Cryptocurrencies, Blockchain and Fraud, Uncategorized

Cryptocurrencies, Fraud Schemes, and Money Laundering

  In many presentations I have done to explain Bitcoin and other virtual currencies, the most difficult part for people to understand is how a virtual currency, which cannot be seen or held in our hands, can represent value.   In fact, critics of buying and trading in virtual currencies maintain that virtual currencies will never be a reliable form of commerce.  I am not promoting or demoting the idea of virtual currencies, but it is now unmistakable that virtual currencies have gained worldwide acceptance.  One can argue that virtual currencies will never replace fiat currencies, which is probably true.

Discussion Points to Consider:

  1. Currently, there are about 2000 virtual currencies
  2. Anyone can create a virtual currency
  3. Bitcoin was the first cryptocurrency and is the most well known
  4. Cryptocurrencies are easily converted to and from government-approved currencies (Fiat Currencies)
  5. Cryptocurrencies appear in multiple fraud schemes
  6. Cryptocurrencies are used to launder proceeds from criminal activity

Although virtual currencies have been in existence since the late 1990’s, they lacked reliability and acceptance for conducting financial transactions.  The release of the Bitcoin ecosystem in 2009 disrupted the financial systems in the world’s first virtual currency using cryptology to provide advanced anonymity, and the Blockchain to solve the “double spending” problem.   Thus, Bitcoin became the first convertible, de-centralized, math-based, cryptocurrency.  Bitcoin became convertible to and from fiat currency, de-centralized because transactions could be conducted Peer-to-Peer without government oversight, based on the mathematical solutions of increasingly complex algorithms, and concealed by cryptology.  The structure of Blockchain technology proved that an owner of Bitcoin could not double spend the same Bitcoin.

                What Are Virtual Currencies?

Virtual currencies can be described as a Digital Representation of Value functioning as a Medium of Exchange that does not have Legal Tender status.  All that is required to hold value is Trust and Adoption.  Bitcoin gained in prominence because of the ease of use and semi-anonymity, but government regulators in the United States and around the world have wrangled Bitcoin into a heavily regulated world of banking.  Bitcoin rivals such as Monero and Zcash now offer better anonymity.  Ethereum is another virtual currency which serves as the basis of Smart Contracts (digitalized contracts) for use in commerce.

What is Blockchain Technology?

Blockchain is described as a Distributed Ledger where all transactions are agreed on by Nodes, or participants.  Once approved, the transaction is time-stamped and added as a new Block to the previous Block.  Each new block is individually identified by a unique hash code and is digitally tied to the previous block by incorporating a portion of the hash code.  In this manner, the Blockchain provides an irreversible record of all transactions in ascending chronological order. 

The Blockchain used in the Bitcoin platform is open to the public, meaning that anyone can freely obtain the software program and become a Node in a Non-Permissioned environment.  Nodes can then “Mine” for Bitcoin for their own use or earn Bitcoin fees for approving transactions of other users of Bitcoin.  In this Public format, the Nodes have no need to know or trust each other.  Hybrid forms of Blockchain have been formed to create a Permissioned and Private system where the Nodes know and trust each other.  In both Non-Public and Public Blockchains, each transaction is recorded on a ledger, but the identity of the person or persons behind the transaction is not disclosed.  This is accomplished by using Public Keys to record the transactions, and Private Keys that allow entry into the Blockchain.  Therefore, the identity of the person or persons conducting the transaction remains anonymous.

How are Cryptocurrencies Used in Fraud Schemes?

Cryptocurrencies are emerging as a payment of choice in many fraud schemes.  More and more, we see bad actors avoid government oversight of financial institutions by demanding payment from victims in the form of cryptocurrencies.  And why shouldn’t they? Cryptocurrencies provide anonymity, speed, and worldwide acceptance for the transfer of funds from victims to the perpetrators.  Four main areas of concern are; (1) cryptocurrencies being used in Securities Fraud matters; (2) cryptocurrencies being stolen directly from victims; (3) cryptocurrencies used as payments in Ransomware and Extortion schemes; and (4) using cryptocurrencies to pay for illegal products and services on the Dark Web.

How are Cryptocurrencies used in Securities Fraud Schemes?

 Currently, one of the hottest investment markets involves high-risk Initial Coin Offerings (ICOs), and these ICOs often result in significant losses to unwary investors.  Certainly, there are legitimate ICOs to consider.  However, regulators have found that many are ripe with fraudulent misrepresentations that can result in significant losses to investors.  ICOs can provide a means for startups to avoid high costs of regulatory compliance found in Initial Public Offerings (IPOs).   ICOs involve crowdfunding centered around cryptocurrencies and sold to investors as Utility tokens or Asset-based tokens.  Tokens are promoted as Future Functional Units of Currency.  A holder of utility tokens can exchange value for a good or service in the future while asset-based tokens are backed by an underlying asset.  Some ICOs can fall outside of existing regulations and escape normal monitoring by government regulators.  We have seen cases where scammers will use ICOs in Pump and Dump schemes and Advance Fee schemes.

Investors in Bitcoin are at risk from Market Manipulation of Bitcoin prices.  Bitcoin, known for volatile price changes, is vulnerable to current-event price swings where illicit actors take advantage of news events to manipulate the prices.  Regulators are scrambling to keep pace as increasingly complex investments are expanding across national borders. 

Question: How do you steal cryptocurrencies?   Answer: Steal the Private Keys.

The Public Keys allow access to the Blockchain ledger to record transactions, but the Private Key unlocks the currency.  Therefore, the sophisticated thieves target the computers and smart phones of the owners to learn how the cryptos were purchased, which bank accounts were used to transfer fiat currency, passwords, security questionnaire answers, contacts with other persons transacting in cryptos, websites visited to buy and sell cryptos, and above all, the identity of the Private Keys.  If Private Keys are found, the criminal can permanently transfer the currencies into their own wallet.

Third-party repositories of Private Keys can become hacking targets.  Also, willing buyers and sellers will find one another in on-line forums to meet in person to buy and sell cryptos.  People carrying cash and/or their Private Keys are then susceptible to robbery, referred to as Stage Coach robberies. 

Ransomware and Extortion attacks are directed to large and small businesses, health care organizations, governmental entities, or other businesses holding sensitive information.  Bitcoin is the most common method of transferring the extortion amount, but other cryptocurrencies offering more complete anonymity are also used.

The Dark Web is the part of the internet accessible only by special programs and are available to anyone.  The Dark Web is used by actors to sell stolen goods, sell Malware and other cyber infections, stolen identities, stolen credit cards, pornography, illegal drugs, and actually any other tool of criminal activity. Cryptocurrencies such as Bitcoin, Monero, and ZCash are used to buy and sell illegal items or services. Tumbler and mixing services are also found on the Dark Web.

What About Money Laundering with Cryptocurrencies?Sophisticated criminals are often burdened by their own success, that is, hiding the money from regulators and investigators can be difficult.  Everybody loves cash but spending too much cash only tips-off authorities monitoring cash transactions.  Cryptocurrencies make it possible to easily hide, transfer, and clean the illicit money.

Money laundering is usually explained in three steps: Placement, Layering, and Integration.  Placement means that the dirty money is placed into the financial system, usually the Federal Reserve financial system in the United States.  Layering means the money is transferred through multiple accounts to confuse the financial trail.  Integration means that the dirty money is then transferred into legitimate accounts and businesses to distribute cash and/or purchase expensive assets.

Cryptocurrencies are purchased using the approved (Fiat) currency of a country.  The purchases of cryptocurrencies can be done through government-approved exchanges, or through unregulated exchanges.   

Current emerging money laundering threats with cryptocurrencies are found in multi-national exchanges, online gambling sources, and mixing/tumbling services. Online gambling is gaining legal acceptance in the United States and other countries and offers multiple, diverse opportunities to cleanse the dirty money. Mixing and tumbling services will take individual cryptocurrency transactions and tumble them through multiple wallets to obliterate the trail of transactions. Mixing and tumbling services are not necessarily illegal, however, nefarious operations abound on the Dark Net.  

Conclusion:  Criminal actors now have assortments of tools to bounce illegally obtained fiat currencies through multiple cryptocurrency transactions, multiple wallet addresses, and multiple countries in blizzards of transactions at a very high rate of speed.  Moving and hiding proceeds from criminal fraud schemes has become faster, more efficient, and harder to detect than ever before.  So, the cat and mouse game continues.  While authorities become better at identifying and following cryptocurrencies, the bad actors adjust and adapt to advances made by the good guys. 

Vulnerable Victim Fraud

Wait, Whadayamean Grandma is Laundering Money?

Can this really happen? The answer is yes and here’s how it works. Financial institutions and investigators are seeing more situations where victims of fraud schemes are recruited to deposit checks from other fraud victims and then forward money to the criminal actors. In a sense, the first victim is becoming an unwitting money launderer. This is particularly true in cases where Senior Citizens are victimized.

One of the most distressing crime trends in current times is the increasing losses due to financial abuse of Senior Citizens and other vulnerable victims. Current population demographics indicate that the general population in the United States is getting older. Many Seniors possess significant assets, others struggle with poverty, and many are somewhere in the middle. The Baby Boom generation is now entering retirement years after building nest eggs of savings and retirement accounts.

To be sure, criminal actors are targeting the wealth created by the aging population. The estimated value of savings and retirement accounts in the United States approaches $27 Trillion. These vast sums have attracted highly sophisticated organized criminal groups from inside the United States and foreign countries. These organized crime groups are responsible for well-known identity theft, lottery, romance, work at home, grandparent, tax payment, fraudulent IRS returns, business email compromise (BEC) scams. Ponzi schemes and other fraudulent investment schemes also cause large losses to thousands of victims.

Successful criminal groups need to move and hide enormous sums of stolen money. To answer the challenge, complex money laundering networks are formed for the placement of money into the banking system, the layering of the proceeds through multiple accounts, and reintegrating money back into the financial system. They can then use the “clean” money to purchase assets, pay co-conspirators, or finance other fraud schemes.

Many victims are directed to send money to overseas locations. However, since many victims are reluctant to send money overseas, criminal organizations have formed networks of money laundering “mules” to receive the initial fraud dollars, deposit the dollars in U.S. based banks, transfer the money into other accounts, and then forward the money to the criminals. Many of the money laundering mules are willing participants in the schemes and are compensated from the fraud dollars. It is also now known that criminals are adept at convincing victims to become unwitting money laundering mules and instruct the victims to use their own bank accounts to deposit and transfer stolen proceeds, or to deposit fraudulent checks and forward the proceeds. These unwitting money laundering mules are found in romance scams, work at home scams, and other internet based scams.

Of course, most fraud victims do not set out to become money laundering mules. However, many feel trapped by the circumstances and will follow corrupt instructions to open new bank accounts, deposit checks from other persons, and forward money to others using money orders, cashiers checks, or wires. Many victims are encouraged to use variations of their actual names like nick names, middle names, or maiden names to purchase money orders or send wires. The fraudsters know that many of the victims are reluctant to lie about their personal names but may be convinced that using a variation of their actual name is not really lying. The criminals know that varying names on transactions make the tracing process more difficult for investigating officials. Other victims may be convinced to use criminal proceeds to purchase gift cards and other stored-value cards and forward the serial numbers to the perpetrators. The victims are often instructed to keep quiet about sending the money because other people may want to interfere or restrict their freedom.
Protecting Vulnerable Victims
No one organization or government can prevent swindlers from attacking victims. Recognizing the early warning signs of fraud schemes is a key factor in protecting people from determined criminals. Currently, a wide variety of government and private organizations offer resources to describe current fraud schemes and recommended protective measures. Reading about the schemes is not enough. Some of our loved ones will appreciate efforts to protect them and some will resist interference. These crimes are seriously underreported because many victims feel ashamed about being defrauded. They often want to keep it quiet fearing that their families will want to take over their lives and finances. If the perpetrator(s) are other family members, the discord within the family can be very contentious.  Regardless of the individual circumstances of each case, documenting the victim’s loss of money and other wealth is necessary to tell the story.
I will be preparing additional blogs and podcasts to continue the discussions about protecting vulnerable victims from determined fraudsters.