The emergence of blockchain technology has brought skepticism and accusations of fraudulent activities, driven by its unique features like decentralization and immutability. Fraudulent incidents have increased, making fund recovery challenging. Factors contributing to fraud include the allure of high returns and difficulties in tracking funds. Various schemes exist, from ICO scams to phishing attacks, with state-sponsored groups like the Lazarus Group compounding the risk.
Activities targeting the cryptocurrency industry sponsored by the North Korean government. (Source: Recorded Future Intelligence Cloud)
For investors, caution is necessary due to evolving fraudulent tactics. While most users may not engage in on-chain operations, using centralized exchanges poses risks. This article will explore security risks on centralized exchanges and advise users on safeguarding their funds.
Unlicensed operation
As cryptocurrency regulations become more standardized, countries are issuing financial licenses to enhance industry legitimacy. Regulation ensures compliance with anti-money laundering and know-your-customer measures, reducing financial crime risks and improving transparency. Despite this, many centralized exchanges operate without licenses, promising high returns.
While unlicensed exchanges may offer attractive opportunities, the risks associated with them often outweigh the potential rewards. Conducting thorough research and due diligence before investing in any cryptocurrency exchange is crucial to mitigate risks and safeguard investments.
On July 8, 2022, a cryptocurrency exchange named JPEX was listed by the Securities and Futures Commission of Hong Kong as an unlicensed and suspicious company. Over the following year, the exchange employed numerous irregular methods to attract a large number of users. For instance, it engaged in false advertising claiming to hold regulatory licenses in the cryptocurrency industry, utilized influencers to make false and misleading statements, and enticed users with high returns to issue its platform token, JPC.
On September 13, 2023, the Securities and Futures Commission of Hong Kong once again mentioned that none of the entities under the JPEX Group had obtained any licensing from the Commission, nor had they applied for a license to operate a virtual asset trading platform in Hong Kong. Subsequently, community members discovered that the exchange began restricting user withdrawals, and offline events planned by the exchange were deserted. The "Asia Blockchain Building," claimed to have a monthly rent of 3.4 million Taiwanese dollars (approximately 770,000 RMB), associated with JPEX, was also found empty. Meanwhile, on-chain data revealed that the exchange had started transferring user assets.
According to the latest reports, JPEX is involved in a $403 million fraud case, affecting over 2,000 victims. The Hong Kong police have arrested 72 individuals and frozen assets related to JPEX worth over $29 million.
Misappropriation of funds
Instances of exchanges misappropriating user funds in pursuit of additional profits are not uncommon. Such behavior may involve theft, misappropriation, or improper use of customer funds. A typical example is the case of FTX Exchange, which declared bankruptcy and closed its doors after misappropriating customer funds in the wake of a run on withdrawals. Given the significant amount of funds involved and the large number of individuals affected, reaching into the millions, such incidents have a profoundly negative impact on the industry as a whole.
The incident stemmed from CoinDesk's disclosure of private financial documents in early November 2022, revealing potential debt issues with Alameda Research, a sister company of FTX and once one of the largest market makers in the industry. According to CoinDesk, most of Alameda's assets on its balance sheet were tokens issued by the FTX platform, with its largest single asset being $36.6 billion worth of FTT tokens as of June 30. Other significant assets included $33.7 billion in public chain tokens SOL and Solana ecosystem tokens. However, its liabilities amounted to $8 billion, primarily consisting of $7.4 billion in loans.
Despite positive responses from the creators of FTX and Alameda, including SBF and Alameda CEO Caroline Ellison, the announcement by Binance to sell all of its holdings of FTT tokens triggered a frenzy of withdrawals from users. On November 11, FTX announced that over 100 entities, including its subsidiaries, had filed for bankruptcy protection in the United States.
After a prolonged wait, creditors and clients of FTX finally received some favorable news. On May 8 this year, FTX Trading Ltd. and its affiliated debtors submitted a proposed amended restructuring plan and related disclosure statement. According to the documents, 98% of FTX creditors will receive at least 118% of their recognized debt claims in cash within 60 days of the plan taking effect.
At the time of FTX's bankruptcy in November 2022, customers on its platform held approximately $8 billion worth of cash and cryptocurrencies. FTX's assets were primarily composed of cryptocurrency tokens, and the bankruptcy filing prevented customers from immediately retrieving their funds. With the recent market rally, the prices of $BTC and $FTX surged, allowing FTX to repay 98% of its customers at a 9% interest rate.
Fake exchanges
In cases of fraud on centralized exchanges, two common types are often observed: 1) imitation of well-known exchanges, and 2) creation of their own exchanges. Imitation exchanges typically mimic the interface, branding, and services of reputable exchanges to gain users' trust, exploiting this trust to steal or misappropriate user funds. Creating a new platform for fraud often involves attracting users to deposit funds through high returns or enticing referral schemes.
Numerous exposures of fraudulent exchanges can be found in the Negative Review section of the blockchain query tool WikiBit.
Considerations for selecting an exchange
Amid the proliferation of fraudulent tactics, users should consider various aspects when selecting exchanges to avoid potential financial losses. Here are key areas to focus on when choosing an exchange:
Cryptocurrency Financial Licenses: Holding a financial license indicates compliance with local laws and regulations, generally offering higher security. Requirements for financial licenses vary by country, and different types of licenses may be issued within the same country to meet various financial needs.
Proof of Reserves (PoR): Proof of Reserves is a method for verifying that a trading platform or cryptocurrency company actually holds digital assets in a 1:1 ratio to represent client funds. This proof can enhance user trust and ensure the security of funds, especially after incidents like the collapse of FTX.
Fees and Usability: Apart from security, users should consider the fee structure and user interface of the exchange. Low fees and user-friendly interfaces can enhance trading efficiency and experience.
Collecting the above information and conducting comparative analysis often requires users to invest a significant amount of time and effort. However, this process can be streamlined by utilizing certain tools and platforms. For instance, by using the all-in-one query tool WikiBit, users can gain comprehensive insights into exchanges in minimal time.
WikiBit has compiled information on cryptocurrency financial licenses obtained by various exchanges. Through methods such as website queries, phone calls, and email communications with regulatory agencies, WikiBit evaluates the authenticity and value of exchange licenses comprehensively. Additionally, WikiBit organizes proof of reserves from major exchanges for direct user access. Moreover, users can find a plethora of authentic user reviews for each exchange on the platform, providing valuable insights for decision-making.
Considering these factors, WikiBit rates exchanges across five dimensions: Regulatory, Business, Risk Management, Influence Index, and Trading Environment Index. With over 200 rating factors involved, WikiBit calculates a weighted average score for each exchange, quantifying the assessment in the most intuitive manner possible. This quantified approach helps users choose exchanges effortlessly and efficiently.
About WikiBit
「wikibit」authoritative inquiry platform in the blockchain industry. wikibit provides you with the latest global blockchain information, industry scandals, inquiries, credit information, operation and other related information to help investors make efficient decisions.
At present, WikiBit has already recorded over 5,800 exchanges, 8,300 tokens, and 26 regulators, with more than 200 global languages available for auto-translation. Right now, WikiBit has provided safe and reliable digital asset information services to over 10 million users in more than 170 countries and regions.