Deep Dive: How Cryptocurrency Exchanges' Onboarding Systems Can Weed Out Fraudsters

Cryptocurrencies have surged in popularity and value over the past several years, with the cryptocurrency market valued at $1.6 billion in 2021 and projected to reach $2.2 billion by 2026. Various players in the field like bitcoin and ethereum have become household names, not only for their surging value but also for their extreme volatility. This has rendered their use as actual currencies tenuous, but they are attractive to many as high-risk investments. The most famous example, bitcoin, was valued at just 8 cents per bitcoin in 2010, $315 in 2015 and a staggering $20,089 in 2017 before plummeting to $7,112.73 in 2019. It is currently valued at nearly $35,000 per bitcoin a mere two years later.

Some cryptocurrencies have also gained a reputation for being used to facilitate criminal activities. Money laundering, fraud and other crimes involving cryptocurrency totaled $4.3 billion in 2019, a larger sum than the previous two years combined. Roughly $2.8 billion in laundered money also flowed through cryptocurrency exchanges in 2019, up from $1 billion in 2018. A recent study found that cryptocurrency crimes dropped to $1.9 billion in 2020, but such strikes are still a major concern for the exchanges themselves as well as the government oversight agencies tasked with regulating them.

Cryptocurrency exchanges must continue to take steps to authenticate their customers and reduce fraud, which can be daunting for their onboarding teams. The following Deep Dive examines the various threats facing the cryptocurrency industry and how exchanges are looking to smoke out bad actors and protect legitimate customers with secure onboarding.

Why cryptocurrency exchanges need secure onboarding 

Cryptocurrency exchanges require strong verification measures because, like all other financial organizations, they deal with money on which fraudsters are eager to get their hands. Bad actors have stolen more than $7.6 billion worth of cryptocurrencies since 2011, with $2.8 billion of this total pilfered through security breaches and $4.8 billion stolen through cryptocurrency user scams. There were 400,000 separate cryptocurrency schemes in 2020 alone, up 40 percent year over year, and a 75 percent increase is projected for 2021.

Unlike the kick-in-the-door bank robbers seen in movies, cryptocurrency thieves are not physically limited in their ability to transport money, allowing for some truly mind-boggling heists. The largest single instance of theft on record occurred in 2018, when $534.8 million in NEM coins were stolen from cryptocurrency exchange Coincheck. The theft affected more than 260,000 Coincheck customers, and the perpetrators quickly unloaded the currency at a fraction of its price on dark web marketplaces.

Cryptocurrency theft is not just difficult to detect and prevent: The intrinsic properties of cryptocurrency often make losses unrecoverable. Cryptocurrencies’ decentralized nature means that no single entity controls them and thus bears the responsibility for security breaches. Most cryptocurrency transactions are also irreversible, making it impossible to compensate victims, and their anonymous nature can make it challenging to track stolen funds and catch the culprits.

This means that the best way to stop cryptocurrency fraud is to keep bad actors out of exchanges in the first place. Effective onboarding measures are therefore of paramount importance.

Deploying secure onboarding at cryptocurrency exchanges 

One reason cryptocurrency exchanges struggle so much with money laundering and illicit activities is that the majority perform little to no due diligence on their customers at all. Studies have found that 56 percent of cryptocurrency exchanges around the world have no KYC solutions in place, even though such solutions are critical to making certain that customers are legitimate. Many exchanges even take steps to avoid complying with government regulations, deliberately omitting their home countries on their websites or providing terms and conditions that obfuscate which jurisdiction regulates them.

Exchanges that wish to comply with relevant regulations and reduce the risks of cybercrime are taking a number of steps to do so in the onboarding process. One of the best methods is to cross-reference potential users’ applications with background checks, international sanctions lists, verified government-issued IDs and even phone interviews. This may seem like a basic step that traditional FIs take for granted, but the fact is that most cryptocurrency exchanges have no noteworthy onboarding at all — and even the most rudimentary systems can make a massive difference.

Security cannot end at the onboarding process, however. Exchanges must continue to monitor regular users’ transactions to ensure that they are neither committing fraud nor unknowingly falling victim to it. Not every eventual fraudster or money launderer enters cryptocurrency exchanges intending to launch illegal schemes, meaning that, like all industries, cryptocurrency exchanges must bake robust authentication into every layer of their businesses.