Industry executives and experts share their predictions for 2023.  Read them in this 15th annual VMblog.com series exclusive.

How both regulators and industry firms will come down hard on crypto fraud in 2023

By Kieren James-Lubin, CEO and Co-Founder of BlockApps

Celsius, Terra/Luna, and now FTX. This year has been steadily punctuated with headline-grabbing instances of crypto-facilitated fraud, which has risen by 6,900% over the last four-and-a-half years. In fact, if current trends continue, crypto is set to facilitate more fraud than all other forms of payment by the end of 2023 – accounting for over 50% of all fraud by Q4 of next year.

Crypto fraud falls into two broad categories. The first is theft, most of which comes from DeFi exchanges. Criminals commonly use code exploits in smart contracts or gain access to users’ private keys through phishing and other exploits.

The second category is scams. While the average crypto thief targets ‘big fish,’ the average scammer will typically prey on a larger number of ‘minnows’ – often users new to crypto. As _­such, while the average amount stolen in thefts is typically higher, scams have a greater impact on the public perception of crypto and are quickly becoming a threat to its very existence.

Crypto regulation is coming in 2023

In the past, regulators have been hesitant to involve themselves in crypto. But, spurred on by spiraling rates of crypto fraud, this is likely to change going into 2023. You only need to look at SEC Chair Gary Gensler’s recent comment following Ethereum’s transition to a proof of stake consensus mechanism. He said, “many of these crypto financial assets have the characteristics of securities. The investing public is hoping for a return, just like when they invest in other financial assets we call securities.” The implication here is that if they’re viewed as securities, crypto assets would naturally fall under the regulatory remit of the SEC.

Looking outside the US, we’ve also recently seen EU lawmakers approve the Markets in Crypto-Assets (MiCA) Regulation, which aims to comprehensively regulate crypto markets across the continent. This crypto regulation will likely come into effect at the end of 2023 or the beginning of 2024.

Is crypto regulation a good thing?

Though there’s clearly a need for some form of regulation to clamp down on crypto-facilitated fraud, overregulation runs the risk of killing off the scrappy, entrepreneurial spirit and disruptive innovation for which our industry has become known.

Many of the industry’s biggest success stories, like the launch of Ethereum, have been pulled off by tiny teams working on shoestring budgets. If too much of a regulatory burden is placed on these companies, the next Ethereum may die before it can even get off the ground.

Aside from regulation, how can the industry clamp down on fraud in 2023?

Although some form of external regulation is necessary, there’s a lot more our industry could be doing to tackle the problem of both scams and thefts.

So far, the industry’s approach to preventing thefts has been focused on firefighting, with technical interventions such as code audits and bug bounties. These have had mixed results. Though code audits can no doubt be helpful, it’s also true that 73% of flash loan attacks occurred using exploits in code bases audited within the last year. So, this approach can hardly be described as watertight.

Similarly, largescale bug bounties, like those paid out by the Wormhole platform at the start of this year, might also help by offering hackers an incentive to report high-impact bugs to developers, rather than exploiting them. However, given the current bear market, it might be some time before there’s enough funding plowed into bug bounties to make them effective at scale.

Aside from enhancing security, perhaps the most effective method for clamping down on crypto fraud is making it harder for criminals to anonymously acquire and move funds. This requires a robust approach to know your customer (KYC), and a willingness to work alongside law enforcement to identify criminals.

Most centralized exchanges have implemented some KYC rules and have the ability to freeze or cancel suspicious transfers of funds. However, this is far less common in the DeFi space, where crypto fraud is 2.6 times more frequent – even after the collapse of FTX (when dividing value stolen by volume traded).

Embracing accountability instead of anonymity will require a culture change throughout the crypto industry. This may be a struggle given that the ability to remain anonymous was a founding principle of blockchain. But it’s necessary for the industry’s survival into 2023 and beyond.

Linked to this is the need for increased transparency across the crypto space, so prospective investors are able to make better choices. Currently, many of the larger centralized exchanges do a good job enforcing disclosure before listing new tokens, though some smaller exchanges and most DeFi exchanges do not. And of course, disclosure by exchanges themselves is also crucial.

Catalyzed by the recent FTX scandal, 2023 will be the year transparency reaches the top of the agenda for crypto bosses – regardless of whether regulators demand it. Recent statements by Binance CEO Changpeng Zhao are an indicator of this. In a recent memo to employees, he wrote, “FTX going down is not good for anyone in the industry…User confidence is severely shaken. Regulators will scrutinize exchanges even more. Licenses around the globe will be harder to get…We must significantly increase our transparency, proof-of-reserves, insurance funds, etc. A lot more to come in this area. We have a lot of tough work ahead of us.”

The bottom line? Blockchain and crypto are still in their nascency – there is huge potential yet to be realized and new applications to be discovered. We hope that in a decade, we’ll be able to look back on current problems as growing pains for an industry that was on its way to transforming the world.

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ABOUT THE AUTHOR

Kieren James-Lubin is the CEO and co-founder of BlockApps, an enterprise blockchain platform company whose mission is to connect individuals, businesses, and industries through global cooperation and trust. Kieren was instrumental in working on Ethereum prior to its launch. He used this knowledge to help build BlockApps’ initial product, STRATO. Kieren is responsible for architecting and implementing BlockApps RESTful API and surrounding products & components, including the authorization framework, peer to peer networking code, Node.js client, and third party integrations. Leveraging his extensive background in technology, Kieren is now responsible for maintaining and growing BlockApps’ business.