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Protecting Crypto Users in a Post-FTX World

It has been a rough 12 months for the crypto community. The FTX saga has been front-page news worldwide, with $8 billion of customers’ money lost. Genesis filing for bankruptcy with a billion owed to creditors. Logan Paul’s failed NFT project, Cryptozoo, is peppered with felons and con men.

So why do we continue to build in this space? Fundamentally, we believe that digital assets are the future of finance. We also believe that more attention needs to be paid to the protection of crypto users from bad actors.

Where there’s money, there’s fraud

Bad actors, bad altcoins, Ponzi and pyramid schemes, and outright fraud plague the crypto industry.

The Onecoin Ponzi scheme defrauded investors out of almost $6 billion over five years. The Trade Coin Club took $295 million from 100,000 investors. This month, Mark Cuban was deposed over his involvement in Voyager, which is being called a Ponzi. This list is added to every week.

And then, of course, there’s FTX. $8 billion gone. Sam Bankman-Fried faces wire, commodities, and securities fraud charges though he maintains a version of innocence.

These are only the cases where money is lost. There are also more profound dangers associated with crypto right now:

  • Money laundering. In November 2022, 21 people were arrested in a $300M crypto money laundering scheme. Many saw the 2021 $25bn boom in NFTs as driven partly by money laundering.
  • Terror financing. As many as 20% of all terror attacks could be financed by crypto. Terrorist organizations need “anonymous, secure, and ready streams of funding” to which cryptocurrency is ideally suited.
  • Human trafficking. A 2021 GAO report found that 15 out of 21 commercial sex marketplaces accepted cryptocurrencies.

(Source: Coinbase)

There is a lot of corruption within the crypto community. Traditional finance suffers all the same problems on a much larger scale.

💡 Ponzi schemes and fraud weren’t born with Satoshi Nakamoto.

BMO Financial group was caught up in a Ponzi scheme and found guilty in November 2022. The Canadian bank will “record a [CAD]$1.12-billion provision” for its part in a $3.65 billion Ponzi scheme. South of the border, the US department of defense failed its audit for the fifth time. The pentagon can’t currently “account for 39 percent of its $3.5 trillion in assets.”

The COO of Wirecard is on Europol’s most wanted list, fleeing after the German payment processor collapsed amid massive fraud, with €1.9 billion “missing.”

Wirecard COO Jan Marsalek’s wanted poster (source: Wikipedia)

There are always these issues in finance, decentralized or centralized, alternative or traditional. This isn’t about downplaying the problem. It’s about realizing the actual problem—bad actors—and putting weight behind those of us in the industry that want it to grow and prosper and become genuinely valuable for the next billion crypto users.

The core of crypto is stronger than the core of traditional finance

Digital assets are a better option for modern finance than the fiat financial system. Three reasons for this:

  1. It’s transparent. Anyone can see the code and read the papers behind large crypto projects.
  2. It’s trustless. Put trust in a public ledger and smart contracts. There’s no need to put trust in unneccessary middlemen.
  3. It’s fast and cheap. Crypto payments can happen instantly and without the fees charged by fiat intermediaries.

Compare this with the fiat system. Where your money is right now is entirely opaque. You must trust your bank and other financial institutions to do as they say. And you have to pay fees for the pleasure.

Case Study: Ukraine Donations

No transaction shows the difference between the Old and the New better than cross-border payments.

“Crypto really helped during the first few days [of the war] because we were able to cover some immediate needs.” Alex Bornyakov, Ukrainian deputy minister for digital transformation (Source: The Economist)

Ukraine raised $100M in crypto in the first month of the war. The bulk of this money came from individuals wanting to help. Consider what this would have looked like without crypto:

*Note – currency fx: In the above example, assume that currency fx fees are the same for both traditional and crypto solutions.

**Note – swift fees: Banks charge ~$50 per Swift transfer. To get around having to pay $50 each time, charities will wait for many donations to come through before grouping donations and sending them in one Swift transfer.

Charities helping the Ukrainian crisis appeal do amazing work. Unfortunately they are hampered by slow processing times and payment processing fees. Taking Miles4Migrants as an example, their donation tool Donorbox (including Stripe fees) charges 3.7% + 0.30c on every donation made by card.

Contrast this to crypto. In this scenario, donors could donate large sums of crypto to a Ukrainian government managed wallet. Transactions are peer to peer and settle in seconds. There are no payment processing fees so what you send, the beneficiary receives. You only have to look after the gas

Versions of these easy, quick, secure, transparent payments play out thousands of times a day across the globe. Not paying for war, but for coffee, or rent, or just to help family members out in another country. This is huge—you can pay anyone, anywhere, for anything, instantly, with crypto

How protection will, and is, working for crypto users

The history of the fiat financial system is the history of institutions and regulators learning and building walls (sometimes literally) around the system and people’s money to keep it safe and build trust. As the National Law Review says of crypto companies:

“Their employees have not been going to industry security meetings and conferences since the days of Jesse James, sharing information on how to prevent thieves.”

Banks have. They have literally centuries of experience. We’ve learned a lot in those years and put in a lot of controls around anti-money laundering (AML), Know Your Customer (KYC), fraud, etc., that have helped us fight terrorism, trafficking, and other global crime.

Some crypto companies in the Centralized Finance (CeFi) space are working on solving these problems, such as Layer2 Financial, Anchorage, and Fortress, improving the space using a mix of regulatory oversight, AML/Fraud tools, and compliance tools.


The simplest win would be better auditing. Quoting John Ray, the CEO of FTX while they sort through the mess:

Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.

Even first-year accountants would have wept when they saw how FTX was tracking assets and liabilities over a mess of spreadsheets and QuickBooks. But FTX had an auditor. Presumably, so does Genesis, even though it listed its $1.1 billion promissory note from its parent company as a current asset.

One of the issues is that many auditors are not sure how to audit crypto firms. An unlikely pair, ‘Big Short’ investor Michael Burry and Binance CEO CZ, have both said this. It’s clear that both sides need to learn. Crypto firms have to learn more about auditing; auditing firms have to learn about more crypto. Movement from both sides is required for movement forwards.


Progress is also being made on serious controls such as AML. Layer2 Financial partners with companies such as Alloy, Chainalysis, and Coinfirm to manage risk and compliance. This includes incorporating the AML ‘travel’ rule into our transactions, passing information about fund transmittors and receivers to other financial institutions to help spot patterns in the movement of large amounts of money.

These partners don’t just help with AML, they help with all types of transaction monitoring. For instance, alerting customers to hacks or issues on the blockchain immediately. This is one of the areas where the transparency of crypto activity is a boon to customers. All on-chain activity is transparent, so you can immediately see any problems. Contrast that with the fragmented, hidden world of tradfi.

A New Type of Regulation:

Finally, not all compliance controls being enacted in the crypto space come from traditional finance. The industry itself is inventing ways to self-regulate and protect decentralized finance.

Smart contracts are the core of DeFi apps, providing a trustless model where everything is transparent—logic, code, transactions, and owners. If you know how to read the contracts you can spot the bad actors and steer clear. Unfortunately, the vast majority of people will not be able to read blockchains or decipher smart contracts. This makes users vulnerable, as it forces them to put trust back with the builders, not the public code.

Smart contract auditors, like Paladin and Certik, have stepped into this gap between the builder and consumer. They audit smart contracts to give the seal of approval that a smart contract is safe to use. Consumers can then have peace of mind when using a smart contract without needing to know exactly how the smart contract is coded.

Other interesting solutions are:

  • Defi KYC. Where project owners are anonymous, companies like Obsidian and Assure Defi can perform KYC on the project / smart contract owner. In the event where the project owner is a bad actor, their verified identity is sent to the authorities.
  • Multi-signature wallets. Multisignature wallets require multiple people to sign a transaction before the transaction is executed. This means no one individual can control all the funds in a wallet for nefarious purposes.
  • Defi insurance. Through projects like Hedera and Nexus Mutual you can now insure yourself against things like exchange failures and smart contract exploits.

A crypto core with institutional controls

FTX was a disaster. It’s set crypto back and lent credence to naysayers. The strongest response to this is to learn from the mistakes of FTX, Genesis, BlockFi and all the other platforms now struggling.

The good actors in the space are moving in the right direction. The auditing, the insurance, the AML, the KYC controls—all are great opportunities for crypto to become stronger.

Financial Institutions, like banks, that have been trusted with money for generations need to participate in this growth. It’s not just about using their institutional knowledge to better control crypto, its about them also learning about this new model of finance and finding the right ways to negate the bad actors while letting everyone else prosper.

About Layer2 Financial

Layer2 Financial is a Crypto as a Service infrastructure that makes it easy for fintechs, banks, and neobanks to launch fully compliant crypto products, in a matter of days. Layer2 provides seamless access to compliant custody, trading, payments, fiat ramps, and yield; all through one user-friendly API. Click here to learn more.

Protecting Crypto Users in a Post-FTX World
by Anthony Lynch
January 27, 2023
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