Confronting the serial scams of fake crypto trading platforms: an ounce of prevention is worth a pound of cure

Produced by Ouke Cloud Chain Research Institute

Author|Bi Lianghuan

The aftermath of the JPEX incident, which involved up to HK$1.6 billion, has not subsided, and another fraud case under the guise of an exchange has occurred. Late last month, the Hong Kong police reported a fraud case involving HOUNAX, an unlicensed virtual asset exchange. To date, 158 Hong Kong residents have reported losing about HK$155 million as a result of being tricked into investing through unlicensed platforms, according to the South China Morning Post. HOUNAX, which “committed crimes against the wind”, set up a bureau within a bureau to let investors “disappear when they recharge”, and Hong Kong crypto investors were hit again.

Both incidents were pyramid scams using Web3 and virtual assets as gimmicks. This is a common financial scam that lures investors to invest with words like “high returns” and “get rich quick”, using the returns paid to early participants with new investors’ funds to create a seemingly profitable situation. Recent cases have all used the name of virtual assets to lure investors into the pockets of criminals, rather than trading on real trading platforms.

SFC Transition Challenges: New technology may become a fraud gimmick

**One of the reasons for the recent increase in this type of fraud is that financial criminals have taken advantage of the SFC’s window for virtual asset trading platforms (VATPs) to mislead victims. **On June 1 this year, the SFC issued the “Guidelines for Virtual Asset Trading Platform Operators” (hereinafter referred to as the “Guidelines”), stating that VATPs operating in Hong Kong must obtain a virtual asset service provider license by June 2024, which means that for unlicensed but still operating exchanges, **SFC retains a one-year transitional window for them to develop and apply for licenses, rather than a one-size-fits-all approach, expressing support for the development of Web3 in Hong Kong. **

Another reason is the blessing of new technology filters. Since the Hong Kong government’s declaration at the end of last year, Web3 has been one of the key technologies that Hong Kong is vigorously developing. We analyze the general pattern of such cases: criminals take full advantage of the eagerness of virtual asset investors to invest and use false information in a targeted manner. In addition, virtual assets, as a new type of financial instrument, have a high operational threshold for new investors. In this case, scams were designed in both customer deposits and withdrawals.

The Web3 market is still immature, and we have observed that scams using Web3 are growing faster than scams using other financial instruments. For example, the Madoff Ponzi scheme that was uncovered in 08 has lasted for ten years, because criminals usually use fake identities to create crypto wallets, open anonymous trading accounts, etc., and some cases will use smart contract vulnerabilities and other technologies to commit fraud, which will increase the difficulty of police investigation, evidence collection, sanctions, etc. Due to the faster development speed and the existence of thresholds, a large number of users have lost assets when they are found and reported, resulting in a lack of intermediate link control in the entire event chain. **

Figure SFC’s implementation process during the transition period

Scammers choose to use virtual assets as a “cocoon”

Based on the past case experience accumulated by OKLink, a regtech product under the Ouke Cloud Chain Group, the Ouke Cloud Chain Research Institute compared it with previous financial crime cases and came to the following conclusions: Criminals in such cases usually use virtual addresses and anonymous wallets to transfer user funds after obtaining them, however, this may be a “cocoon”. **

We believe that if financial crimes involve virtual assets, blockchain technology will completely disrupt the way law enforcement handles cases in the past. **According to CBInsights, 90% of European Payments Council members believe that blockchain technology will fundamentally transform business in terms of legal compliance by 2025. When a transaction is on the chain, the transaction record will be permanently recorded on the blockchain, and through only one wallet address, any institution and user can query all transaction chains on the chain. **Rectify the difficulties of information asymmetry, cross-border cooperation, and underutilized unstructured data that existed in financial crime cases in the past.

It is precisely because of this “disruption” that in order to fully understand the complete chain of on-chain fund transfer, without corresponding technological solutions, participants such as regulatory and law enforcement agencies will face cumbersome operations. For such scenario needs, regulators and law enforcement agencies can use effective blockchain analysis tools to track and analyze virtual asset transactions more quickly, and ultimately obtain critical information.

Figure: OKLink, a blockchain analysis tool, analyzes the capital link

“An ounce of prevention is worth a pound of cure”

Benjamin Franklin once said that the same is true for investor protection.

**For virtual assets issued based on blockchain technology, blockchain analysis tools can not only be an efficiency tool for regulators and law enforcement agencies, but also a must-have compliance tool for virtual asset service providers, which can help avoid criminal risks, including money laundering. At the beginning of this year, when SFC inquired with the public about the VATP license, Ouke Cloud Chain Research Institute shared with SFC the case experience of using its product OKLink as an example to track on-chain assets and identify potentially suspicious transactions. In a subsequently updated official document, the SFC highlighted the importance of blockchain data analysis tools and updated the AML/CFT Self-Assessment Checklist on November 14 to include blockchain analysis tools as part of the self-assessment. As can be seen from this series of released documents, SFC hopes that VATP will adopt technological solutions such as blockchain data analysis tools to help investors avoid risks in advance from the institutional level. **

Figure: The road to “examination and editing” of blockchain analysis tools

It should be emphasized that the above measures and recommendations are for VAT that the SFC wants to operate legally and for a long time. Before individual investors can trade, no matter what kind of financial instrument, they need to conduct sufficient due diligence or choose a well-known trading platform in the industry. In addition, investors can also look at whether this trading platform uses Regtech tools such as Chainalysis and OKLink to cooperate, and can conclude whether this trading platform has compliance and long-term operation intentions, so as to make the right choice to prevent their investment from “going and not returning”. **

When your transaction enters the chain from off-chain, individual investors can also use blockchain analysis tools to avoid risks, and can conduct a preliminary round of screening in advance by querying the risk score of the counterparty’s transfer address and other measures. Jiang Qian, a partner at Ashurst Law Firm and a lawyer representing the victims of the JPEX case, said that in addition to the on-chain use of blockchain analysis tools, investors can also retain relevant off-chain evidence in advance when using VATP, such as the agreement signed between the user and the trading platform (if any), or whether the relevant influencer (KOL) promotes the promotional materials they have, and in case of property loss, they can apply to the court for a bank disclosure order, asset freezing injunction, etc., to identify and preserve assets.

Figure: OKLink performs risk screening on an address

As builders of the Web3 industry and industry witnesses for a decade, we call on technology companies in the industry to increase investor education and R&D investment in pre-event risk management. In addition to providing regulators with effective blockchain analysis tools to improve the efficiency of combating financial crimes, it is also necessary to educate investors on a large scale to use blockchain analysis tools to avoid risks before investing and transferring transactions involving on-chain transactions. **