Discusses recent DOJ enforcement activity in digital currency

The U.S. Department of Justice has started targeting crypto exchanges that have either weak controls that allow scam artists to commit investment fraud of investor’s crypto accounts, according to a May 15, 2023, article found on CoinDesk. The article quotes the FBI as stating that as estimated $2.5 billion in crypto assets were stolen in 2022 alone, and the DOJ’s National Cryptocurrency Enforcement Team (NCET) is going to start cracking down on that activity. This is important for two reasons which I will get to in a second, but suffice it to say that the story here is only the tip of a much larger iceberg than you might expect.

The first issue is the more practical one and right down my line of work, which involves the recovery of stolen assets ― or, rather, the steep difficulties that an investor faces in attempting to get back lost crypto assets. Many of the hackers or scam artists, or whatever you want to call them, are from outside the U.S. where it is very difficult to get at them. Consider, for instance, the recent heist of $35 million by suspected North Korea hackers.

Think about what this entails. First, an investor has to figure out who stole their crypto assets. Good luck with that. Digital tokens by whatever name can be traded a dozen times, thus creating a paper trail which will take months to unwind, and then liquidated into some currency, very likely a foreign currency, where it is then laundered to look like legitimate funds. So the odds of an investor being able to ever identify the thief starts at near absolute zero.

Next, even if the thief was identified, the investor would have to bring a civil lawsuit to obtain a judgment, and that would mean obtaining service on somebody who is likely overseas. Then, even if the investor gets a judgment, good luck in finding the hacker’s assets which are probably squirreled away in yet some other country and probably an offshore debtor haven, and this assumes that it isn’t a state actor like North Korea that simply is going to refuse to pay and there is utterly nothing that one can do about it.

The bottom line is that an investor would end up spending many millions for what amounts to an uncollectable judgment. And probably a good deal of that money would be wasted on yet another breed of scammers, known as asset recovery specialists, who demand big fees up front to ultimately do little more than generate worthless reports which tease a recovery just over the horizon so long as their checks keep clearing. All this is why most investors grudgingly just eat their losses from crypto thefts and move on, presumably (but not necessarily) wiser from the experience.

So who cares anyway? Crypto in its current form is simply a unit for investment gambling. The price of crypto goes up because investors believe it will go up, and it goes down because investors believe it will go down. The use of crypto as a form of money is very limited ― hardly anybody in the United States at least is using it for them. Thus, if there is a theft of crypto, that is more akin to a thief who steals a gambler’s chips while they are not looking more than it is a serious crime which threatens commerce. It’s still wrong, it’s still bad, and it’s still a crime, but it is not the sort of crime that is going to bring the economy to its knees. So who cares other than the victims?

I’ll tell you who cares, and this is where things start to get really interesting. The U.S. Federal Reserve cares.

If you haven’t followed it, the Fed had been experimenting with its own digital currency, called, bureaucratically enough, Central Bank Digital Currency (CBDC) as part of its Project Cedar. You can read the report of the first phase of testing here. The project is currently focused on so-called “wholesale” transactions, meaning transactions between banks and clearing firms but not with the general public. According to the New York Fed’s press release:

“In Project Cedar Phase I, the experiment simulated a foreign exchange (FX) spot trade and introduced a wholesale central bank digital currency prototype to test whether using blockchain technology could improve speed, cost, and access to cross-border wholesale payments. FX spot trades are among the most common wholesale cross-border transactions, as they are often required to support broader transactions, such as for international trade or foreign asset investment. While these payment systems function well, there is opportunity for improvement around settlement. Currently, it takes two days for most FX spot trades to settle. During this period, payment senders and recipients are exposed to settlement, counterparty, and credit risk which, among other things, can hinder an institution’s…