Fighting cyber-crimes and strengthening security is a collective industry effort

For a long time, cash held in the form of fiat currency has served as the preferred medium for transactions globally. This has been attributed to ample liquidity maintained by the central banks and fiat currency’s relative price stability over a long period of time. It is, however, believed that this status quo would see disruption due to the rise in both prices and investor acceptance of cryptocurrencies as assets over the past few years. Additionally, crypto assets have earned the reputation of being fraud & counterfeit-proof as they are based on Blockchain technology described as the most secure technology today. Coupled with lower transaction costs, higher transparency and no geographical trade restrictions, cryptocurrencies are being touted to replace fiat currency altogether in the future.

While there has been significant appreciation in the value of most crypto assets, more investors are lapping them up at an increasing pace. This has, in turn, contributed to a rising trading volume of popular cryptocurrencies like Bitcoin, Ether. Despite the increasing volume, the crypto industry saw a drastic fall in crypto crime from $4.5 billion in 2019 to $1.9 billion in 2020, representing a whopping 57% drop and accounting for just 0.5% of the total transaction volume. This reduction in crypto-related cyber-crimes is due to a collaborative effort by the crypto industry leaders to mitigate transaction risks and build stronger controls into the various trading platforms.

That said, losses from crypto asset theft, hacks and exit scams over the past few years have dented its infallible reputation and warrants a closer look at the various mediums through which such crimes have been perpetrated. Most of the losses have stemmed from ‘exit scams’, which are fraudulent practices by unethical crypto asset promoters who have fled with investors’ money during or after an Initial Coin Offering (ICO). Prominent exit scams like the PlusToken scheme in 2019 & the WoToken scheme in 2020, both operated by the same set of promoters, together accounted for nearly $4 billion of investor wealth being destroyed and contributed to a bulk of the total blockchain-related fraud in the two year period.

Excluding these scams, though, the drop in crypto crime since 2019 reflects the maturity setting into the crypto industry. This has been made possible by improved infrastructure and enhanced security systems integrated into the operations of crypto exchanges and associated companies. An example of this can be seen in the $281 million hack of a cryptocurrency exchange in 2020, where subsequently, the exchange recovered 84% of the stolen funds due to their advanced security & tracking protocols. Data suggests that cybercriminals have shifted focus to DeFi protocols since the second half of 2020 as they cater to the traditional finance industry and are more susceptible to attacks. In fact, nearly half of all crypto hacks last year were related to DeFi protocols and involves performing “rug pulls” to fraud investors. These “rug pulls” involve the liquidation of the entire DeFi asset pool driven by sudden liquidation by some investors, leaving the remaining token holders with no liquidity leading to an inability to trade with their holdings. Crypto industry leaders believe that the loan growth rate on DeFi platforms has attracted unscrupulous market participants and will need a collective effort to build robust systems devoid of loopholes. To provide context, the total number of loans on DeFi platforms is already up ~400% from $11 billion in October ’20 to around $54.5 billion as on 22nd May ’21 and is only slated to grow further.

Virtual Asset Service Providers (VASPs) that include cryptocurrency exchanges, digital wallet providers and even some financial institutions dealing with crypto assets are the front line in preventing such financial crimes. VASPs also play a key role in controlling the spate of smaller scale cyber frauds & hacks that have now gained prominence. The Financial Action Task Force (FATF), an intergovernmental organization founded to develop policies that combat money laundering, has set guidelines for the same. It has urged VASFs and other entities through its FATF Red Flag Indicators Report to strengthen their Anti-Money Laundering (AML) & Combating the Financing of Terrorism (CFT) procedures and adopt a risk-based approach that befits crypto-assets and their trading.

Leading cryptocurrency exchanges are therefore collaborating with leading regulatory technology and blockchain analytics providers to deploy robust AML Platforms to counter cybercrime focal points. The primary focus remains on curbing the rise of darknet marketplaces, Ponzi scheme operators and proliferation financiers through these protocols. These AML systems automate and streamline anti-money laundering protocols and analytics, thereby enabling crypto exchanges to fulfil regulatory requirements more effectively than previous standards. With real-time asset monitoring, tracking & investigation of illicit funds and the customization of the AML Platform’s red flags to mitigate false positives, crypto exchanges are ensuring the safety and security of their customers and partners. Moreover, ready access to risk reports generated from a range of threat checks and data points can help identify patterns commonly adopted by cybercriminals and take measures to prevent such entities.

Thus, the focus continues to remain on fighting crime in the booming decentralized finance space as transaction volumes continue to grow exponentially. As VASPs continue to mature and adopt more robust security measures, losses from crypto asset theft, hacks and fraud have further fallen in the first four months of 2021. This is a measure of the tightening controls being implemented across the crypto industry. By adopting advanced analytics, AML & CFT platforms and improved KYC procedures, entities in the crypto industry are enhancing their infrastructure & strengthening the crypto ecosystem to make it scalable, secure and sustainable in the times ahead.

Authored by By Neeraj Khandelwal, CTO & Co-founder, CoinDCX