The Crypto Conundrum: why fraud is running rampant and how regulators can stop it

In an era where digital assets are redefining finance, cryptocurrency payments remain a high-risk frontier. Despite the promise of decentralization and financial independence, crypto transactions have become a breeding ground for fraud, leaving victims without the protection afforded to traditional banking customers. With crypto hacking thefts skyrocketing to $1.38 billion in the first half of 2024 alone, the question remains: how can we make crypto payments safer?

The problem: crypto’s inherent vulnerability

Unlike traditional fiat currency transactions, which are safeguarded by regulations like the EU’s Payment Services Directive (PSD2), crypto payments—especially those involving unbacked assets like Bitcoin—lack a safety net. When fraud occurs, victims bear the entire financial loss, with no recourse for reimbursement.

At the heart of the issue lies blockchain technology itself. Designed for transparency and security, blockchains operate on consensus mechanisms like Proof of Work (PoW) and Proof of Stake (PoS). While these systems prevent tampering under normal conditions, they are not invulnerable. Cybercriminals can manipulate transactions by executing 51% attacks, gaining majority control of a blockchain’s validation process to rewrite transaction history. Additionally, private key thefts—where hackers gain access to users' wallets—allow criminals to siphon funds without resistance.

The legal landscape: a patchwork of protection

Theft and fraud involving cryptocurrencies are technically already criminalized under most national legal frameworks. However, enforcement is hindered by the anonymity of blockchain transactions and jurisdictional complexities. In England and Wales, for instance, the 2006 Fraud Act covers crypto-related fraud, while Denmark’s Crime Act criminalizes digital financial manipulation. However, apprehending perpetrators remains a significant challenge due to the difficulty of tracking transactions across decentralized networks.

In response, the UK recently introduced provisions under the Economic Crime and Corporate Transparency Act (2023), empowering authorities to seize crypto assets linked to illicit activities. The EU, on the other hand, has yet to implement a unified regulatory framework to tackle crypto fraud effectively.

The regulatory gap: why financial laws are failing consumers

A major shortfall in financial regulation is the lack of consumer protection for crypto payments. Unlike fiat transactions, which benefit from chargeback mechanisms and fraud liability provisions under PSD2, Bitcoin and other unbacked cryptocurrencies fall outside these protections. The upcoming Payment Services Regulation (PSR) and PSD3 aim to enhance consumer security for electronic money tokens (EMTs), but Bitcoin and similar assets remain excluded.

This regulatory oversight leaves consumers vulnerable. If a credit card is fraudulently charged, banks are legally required to reimburse the victim. If a Bitcoin wallet is drained due to a hack, the victim has no legal recourse.

The solution: reforming crypto regulation

To mitigate fraud and protect consumers, regulators must rethink their approach to crypto payments. Potential solutions include:

1. Extending PSD3 Protections to All Crypto Payments: If unbacked cryptocurrencies were brought under the same legal framework as fiat payments, consumers would gain essential rights, including fraud rectification and reimbursement.

2. Mandating Stronger Authentication Measures: Financial regulators could impose stricter authentication requirements on crypto transactions, similar to the strong customer authentication (SCA) rules for fiat payments.

3. Restricting Use of High-Risk Crypto Assets: Policymakers could limit the use of unregulated crypto assets for payments, allowing only stablecoins or EMTs that meet specific security criteria.

4. Enhancing Law Enforcement Capabilities: Governments should equip agencies with better tools to trace blockchain transactions and apprehend fraudsters, potentially through public-private partnerships with blockchain analytics firms.

The future of crypto payments: innovation vs. consumer protection

The crypto industry stands at a crossroads. If it continues to resist regulatory oversight, it risks losing consumer trust and mainstream adoption. Conversely, if regulators step in too aggressively, they may stifle innovation. A balanced approach is essential—one that preserves the benefits of decentralization while ensuring that consumers are not left defenseless against financial crime.

Without intervention, crypto payment fraud will only escalate, further discouraging mass adoption. It is up to regulators, industry leaders, and consumers to demand a system that is both innovative and secure. The question is no longer whether crypto payments should be regulated—it is how soon we can do it before more people fall victim to digital financial crime.

Full article:

https://www.sciencedirect.com/science/article/pii/S2949791424000769?ref=pdf_download&fr=RR-2&rr=90dddc90c81b1903

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