OTC crypto deals, part 1: Traps, scams and potential risksby@mindrockcapital
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OTC crypto deals, part 1: Traps, scams and potential risks

by Mindrock CapitalOctober 3rd, 2018
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<em>By Pavel Cherkashin</em>
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By Pavel Cherkashin

The OTC crypto market is huge and growing. Though it is impossible to get exact data on its daily transaction volume, $10B would be a safe estimate. Most of that volume is traded in large transactions. Given the very heterogeneous and often shady and inexperienced crowd involved in the OTC crypto market and the lucrative sizes of the deals happening there, the exposure of both buyers and sellers to fraud is unprecedented. In this post I’m going to talk about the main traps to be aware of.

Common tricks fraudsters use before the deal is closed

Fraudsters are always on the lookout for people looking to buy or sell cryptocurrency. Here are the most common traps they set up to lure them in:

Fake videos. Scammers often use videos to prove they have the amount of cryptocurrency they are claiming they are ready to sell. They write the current date or open their news feed to persuade a potential victim that the video has just been taken and then open their crypto wallet to show how much they have in it — sometimes they claim to have billions of dollars in bitcoins. Potential investors should never trust such videos because they are easily faked and stolen. Experienced buyers and sellers don’t use videos anymore because as soon as one is out, scammers begin circulating it on the internet.

Fake agreements. To make an agreement look legit, fraudsters might include the signature of a seller inserted as a picture or a scan of the seller’s passport. But the fact is, an investor can easily get five documents from five different sources, all with the same signature or passport photo. In fact, a Google search offers plenty of passport pictures — but whether they’re real or fake, nobody knows. Wise buyers and sellers never send that kind of information via the Internet to a stranger; instead, they have professional lawyers verify the information.

Phishing. Adversaries also hunt for any information about sellers and buyers in order to sell it later. Often the communication begins with a letter of intent in which one party tells the other what they want to buy or sell. Errors like “letter of intention” and typos in the text immediately indicate fraud because no professional would make such mistakes. Scammers also like to use logos of real companies; in that case, a simple way to verify the information is to contact the company’s management via LinkedIn and ask them directly whether they really sent the letter and if the person who signed it really works for the company.

Other creative approaches. Fraudsters sometimes create a long and complex purchase agreement that they call something like a “partnership agreement of investment and financials.” If the seller swallows the hook and transfers their funds under this agreement, they might get an initial small test payment, but then nothing more. The agreement gives them no rights whatsoever and the fraudsters have zero liability, so the victim has no legal recourse. Another way fraudsters cheat is by offering a discount but reducing it later, because the agreement specifies that the exchange rate is fixed on the day the funds are received and the pick the day when the price is the most favorable for them.

Risks during deal closing

There are two primary ways that large cryptocurrency sellers and buyers close deals; each one has its own risks.

Via an escrow service

Buyers and sellers turn to escrow services to avoid fraud: Under the supervision of an escrow service, the seller provides a flash drive with the key to the cryptocurrency and the buyer deposits cash, and then the two assets are exchanged. But there are several risks associated with this method.

First, it is not uncommon for banks to block the accounts of escrow services that work with cryptocurrency. In fact, if any customer of an escrow service does something wrong, the bank will often block the escrow service’s account, and all customers will have to wait until the issue is resolved, missing their opportunities.

Second, the steps escrow servers take to avoid having their accounts blocked can delay deal closings. In particular, escrow services apply restrictions to who can participate in cryptocurrency transactions and how they must proceed. They may inquire about the sources of cryptocurrency and money and ask customers to pass the complete know-your-customer (KYC) procedure, which can delay the deal for weeks or end in failure, cancelling the deal.

The third major risk is fraud by the escrow service. There are numerous cases when the manager of an escrow service has run away with customers’ money.

Via a bank transaction

Usually, buyers and sellers meet in a bank office and exchange cryptocurrency on a flash drive for fiat money under the supervision of a bank representative. Since the exchange is happening in a bank office, there are no limitations on the size of the deal. The transaction goes through almost immediately, so the parties involved do not leave the room until it is successfully completed.

Even though a bank transaction seems the most civilized way to exchange funds, there are still many possibilities for fraud. First, bank representatives do not check what is on the flash drives, since they don’t really participate in bitcoin sales; they are merely facilitating the exchange.

Second, even if the flash drive does contain a cryptocurrency key, there is a risk of double spending. Since cryptocurrencies are decentralized systems, there is no single ledger that fixes that some currency was taken from one account and transferred to another; the ledger is thousands of computers in the network. This means that until enough computers confirm the transaction, there might be an alternative version. In face-to-face bank transactions, a seller exchanges the flash drive with the bitcoin key for the cash and then immediately cues their partner in crime to transfer the same bitcoins somewhere else. If the latter transaction gets more approvals earlier than the legitimate one, in a few hours, the buyer will learn that their transaction has been denied, even though the fiat money is already in the seller’s pocket. For this reason, sellers often insist that buyers transfer money first.

Third, the buyer may require the seller to return the fiat money for some reason, since there are certain bank rules that allow that. But those rules won’t help the seller get back the bitcoins that have already been transferred.

Forth, old scam schemes that used SWIFT messaging to illegally ship wares from one country to another and steal money from accounts have now cropped up the crypto world. There are a number of bank messages that allow for fraudulent transactions, such as blocking funds on the seller’s account.

In my next blog post, I’ll offer some tips for minimizing your risks in large OTC deals.


Pavel Cherkashin is a cofounder and a managing partner at Mindrock Capital and a managing partner at GVA Capital. A former angel investor and entrepreneur, he now invests in cryptocurrency, artificial intelligence, blockchain and self-driving tech.