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Crypto Fraud Fears Are Overblown

It seems there is a never-ending stream of negative headlines warning about crypto fraud. But is it really that bad?

Image: Pixteller

Legitimate institutions historically have been defenseless in the face of outright fraud — Gary Weiss

Crypto Fraud is Exploding?

As legacy news media continues its slow death spiral, their roots in tabloid journalism are really starting to show. The US ranks dead-last for trust in news organizations. How could you blame us?

Rightwing media outlets say with a straight face the attack on the US Capitol didn’t happen. Leftwing media outlets say with a straight face riots are peaceful. Somehow both seem to agree crypto fraud is a huge problem.

Is the IRS really seeing ‘mountains’ of crypto fraud? Is crypto fraud really ‘exploding’ in Canada? It’s possible this is all true. The real question is: compared to what?

What does a ‘mountain’ of fraud look like? How big of an ‘explosion’ are we talking about? To put it differently, if I lose $10,000, that might be an ‘explosive’ loss for me. If Google loses $10,000 it means almost nothing.

If we’re worried about becoming a victim of fraud, what’s important is the likelihood we will be victimized. For instance, if there are 10 million transactions and 10 instances of fraud, that’s pretty safe. But if there are 10 million transactions and 2 million of them are fraudulent, we need to be really careful.

Is there fraudulent activity in the crypto space? Absolutely. Is it worse than, say credit cards? Or banking in general. Or social security scams, identity theft, real estate fraud, porch pirates, or any of the thousands of ways people can use to steal your money? Let’s find out!

How bad is crypto fraud?

To start, we’ll look beyond the headlines. Using data from Coinmarketcap, the entire crypto space did roughly $54 trillion in transactions during 2020. In contrast, according to Nilson, the major credit card companies did around $42 trillion worth of transactions in 2020.

Not exactly apples-to-apples, but at least the transaction volumes are roughly comparable. So, how do they stack up? Well, I hate to break it to the FUD bois (and by extension, the journalists), but crypto looks a lot more secure to me.

Credit Cards in 2020:

  • Credit Card Transactions: $42 trillion
  • Credit Card Fraud: $28 billion
  • Fraud rate: 0.06%

Crypto in 2020:

  • Crypto Transactions: $54 trillion
  • Crypto Fraud: $1.9 billion
  • Fraud rate: 0.0035%

I tried to make a chart, but the fraud rates are so low on both compared to transaction volume, you couldn’t see the fraud numbers. It’s also worth mentioning that crypto fraud went down by over 50% from 2019. This despite an ‘explosion’ of transaction volume over the same time frame.

Meanwhile, credit card transactions dipped .08% in 2020, but fraud remained nearly constant year over year. To put this in perspective, for every $100 in credit card transactions, $0.06 cents is fraudulent. For crypto, it’s $0.03 per $1000.

Moreover, the majority of fraud in the crypto space is from rug-pulls and exit scams. For those who don’t know, with both rug-pulls and exit scams, the founders take funds from a project and run off. They just differ slightly in how they are executed.

In turn, the majority of fraud in the credit card space is good old-fashioned fraud. Counterfeiting, ID theft, bogus accounts, chargebacks, phone scams, dark-net lists, etc. These are the same basic problems credit card companies have been facing for over 50 years, and the best they can do is live with 6% fraud a year.

Crypto doesn’t have those constraints. You can write contracts that prevent rug-pulls and exit scams. You can teach people how to spot those scams. Those are big reasons fraud in the crypto space went down 50% from 2019 to 2020. Fix the code, harden the infrastructure, educate the users, problem gets better.

There’s a reason the vast majority of ‘hacks’ you read about today are socially engineered. With the current state of network and software tech, it’s really difficult to attack properly configured networks and computer systems. It does happen, but more often than not, it’s a nation-state, not some Russian kid in his mom’s basement.

To be sure, hacks do happen in the crypto space. But in 2020, hacks only accounted for around $500 million in losses. Considering the $54 trillion in transaction volume, we’re talking a fraud rate of 0.00093% due to hacks.

So, of course a $300 million hack is going to make headlines. It sounds scary in isolation. But in context, the risk of victimization is so low, it’s barely worth mentioning. The bigger problem lies with the exit scams, but even that is minuscule compared to credit cards. And unlike credit cards there are workable solutions for crypto scams.

But banks are safe…

Here’s a little thought experiment. What would happen if you walked into your bank, deposited a $250,000 check, and then asked to wire $50,000 overseas? I can give you an idea.

The deposit alone is going to trigger a Suspicious Activity Report (SAR) that goes to law enforcement. It’s a federal requirement for any large, or unusual transaction. The wire transfer is also going to trigger a separate SAR. You will have to provide sender and recipient information, including ID, account number, and routing number. And you’ll probably be answering a lot of questions from the bank teller, the bank manager, and the fraud department.

The wire is not likely to go out the same day. You’re going to be waiting while the check clears the Automated Clearing House (ACH) system. It will probably take at least 3–4 days, but probably more out of ‘caution’. Then the wire will have to transmit and clear, which will be another couple few days, maybe a week depending on the country.

There will be an outbound wire fee, which can be quite high going overseas. There might also be an inbound wire fee to your recipient. The bank is obligated to report the transaction to the US Treasury Office of Foreign Assets Control (OFAC). If your recipient is in a ‘banned’ country, your wire assets might get frozen by OFAC.

The wire might also get frozen if it triggers an Anti-Money Laundering (AML) risk algorithm. Here’s a quote summarizing what the authorities must do:

“Comprehensively — but also dynamically — choose from a list of nearly 200 predicate crimes, subjectively associate them with nearly 200 different political, economic, social, technological, environmental, legislative and institutional factors, and then compare that against an indeterminate list of consequences that may or may not occur as a result of the still undefined risk manifesting”

And if your assets get frozen because it triggered something in the convoluted mess of AML regulations, your money is going to be tied up for a while. Like months, or years. In fact, you might never get it back, because the legal expenses might not be worth it.

Even if none of that happens, your recipient might also get extorted by the receiving bank, or someone who works there. It’s a common occurrence in low-income and underdeveloped nations. Or the authorities in the receiving country might just confiscate it. Nothing really stopping them, and what are you going to do about it anyway?

The Crypto Difference

Let’s see how the process would work if I used a stable coin. I would open my wallet, enter the recipient address and press send. About one minute later, they’d have the $50,000. The only real risk I have is losing the key to my wallet, or entering the wrong address.

That’s it.

Well, I suppose the stable coin could collapse. But then again, so could the US dollar. Things like that exist, but they are tail probabilities. They’re hard to protect against no matter what.

The point of all this is crypto is much safer than the headlines might suggest. The true risks are relative and should always be put in context. But crypto also requires personal responsibility.

The trade-off gives you far more secure transactions than legacy finance could ever dream of supplying. Not to mention nearly instant settlement with no middlemen, no extortion or bribery to get funds on the receiving end, and no third-party interference.

Did I mention the low fees?

The takeaway

Ignore the headlines. The fear of crypto fraud is overblown. It’s certainly safer than credit cards and I’m not losing any sleep over either one. That’s it for now, until next time, be safe, be smart and be sure to tie the camel.

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