Behind every great fortune, there is a crime


Targ Patience for CITYA.M.

My previous article looked at the effects mass-adoption of DeFi might have on financial markets, with a focus on systemic risks. That was the first step on my stated journey, to explore the evolving DeFi landscape, its major players, components and risks, and the regulatory approaches and proposed solutions to them.

Continuing on that path, this article ventures into somewhat shadier territory. It’s financial crime time, and I’m feeling allegorical.

“Poverty is the parent of revolution and crime”

This Aristotelian proverb has all the right ingredients: revolution, crime, and a promised answer to their origin. Certainly, the Bitcoin Whitepaper references “inherent weaknesses of the trust based model” and susceptibility to reversible transactions as justification for a new system, based on cryptographic proofs instead. So it might be said that the intrinsic threat of poverty from trust-based systems had indeed given birth to the crypto revolution.

But what about crimes committed within, and by way of, the new systems and markets that characterise this revolution? Are they borne of poverty, or the threat of it; or should they be regarded more as cynical exploitations of fresh opportunities? An extract from the far younger William Graham Sumner’s 1883 book, What Social Classes Owe to Each Other, appears more relevant:

“Undoubtedly there are, in connection with each of these things, cases of fraud, swindling, and other financial crimes; that is to say, the greed and selfishness of men are perpetual. They put on new phases, they adjust themselves to new forms of business, and constantly devise new methods of fraud and robbery, just as burglars devise new artifices to circumvent every new precaution of the lock-makers.”

Although much changes over time – technology, economies, lifestyles – human behaviour evidently does not. As it was in the 19th century, remains today, and will be in the future, the conflict between those who choose to perpetrate, and those who hope to prevent, financial crimes, is an arms race. Society’s least scrupulous will reliably scour every stride of progress and innovation for any exploitable aspect, and each mechanism meant to detect or prevent them for flaws, fissures and failings. Society fortifies itself for this war with legislative defences, which mandate minimum controls and standards to which all players in the financial game must adhere. The challenge is one of balance: poorly constructed defences can readily collapse or trap you.

So, what consequences is the crypto revolution exerting on financial crime, and are our traditional structures and strategies for defence even necessary in this Brave New World?

Community, identity, stability

The term ‘financial crime’ encompasses a broad spectrum of transgressions: from the acquisition of wealth by theft, fraud, deceit or corruption; through undertaking or facilitating the protection, concealment, or realisation of financial benefits obtained illegally; to financing, or facilitating the financing, of illicit activities such as terrorism or the proliferation of proscribed weapons of mass destruction. Any single action may range from the seemingly-trivial to the manifestly devastating, but prevalence of economically motivated crimes can collectively undermine the development and stability of economies and, ultimately, societies.

Conversely, in what I have decided to dub the ‘Second Law of Financialcrimedynamics’, even systems of economic development pursue equilibrium. A 2021 study of EU Member States by academics at Babeș-Bolyai University in Romania concluded that higher economic and sustainable development results in corresponding developments to the nature and sophistication of financial crimes.

It stands to reason that the advent of virtual assets, built on complex technological cryptography, will give rise to more sophisticated financial crimes. Subsequently, with greater complexity and anonymity in financial systems, and the criminal contrivances that plague them, the challenges of understanding, detecting and preventing financial crime grow too.

Quantifying crypto crime

Chainalysis Report, published in January this year, provides some valuable insights into the evolving nature and scale of these problems across the span of five years. For example, as of early 2022, illicit wallet addresses hold at least $10bn worth of cryptocurrency, and since 2017, over $33bn of money laundering using cryptocurrency has been detected. Almost half of this was in 2021, when a record $14bn of illicit crypto activity was identified, up 79% from 2020.

Crypto theft also hit a record high, with $3.2bn stolen in 2021, up 516% from 2020. Shocking though these figures may seem, they coincide with massive growth in crypto adoption and usage – up 567% since 2020, to a staggering $15.8trn – with illicit activities representing a record low of just 0.15% of all monitored transaction volume.

Meaningful comparisons with the wider global financial system are difficult, as they rely on fragmented and error-prone data. But according to a 2021 report by the United Nations’ FACTI Panel, money laundering is estimated to account for around 2.7% of global GDP. Assuming this to be accurate and relevant would mean that illicit transactions are around 18 times less prevalent in crypto as in the wider global economy.

Either way, $14bn remains a hefty amount of dirty money. The analysis identified payments related to child abuse, illegal marketplaces, fraud operations, ransomware and hacks; but scams and stolen funds made up over half of the total, or $7.8bn, of which $2.8bn was related to ‘rug pulls’. A single, centralised exchange, Thodex, accounted for almost 90% of that amount, although Chainalysis noted that “all the other rug pulls in 2021 began as DeFi projects”.

Rug pulls are a relatively new phenomenon, and a clear example of criminal ingenuity riding on the coattails of innovation. This flavour of swindle involves developers of a project – typically a new token or platform –disappearing suddenly and unexpectedly, along with their users’ crypto assets and pride. Ranging from brief, simplistic schemes swaddled in screaming red flags, to immensely convincing, complex and well-produced simulations of credibility, rug pulls always rely on intense promotion to build excitement and FOMO to attract unwitting investors, often assisted by the siren song services of ‘crypto influencers’. In the confusing wake of these heists, it can often be difficult to discern a useful idiot from a complicit co-conspirator.

In traditional financial markets, under frameworks like the EU Market Abuse Regulation dissemination of false or misleading information about a financial instrument – including via the internet, social media or unattributable blogs – is a criminal offence. Irrespective of desirability, applying such stringent controls to crypto markets would be impractical. It has been estimated that just an hour of Twitter activity would overwhelm humanity’s entire judicial and penal systems.

So in the absence of restrictive measures on the flow of information, how can crypto users, and DeFi users in particular, be protected from this banditry?

The DYOR darling

Do Your Own Research (‘DYOR’) is a ubiquitous phrase of the modern world, and its use extends far beyond crypto and DeFi. Cropping up under far-ranging topics, from politics, science, and medicine, to religion and far-out conspiracies, DYOR is a blanket disclaimer, projecting the principle that each person should take responsibility for researching, and sufficiently understanding, the relevant topic. This conforms to a central tenet of libertarianism, that “the values of personal freedom and responsibility are indivisible”, and to crypto’s own libertarian foundations. Such an approach is also necessary and sensible in any environment with no accountable, authoritative sources of information.

Sole reliance on personal research is, at its core, Darwinistic: the fittest – those who have ‘done their own research’, so are adequately educated and informed to make good decisions – survive, whilst those who fall victim to a fraud, scam or theft will not; they must take personal responsibility for their victimhood, which is logically attributable to inadequate research and understanding on their part.

But is this a rational perspective, or a sufficient defence against the risk of financial crimes?

Allegorical dimensions

Let’s imagine a world in which DeFi has superseded all centralised financial systems, and humanity is enjoying the fruits of blistering efficiency, seamless interoperability, boundless innovation, and barrierless financial participation. The prescriptive and punitive controls of legacy financial markets are consigned to history, with DeFi’s inexorable march of mass-adoption succeeding under the fêted banner of “DYOR”.

How should this world regard its victims of fraud, theft and deception? Would those who have concerned their lives with things other than crypto and DeFi be at fault if duped and robbed? How should this society treat those without the time, or depth of background knowledge, to adequately ‘research’ their every financial step, to discern what information should be trusted, or to interrogate smart contract code? Should they be considered culpable for their vulnerability to the technical tricks of scammers, swindlers, fraudsters and thieves? Surely not. Such a society would be deeply inequitable, favouring a privileged elite whose dumb luck had ultimately afforded them the luxury of time and specialist knowledge. This would also be in stark conflict with the DeFi premise of financial equality and democratisation.

But devotion to the DYOR dogma runs deep. I have been assured, by several dedicated degens, that they would prefer a world in which their elderly parents were rendered destitute by a DeFi scam, and treated as culpable on the basis of ‘personal accountability’, than one in which DeFi would be constrained by any regulation. This perspective may be extreme, but such is the strength of their conviction. But is that strength drawn more from principles, or the unconscious bias of the ‘privileged elite’ in our envisaged scenario?

Let’s consider another timeline for our hypothetical world, in which the immaculate brilliance of DYOR has ignited a righteous bonfire of regulation, spreading far beyond finance. Other, hitherto regulated, industries enjoy absolute freedom, and all consequences are delegated to market forces and the tenet of personal accountability. Just as the crypto elites have an unfair advantage in financial endeavours, it is the chemists and pharmacologists who have the upper hand when it comes to medicine. How should this society regard the financial elite whose family are poisoned by mislabelled toxins they trusted to be paracetamol? Should they be expected to ‘do their own research’ by performing the wet chemical, chromatographic and spectroscopical analyses required to properly understand their tablets’ composition?

Back to reality

These examples are melodramatic, of course, and drawn from extreme logical conclusions. However, setting aside the dangers of any worldview predicated on victim blaming, one thing is made abundantly clear: sole reliance on concepts of ‘personal accountability’ leads to consequences only for the victims of financial crimes, and rarely their perpetrators. This would not only hinder crypto and DeFi in delivering social equity and financial democratisation, but also conflicts with long-established societal and legal principles.

As our financial systems evolve through innovation, so too does financial crime; our systems of defence must follow suit. In my next article, I will take a far less allegorical look at our current legislative foundations, and how they are faring or adapting under the weight of the crypto insurgence.