC states in its report.

Let’s get real. It’s going to take a heck of a lot more than polite prodding to get wayward industry players to follow the rules. Their very ethos is non-compliance. After all, these crypto enthusiasts are partial to digital currencies precisely because they reject the international monetary system and its corresponding norms.

Now is the time to take action. Crypto fraud is sure to increase over the coming months. Bitcoin, the most popular cryptocurrency, was worth US$9,475 in recent days and is expected to skyrocket this year.

Financial and fintech advisory deVere Group is among those making such bullish predictions, citing Bloomberg analysts who forecast bitcoin to reach US$20,000 in 2020.

"Investors will increase exposure to decentralized, non-sovereign, secure digital currencies, such as bitcoin, to help shield them from the potential issues in traditional markets,” Nigel Green, chief executive of deVere Group, said in a recent statement.

It’s entirely possible. Bitcoin came within a hair of reaching US$20,000 in December, 2017.

Mr. Green contends there are several catalysts for price appreciation this year: The COVID-19 pandemic is increasing demand for digital currencies; central banks’ quantitative-easing programs will devalue traditional currencies; people will use digital currencies as a “hedge" against future inflation; and geopolitical risks such as the U.S.-China trade war, Brexit and the U.S. presidential election will also buttress bitcoin’s value.

“Globally, we have seen client interest in bitcoin, and other cryptocurrencies such as ETH [ethereum], spike since the beginning of May," Mr. Green said.

That’s all well and good for legitimate players, but there’s no doubt that fraudsters will also see this as an opportune time for a shakedown.

Although the OSC has taken pains to suggest that Quadriga is “an extreme example” and not necessarily representative of the broader crypto industry, it’s apparent Mr. Cotten’s victims hadn’t the faintest idea of the risks. It’s shocking that so many people around the world blindly entrusted Quadriga with their savings.

There’s a sucker born every minute. Some people are desperate to make a quick buck, while others are seduced by dubious claims that digital currencies are safe-haven investments or somehow help humanity by creating a “moral economy." These folks are easy targets for crypto scammers.

The OSC deserves credit for investigating the Quadriga meltdown and making its findings public to warn investors about potential risks in the crypto market. But subtle threats of enforcement action from earnest securities regulators won’t make offending operators fall in line. There needs to be severe consequences for breaking the rules.

Mr. Cotten’s crimes were brazen. The moral of the Quadriga story is that curbing crypto crimes requires a dragnet, stiffer financial penalties and serious jail time. Securities regulators need to up their game and make the Gerald Cottens of this world shake in their boots.

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