Seminar Sidelights | Unmasking Crypto: A Glimpse into Cryptocurrency Operations and Fraud Schemes (Part 2)

In recent years, fraud cases have emerged endlessly, and with the evolution of times, the tactics of fraud syndicates have also changed rapidly. From the "golden gang" phone scams and kidnapping phone scams in the 1990s, to point-card scams in recent years, and more recently virtual currency and NFT scams, fraud syndicates mostly exploit people's desire for high returns combined with human weaknesses to carry out scams. Fraud syndicates lurking on major dating apps and social platforms often use photos of handsome men and beautiful women to strike at people's psychological expectation of finding a significant other on dating platforms, and then use the high returns of virtual currency as bait to lure unsuspecting people into the trap. For this reason, Attorney Liao introduced the operating principles of virtual currency and NFTs, normal investment channels for virtual currency, and common fraudulent methods involving virtual currency, teaching the public step-by-step how to avoid falling victim to scams.

Definition of Virtual Currency

Virtual currency originated in 2009 with Satoshi Nakamoto issuing the first batch of 50 Bitcoins. The operation of Bitcoin and other virtual currencies relies on cryptography (distributed ledger records) to control the creation and management of currency. Compared to the fiat currency we normally use, virtual currencies are not regulated by any central government. Unlike gold, banknotes themselves do not possess economic value; the value of a banknote comes from the legislative endowment of the central government. Some central governments also peg their legal tender to foreign exchange, using their foreign exchange reserves to maintain the exchange rate at a certain level and safeguard the value of their domestic fiat currency. However, virtual currencies are completely unpegged from any fiat currency of any country, nor are they recognized as currency by our central bank. In 2014, our Financial Supervisory Commission also classified them as highly speculative digital virtual commodities. In short, virtual currencies are not endorsed by any national central bank, and investing in virtual currencies inherently carries a high degree of risk.

Types of Virtual Currency

Bitcoin is currently the virtual currency with the highest total market capitalization and was the first virtual currency based on blockchain technology. Ethereum, on the other hand, is a virtual currency with a broader range of uses and is more frequently applied in smart contracts (contracts deployed on the blockchain that can no longer be modified and execute automatically). NFTs are also developed on the basis of Ethereum. In addition, there are various small coins and meme coins, such as Dogecoin, which is one of the meme coins that skyrocketed in popularity for a while recently. Besides these, there is another type of virtual currency called "stablecoins." As the name suggests, stablecoins are stable in price and not prone to fluctuation. Issuers of stablecoins use different methods to stabilize the prices of stablecoins. Fiat-backed stablecoins, such as Tether (USDT), require the issuer to back every single coin issued with one U.S. dollar to ensure solvency and maintain the value of the stablecoin. Crypto-backed stablecoins are similar to fiat-backed stablecoins, except that the collateral is changed to other virtual currencies, such as Bitcoin, Ethereum, etc. Algorithmic stablecoins use algorithms to calculate the volume of supply and demand in order to keep the virtual currency itself pegged to the U.S. dollar. However, because algorithmic stablecoins are not anchored to any assets, solvency itself is problematic. The collapse of the Luna coin this year is a bloody example.

As for NFTs, it is the abbreviation for Non-Fungible Token, which is the exact opposite in nature to the virtual currencies (fungible tokens) mentioned earlier. Each NFT is an independent existence, but they all apply blockchain technology and therefore have tamper-proof code. After users convert physical paintings and music into NFTs, they become a unique piece of code that cannot be copied and pasted. If this painting is transferred to someone else, everyone's ledger will have a record, just like virtual currency transactions. Besides paintings and pictures, other things can also be converted into NFTs, such as the first tweet by the owner of Twitter. In addition, Attorney Liao pointed out that the issuance of NFTs may not fall under the reproduction, distribution, or adaptation prescribed by the Copyright Act, so using other people's works to create NFTs may currently be unregulated.

Normal Investment Methods

Attorney Liao suggested that when investing in virtual currencies, one should still follow normal investment methods to better safeguard property safety. The largest virtual currency exchange is Binance, which is a Chinese platform. Other platforms such as Huobi (a Chinese platform) and BitoEX (a Taiwan platform that allows deposits in New Taiwan Dollars) are also relatively reliable platforms. The largest platform for NFT transactions is Opensea, which hosts transactions for NFT games, music, artwork, etc. When members of the public want to buy cryptocurrencies but do not know how to get started, they may easily become targets of fraud syndicates under such circumstances. Although the transaction fees of these large trading platforms may not be cheap, it is still recommended that members of the public with less relevant investment experience prioritize conducting virtual currency transactions through these more reliable platforms.

Methods of Storing Virtual Currency

Hot Wallets and Cold Wallets:

A hot wallet refers to storing held virtual currency in a cloud wallet, but storing it in the cloud carries the risk of being hacked and having the virtual currency stolen. For example, even though Binance is currently the largest exchange, it has previously experienced incidents where hackers broke in and stole a large amount of Bitcoin. However, such platforms typically also have fund guarantees to cope with the occurrence of such accidents; conversely, smaller exchanges may not necessarily have such funds to guarantee the emergence of this risk, and these are all factors that the public should consider when choosing a trading platform.

The safest storage method is to store virtual currency in a cold wallet, putting the virtual currency into a physical wallet shaped like a card or USB. It only connects to the internet when plugged into a computer and linked with it; once unplugged, there is no need to worry about hackers invading the wallet. However, storing in a cold wallet also carries risks. A German-born engineer in the United States stored 7,002 Bitcoins in an encrypted hard drive but forgot the password to the wallet, and to this day still cannot retrieve the Bitcoins inside.

Mining – A Way to Actively Earn Virtual Currency

Mining refers to executing proof-of-work or other similar computer algorithms (solving complex mathematical problems). The user who solves the problem first can receive a virtual currency reward. Such mathematical problems are quite difficult and can usually only be solved using brute force. Therefore, users will purchase a large number of graphics cards to assemble a "mining rig" dedicated to mining, allowing the mining rig to solve problems twenty-four hours a day without stopping in order to earn virtual currency rewards. The process of mining with a rig consumes a massive amount of energy. If members of the public use household electricity for mining, I am afraid that the electricity expense alone would be greater than the virtual currency income obtained. In addition, since only the user who solves the problem first can receive the reward, if the mining rig equipment is not powerful enough (commonly referred to as "computing power"), I am afraid not only will nothing be mined, but a bunch of electricity will also be wasted. In order to reduce mining costs, some members of the public have even gone so far as to violate the Criminal Code by stealing electrical energy to conduct mining.

Fraud Schemes Involving Virtual Currency

Generally speaking, the scale of virtual currency fraud is usually perpetrated by criminal syndicates consisting of three or more people. Virtual currency fraud is merely a pretext for fraud; as Attorney Liao stated at the beginning, past child kidnapping, romance fraud, and stock fraud, up to the current virtual currency fraud, all fall within the scope of organized crime, except that fraud syndicates constantly invent new pretexts to carry out scams. Their essence is aggravated fraud as stipulated in Article 339-4 of the Criminal Code, which carries a sentence of imprisonment for not less than one year and not more than seven years. Therefore, members of fraud syndicates are, in principle, unable to commute their sentences to fines in the absence of other mitigation grounds.

Fraud-Related Crimes: Money Laundering

Because virtual currencies or NFTs possess an extremely high degree of anonymity, they are often used by criminal syndicates to cover up and conceal criminal proceeds. Criminal syndicates mostly utilize the advantage that stablecoins are not prone to price fluctuations to conceal their illegal proceeds and create broken links in the flow of funds. The Money Laundering Control Act punishes such money laundering activities with imprisonment for up to seven years, plus a fine of up to five million NT dollars.

Fraud Scheme 1: ICO Fraud

An ICO (Initial Coin Offering) is similar to an Initial Public Offering (IPO) of stocks, but buying and selling stocks is a more mature investment method, and our country has also formulated many corresponding regulations, making it relatively safer by comparison. The fundraising method of an ICO is very likely to develop into a Ponzi scheme. Through layers of investments, the facade of guaranteed profits, and the temptation of high returns, bottom-layer investors often only realize they have fallen for a Ponzi scheme when they discover that the fraud syndicate can no longer pay the high returns it guaranteed. Investment definitely has both gains and losses; even stocks generally recognized by investors as the most stable, such as 0050, can decline and lose money. Investment opportunities that claim to be foolproof with guaranteed high returns must be fraudulent. In addition, there are quite a few whales in the crypto circle who grasp many sources of information. If a newly issued virtual currency is profitable, these profit opportunities have naturally already been seized by the whales first, making it difficult for retail investors to truly seize the opportunity to enter the market and make a profit. Therefore, rumors about "certain small coins" having room for profit are mostly just rhetoric used to trick retail investors into entering the market. Attorney Liao suggested that if one wants to invest in virtual currencies, one should focus on relatively stable virtual currencies (here not solely referring to "stablecoins," but rather those traded in the market for a longer time), such as Bitcoin, Ethereum, or USDT, which are more ideal. Some small coins that skyrocket with meme crazes, such as Dogecoin and Squid Coin, have the potential for price crashes after the craze passes, carrying higher investment risks. Meanwhile, OneCoin is one of the largest virtual currency Ponzi scheme cases in recent years, with the criminal syndicate defrauding a total of up to 4 billion U.S. dollars in assets.

Fraud Scheme 2: OTC (Over-the-Counter) Trading Fraud

This type of fraud scheme is similar to online shopping fraud, mostly posting buying and selling messages on non-exchange places such as Facebook, Line, and forums, making it impossible to verify the seller's identity. For example, posting advertisements for selling virtual currency in Facebook groups and demanding face-to-face transactions.

Fraud Scheme 3: Fake Transactions

This fraud scheme exploits modern people's psychological state of being prone to loneliness. Through dating apps or social communities, it first builds trust through chatting, and then recommends fake exchanges to carry out virtual currency fraud. Such websites may also be set up in English to create the illusion of a professional exchange and confuse the public. An investor named Ch'en was defrauded out of a staggering sum of 50 million NT dollars by a 27-year-old man named Wang who claimed to be a "professional Bitcoin miner," using the aforementioned method of building trust through chatting.

Fraud Scheme 4: NFT Fraud

It is still relatively difficult to define NFT fraud at present. For example, buying an NFT product and watching its price plummet, getting "harvested like leeks," may still not constitute fraud because NFTs themselves are highly volatile properties. Recently, there has also been news regarding disputes arising from a well-known livestreamer issuing an NFT.

Organizational Structure of Fraud Syndicates

As Attorney Liao stated earlier, virtual currency—much like kidnapping phone calls, gaming point-card scams, etc.—is merely one of the pretexts used by fraud syndicates. Therefore, understanding the organizational structure of fraud syndicates will help prevent being defrauded by new pretexts used by fraud syndicates in the future. The organizational structure of fraud syndicates primarily includes dummy accounts and cash mules:

Dummy accounts refer to accounts of other people collected by fraud syndicates through various methods. The purpose is to have victims' funds wired into the dummy accounts, and then dispatch cash mules to withdraw them, creating broken links in the fund flow to obstruct investigations by prosecutors and investigators. If an account is unfortunately used as a dummy account, there is a strong possibility of facing criminal liability for aiding and abetting fraud. To this end, Attorney Liao also proposed several countermeasures, such as immediately reporting the loss, filing a police report, and preserving communication records in such situations to prove one's lack of intent to aid fraud. In addition, if the individual can present relevant data to corroborate that their account was indeed defrauded by the syndicate or can prove the usage status of their account (such as salary account), it will also be more favorable for proving their lack of intent to aid fraud, thereby obtaining a judgment of not guilty.

Cash mules are the role assisting fraud syndicates in withdrawing illicit money from dummy accounts. Fraud syndicates attract younger groups (such as college students in urgent need of living expenses) with rewards of several thousand NT dollars per withdrawal to assist them in withdrawing illicit money. However, Attorney Liao also appealed that as long as one assists in withdrawing money, they may be charged as a principal co-offender in aiding and abetting fraud or fraud itself, and perpetrators will face heavy sentences of not less than one year and up to seven years. One must exercise extreme caution.

Conclusion

Virtual currency itself is a high-risk investment. Investors should properly assess its risks when investing in virtual currencies, and should be especially careful when blindly following trends to buy emerging meme coins and small coins, to avoid being "harvested like leeks" once the craze passes, resulting in losses that outweigh the gains. Every investment comes with risks; one must never believe the classic Ponzi scheme pitches of "guaranteed principal and high returns," nor should one blindly trust the handsome men and beautiful women recommended for investment on dating apps, lest they lose everything.

Further Reading

Seminar Sidelights | Unmasking Crypto: A Glimpse into Cryptocurrency Operations and Fraud Schemes (Part 1)