Cryptocurrencies like bitcoin are based on systems that are supposed to be inherently protected from fraud. Yet the U.S. Department of Justice has opened a criminal investigation into manipulation of bitcoin prices. How is that sort of activity even possible?
From researching blockchain and cryptocurrencies for the past three years, I know that blockchain systems have some immutable security features. For instance, if I sent you some amount of bitcoin, and that transaction were recorded in the blockchain ledger, I couldn’t force the system to give that money back. The technology itself prevents the transaction from being reversed.
But that is only true if transactions happen within the system. And there are other elements of cryptocurrency technologies that actually make fraud easier.
"Exploiting anonymity"
Another type of fraud the Justice Department is investigating is called “wash trading,” in which one person sets up what looks like a legitimate purchase-and-sale deal, but actually does the deal with himself or herself. That makes it look like there is more activity in the market than there actually is, artificially increasing demand and value.
Anyone can have as many cryptocurrency accounts as they wish to set up. And many blockchain-based systems keep users’ identities anonymous. The transactions themselves – if they actually happen – are recorded and publicly viewable, but the accounts involved are only identified with bitcoin addresses, which are long alphanumeric codes like “1ExAmpLe0FaBiTco1NADr3sSV5tsGaMF6hd.”
That anonymity can make it very hard to prove that wash trading is happening and challenges law enforcement to identify and catch fraudsters. At a June 2017 congressional hearing a former federal prosecutor told of cryptocurrency investigations revealing an account set up by a person claiming to be “Mickey Mouse” living at “123 Main Street.”
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