16 Nov 2022

Crypto Identity Fraud: Risks & Solutions

Cryptocurrency platforms and providers are at risk of constantly-evolving scams and crypto-based fraud that pose financial, regulatory and reputational threats. Over the last few years crypto-related scams have surged. 2021 alone saw over US$14 billion being lost to scammers

As the space continues to grow and cryptocurrencies gain wider adoption, the risks posed to crypto exchanges and other virtual asset service providers (VASPs) are also expanding.

In much the same way as they have learned to exploit  and bypass safeguards in the traditional financial system of banks and other financial institutions, criminals are finding new ways to exploit crypto systems for illegitimate financial gain – whether it’s through money laundering, stolen crypto assets, identity theft or tax evasion. 

This article will first outline some of the key features that make cryptocurrency attractive to financial criminals. We'll then cover how businesses can protect themselves from regulatory fines and financial loss through implementing effective Know Your Customer (KYC) processes as part of a robust Anti-Money Laundering (AML) procedures.

Crypto’s fraud vulnerability

Before discussing how cryptocurrency and the platforms that are used to trade and exchange the assets can be exploited for financial crime – it’s important to add a caveat: financial criminals have been exploiting the 'traditional’ financial system for illicit gain for decades, and the vast majority of financial crime takes place in the traditional financial system.

However, there are several key factors that make cryptocurrency attractive to fraudsters, which is why global regulators such as the Financial Action Task Force (FATF) have been spending the last several years updating their AML guidance – which was originally designed for the the traditional financial system – to include safeguards that are designed for the emerging crypto economy. 

Some of the key risk factors of cryptocurrencies from a fraud and AML perspective include:

  • Cryptocurrencies’ digital architecture makes them theoretically accessible to anyone in the world with an internet connection. Their inherently transnational nature makes them hard for any single regulator to keep track of, and hackers and fraudsters can exploit jurisdictions with patchy regulation to carry out hacks and other financial crime with relative impunity. 
  • The irreversibility of transactions makes it hard – if not sometimes impossible – to retrieve funds once they are stolen or misappropriated from crypto wallets. 
  • As decentralized assets, cryptocurrencies are held in either custodial or non-custodial wallets. Each option has certain benefits and downsides: custodial wallets hosted on crypto exchanges are attractive targets to hackers, while the security of non-custodial wallets is entirely the responsibility of their owners. If/when fraud or a hack does occur, cryptocurrencies’ decentralized nature can make it very hard to retrieve funds or compensate for losses.
  • Cryptocurrencies’ anonymity makes it very hard to track transactions, especially in the absence of robust KYC processes that require verified identities in order to use a crypto platform and/or use a crypto wallet. 

These factors all contribute to a wide range of crypto scams and frauds in varying and fluctuating degrees. Some of the most prominent scams and exploitations include:

  1. Crypto investment scams – these can take many different shapes and forms, but the general theme is that a fraudster will try and get an unsuspecting victim to hand their money over to them (often through an anonymous crypto wallet). Fraudsters can use email phishing, social media scams, fake websites and other fraudulent investment ‘opportunities’ to lure in their victims. 
  2. Fraudulent account creations - fraudsters can exploit crypto platforms with minimal, weak or non-existent KYC protocols to set up fake accounts using ID documentation they have downloaded from the internet, stolen or purchased. These ‘verified’ accounts can then be used to carry out a wide range of financial crimes – from money laundering to tax evasion and procuring illicit goods on the dark web – or can be sold on to other individuals who want to use anonymous accounts for illicit purposes.
  3. Cryptojacking – when malicious actors gain access to a victim’s computer and use that computer to mine crypto. 

Crypto platforms, providers and other VASPs are not only affected by fraud when they are hacked – if their systems are used to steal their customers’ assets, this can cause both permanent reputational damage as well as severe regulatory fines and sanctions that can cripple a business. 

As such, it’s important that crypto providers view the threat of fraud – and the solutions to prevent it – as a critical component of their business strategy. 

KYC for Crypto Platforms 

By using secure and effective customer onboarding systems, crypto platforms can verify their users’ identities and establish a strong first line of defense against fraud and exploitation. 

The first step towards establishing a more secure crypto ecosystem – and protecting investors and crypto providers against the threat of fraud and regulatory oversight – is a robust KYC onboarding system. By weeding out bad actors before they gain access to a platform, crypto providers can significantly reduce their risk exposure. 

In parallel, crypto companies need to provide their customers with a seamless and accessible experience that does not dissuade legitimate investors and users from signing up in the first place. 

In order to balance these two critical goals, adopting an automated and dynamic onboarding solution is a viable, affordable and scalable strategy for crypto companies of all sizes.

An effective KYC onboarding solution will allow legitimate users to sign up with relative ease, while also leveraging a risk-based approach that applies incrementally more stringent checks on potential customers based on their risk profile. 

For instance, users that are deemed to be low risk can be processed using ID verification checks that ensure a submitted document is authentic. Medium or higher risk customers can be subjected to biometric or Passive Liveness checks, as well as additional crypto wallet screening and other more enhanced due diligence (EDD) techniques

KYC-Chain’s onboarding solution is designed to be dynamic, adaptable and effective across multiple global jurisdictions and use cases: we customize our offering for our clients, implementing current technology to keep up with the rising threats posed by scammers and hackers while ensuring a seamless and user-centric onboarding experience. 

By implementing KYC-Chain’s end-to-end workflow solution, crypto companies can onboard customers, scale into new markets and focus on their core business while remaining compliant with global regulations and securing their systems against exploitation. 

Looking for a reliable and market-leading KYC onboarding solution for your crypto business? Get in touch and we can tell you more about how KYC-Chain can help. 


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