By: Alex Burke
Between June and November of 2021, a group of Australians collectively lost an estimated $374,000 to an investment scam.
Stories like this aren’t exactly unique; you can easily find plenty of high-profile incidents, where people have lost their savings—homes, even—due to poor investor education, directorial negligence, or outright fraud. But what’s different about this specific case are the channels involved, the assets being invested in, and the fact that the company that investors were trying to access was, and remains, entirely legitimate.
In short: multiple people looking to invest in cryptocurrency (crypto) assets were duped into sending their money to a fake crypto “wallet”. Crypto wallets effectively function like a bank account, allowing users to trade on crypto exchanges—what’s important is that they contain your credentials and are protected via a private key. Whatever type of wallet an investor uses, it’s the private key that’s important: without it, they can’t prove ownership over (and access) whatever monies they’ve invested or transacted on a cryptocurrency exchange.
In this case, people were trying to invest using WalletConnect—not a crypto wallet in and of itself, but software that connects crypto wallets to blockchain-based applications, or “dapps”. (Bear with me.) Searching online, they found a WalletConnect phone app that used the company’s official logo and had high customer ratings. In order to facilitate customers’ transactions, the app requested their “seed phrase”, which (for brevity’s sake) is essentially a human-readable version of a private key.
The problem? WalletConnect doesn’t offer a phone app and, per the company’s website, “will never ask for your private key or wallet seed words … If you have shared your private key or seed words you will lose everything in your wallet.” Aspiring crypto investors basically gave a fraudulent app the keys to their house and returned home to find everything gone with almost no chance of getting it back.
Could investors have avoided this scam with a little more research? Possibly. But the rate and sophistication of scams like this can be almost too much for even companies like Google and Apple to keep up with—as WalletConnect co-founder Pedro Gomes told the ABC, “this is, unfortunately, a reality of the cryptocurrency space as a whole.” Gomes said WealthConnect has used automated services which submit scam reports to Google and other app hosting providers, “but scammers create [apps and websites] much faster than the platforms can actively take them down.”
And even if app providers were more efficient at tackling crypto scams, there’s a much bigger issue at play here: the crypto market is large, complex, and not particularly easy to understand. Despite the incredible popularity of crypto in Australia—this time last year, the ATO estimated there were at least 600,000 Australian taxpayers with some kind of crypto investment—there isn’t much in the way of in-depth information and education needed to help safeguard investors against scams like the WalletConnect app. Plus, because of the decentralised nature of cryptocurrencies, there’s very little in the way of recourse if an investor does get scammed.
Investors also need to be aware of what’s known in the crypto market as a “rug pull,” where a developer or issuer takes investors’ money and disappears. One notable recent rug pull involved the project Evolved Apes, which raised development costs via non-fungible tokens (NFTs) to produce a videogame before syphoning off approximately $3.6 million from the project’s funds and vanishing from the internet.
But it’s not just investment risk—there are also new kinds of estate planning considerations to note. How many crypto assets will be lost when an investor passes away without making their credentials accessible to beneficiaries? Without the private key or seed phrase, those assets are effectively lost.
These concerns aren’t just theoretical: losing access to one’s crypto holdings can happen (and has happened)—even when an investor is still alive. Horror stories like the young British man who has spent years petitioning a local council in Wales to search landfill for an external hard drive he accidentally disposed of—one containing access to over $531 million AUD in Bitcoin—could become increasingly commonplace.
Compounding this problem, from a financial advice regulatory perspective, most crypto assets fall outside the bounds of what advisers can talk about with clients.
If you were confused about any of the terminology used in the WalletConnect story above, you’re not alone.
Crypto, in brief
Crypto may seem like a recent phenomenon given the volume of headlines generated about it over the past few years, but it has roots stretching back to at least the 1980s. Cryptographer David Chaum proposed the idea of secure digital cash in 1982 along with the encryption framework that would allow for secure and verifiable transactions between different parties.
Those ideas would form the basis of what is now known as the blockchain—a means of storing digital information in a record that is distributed across all participants, theoretically meaning that no single entity has the power to control or alter the record. Unlike a database, where information is sorted into tables, blockchains store information sequentially in “blocks” with finite storage capacities; once a block is full, it is closed off, added to the “chain” and a new block is created.
The most common use for a blockchain is as a distributed digital ledger of financial transactions, and the most common transactions on those ledgers tend to involve Bitcoin. First proposed in a 2008 whitepaper by “Satoshi Nakamoto”—the pseudonym may refer to one person or a group, but the identity of the author has never been verified—Bitcoin was subsequently introduced a year later and, to this day, remains the most popular cryptocurrency with a market cap of over $1 trillion AUD at the time of writing.
Bitcoin was proposed as a solution to the prevailing model of electronic commerce, where financial institutions serve as trusted third parties to process payments. According to Nakamoto’s paper, these weaknesses included the impossibility of “completely non-reversible transactions” given that financial institutions “cannot avoid mediating disputes”; the cost of this mediation, the paper argued, “increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions.”
Moreover, Nakamoto said that the possibility of reversing transactions increases the need for trust, which leads to merchants “[being] wary of their customers, hassling them for more information than they would otherwise need” and the market accepting “a certain percentage of fraud” as “unavoidable”. It’s also worth noting that when the first Bitcoin block went live in 2009, it was accompanied by a line of text reading “Chancellor on Brink of Second Bailout for Banks”—the appeal of a means of exchange that didn’t rely on trust in financial institutions, something that was in very short supply in the years following the Global Financial Crisis, cannot be overstated as a primary contributor to Bitcoin’s subsequent popularity.
Even so, it took some time for Nakamoto’s argument (and Bitcoin itself) to develop sufficient consensus to be used in mainstream commerce. But as of 2022, some of the biggest companies in the world accept payments in Bitcoin in various contexts. These include Tesla, Microsoft and PayPal—in Australia, online retailers such as Zumi, Pet Parlour, and Cheap Air also accept cryptocurrency. Multiple “altcoins”—that is, digital currencies other than Bitcoin—have also emerged since 2009, including Ethereum, Tether and Solana.
However, the rising popularity of Bitcoin (and other cryptocurrencies) as a means of transacting goods and services online doesn’t really tell the whole story—and certainly doesn’t explain why investors like those scammed by the WalletConnect app were perhaps so keen to get into the crypto market.
While cryptocurrencies are foremost proposed as an alternative medium of exchange, they also function as a speculative investment for many people. And it’s not hard to see why: having first achieved parity with the US dollar in 2011, Bitcoin (BTC) reached an all-time high of $65,000 USD in 2021. You may be aware of the famous story where a Bitcoin pioneer paid 10,000 BTC for the delivery of two pizzas in 2010—if the deliverer had held onto that amount until last year, they’d be a multi-millionaire today.
Understandably, many people want to be that pizza guy. So they’re investing in Bitcoin and many other (less expensive and increasingly niche) cryptocurrencies, as well as initial coin offerings (ICOs), which are a form of cryptocurrency that allows businesses to raise capital for projects on a crypto exchange, and non-fungible tokens (NFTs), which theoretically confer ownership over a unique object or piece of intellectual property.
Australia as a “crypto hub”
As you’ve likely gathered, the size and breadth of the crypto market is staggering. While “crypto” and “Bitcoin” are often used interchangeably, the former refers to a wide variety of assets with varying degrees of investment risk (and overall legitimacy). As the Australian Securities and Investments Commission (ASIC) has noted regarding its regulation efforts in the crypto market, “cryptocurrency assets aren’t a homogeneous asset class that we can identify consistent principles across the board that would apply to them in a generic sense.”
ASIC has also said that the “rights and features of each crypto-asset can raise different considerations for consumers, product issuers, and regulators,” and that crypto assets are considered speculative, “with volatile prices and minimal to no regulatory oversight.”
Please note: If you are considering investing in cryptocurrency, it’s important to keep in mind investment fundamentals (eg diversification, risk versus return and liquidity), the potential to lose funds via security vulnerabilities and investment scams, and the associated tax treatment, as well as carefully consider whether such an investment is appropriate to your financial situation, goals and objectives.
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