Since Bitcoin—the world’s first cryptocurrency—emerged, the development of cryptocurrencies has been quite astonishing, demonstrated in both the ever-increasing types and their soaring prices. The financial value and appreciation potential encompassed by cryptocurrency itself has provoked a tide of cryptocurrency speculation. The appeal of speculation in cryptocurrencies is the enormous benefit which can be earned through investment. However, new inventions bring along new risks. In cryptocurrency speculation, speculators all too often face multiple associated risks.

Three types of risk

The first risk is ordinary fraud. Fraud is when a perpetrator commits intentionally deceitful behaviors against cryptocurrency speculators, thus creating behavioral risks concerning fraudulences. Among the list of risks associated with cryptocurrency speculation, ordinary fraudulent behavior has high occurrence rates according to judicial practices. With cryptocurrency as “bait,” diverse online behaviors have enabled perpetrators of fraud to seize the opportunity to penetrate into people’s lives. Ordinary fraudulent risks not only include group fraudulences, cases which often involve many joint perpetrators and victims at the same time, but also individual fraud, which mostly takes place among individuals, with a relatively higher rate of occurrence of these cases due to the relative ease of access.

The second type of risk is a “Ponzi scheme,” which is an associated risk that easily occurs in digital currency speculation. In this context, it refers to organizing or leading pyramid selling activities based on digital currency, which usually function as a gimmick to attract more people into the organization. These Ponzi schemes usually hype the investment value of digital currency by boasting its potential in appreciation and development, while artificially inflating its value with adjectives like “technical,” “high-tech,” and “cutting-edge.” What is more, they have even made use of the government’s policies for digital development, which makes the general public less vigilant against risks of digital currency, and thus more likely to believe in made-up projects run by pyramid scheme organizations. Nevertheless, however many layers of “high-tech” or “legitimate” language are used, it cannot conceal the true nature of a pyramid scheme.

The third risk is the risk of illegal fund-raising, including illegal absorption of public deposits, fund-raising fraud, and illegal business. In the scenario of digital currency speculation, the risk of illegal fundraising refers mainly to project investors who raise digital currency funds from the general public, which is called an Initial Coin Offering (ICO). However, ICOs represent a very high-risk financing mode, and in some cases are scams while other cases may lead to investment failure. ICOs may constitute illegal absorptions of public deposits, the crime of fraud in financing, organizing, or leading a pyramid scheme, and so forth. The Announcement of the People’s Bank of China, the Office of the Central Leading Group for Cyberspace Affairs, the Ministry of Industry and Information Technology, and Other Departments on Preventing the Financing Risks of Initial Coin Offerings (hereinafter referred to as “the Announcement”) introduced in 2017, banned all ICO projects in a bid to prevent related risks. However, risks associated with ICO activities have not ended here, as digital currency prices continue to surge ahead, while speculative risks connected to ICOs persist.

Risk sourcing

For speculators, it is difficult to differentiate between virtual and digital currencies. Digital currencies can be decentralized, which is among their key characteristics. By exploiting people’s trust in this feature, criminal offenders “dress” controllable virtual currencies as digital currencies to swindle others’ property.

Some so-called “digital currencies” in these speculative arenas are actually virtual currencies such as “game currencies” used in local area network systems. Having built the stage for this type of virtual currency, offenders can manipulate price fluctuations, exchange rates, and trading volumes over the system. Virtual currencies and digital currencies have many features in common. For example, both exist in a digital format and rely on the internet. It is difficult for the average person to distinguish between the two based on their appearance. Even if they are distinguishable using technologies, it would be hard for victims to identify them by directly entering and examining the system. Then again, even when a victim does find an anomaly, they will find it hard to convince other victims of their findings.

The second risk lies in the value of digital currency, since bubbles exist in the digital currency market. Decentralization and issuing digital currencies in a fixed amount helps control inflation, which helps counteract a country’s potential credit crisis. However, in a market mechanism, where necessary government control is lacking, giant value bubbles can occur in digital currencies.

These bubbles not only arouse the general public’s profit-driven instinct, but also impact digital currency speculation in three ways. First, value bubbles lead to more speculation and even criminal acts. Human beings are inately profit-driven, and bubbles inevitably attract opportunistic actions and tricks of criminal behavior. Second, value bubbles conceal swindles. By making good use of these astonishing bubbles, perpetrators are more capable of disguising their deceptions. When the public’s guard is down, they lure people to their fraud. Third, when bubbles burst, it is difficult for members of the general public to retrieve their lost assets. Bubbles spur price booms as well as price drops. In a decentralized issuance model, no one is held accountable for burst bubbles and failed speculations. Even when speculations are considered an assumption of risk, public loss due to lack of proper guidance may still trigger mass unexpected incidents, and cause social instability.

The third risk lies in the external environment, such as supervision loopholes that exist in gaps among countries. The Announcement reiterated the non-monetary attributes of digital currencies, and banned ICOs or any related financing transaction businesses. However, although this is forbidden in China, some countries like the US, Germany, and Japan are still embracing digital currencies while actively revising their national law to prepare for potential changes. The differences in supervision measures among countries have been exploited by criminal offenders, which has led to, or increased, risk in digital currency speculations. The differences in supervision have placed China’s speculators in a disadvantaged position. Chinese speculators are more vulnerable to fraud, thus their interests are susceptible to the encroachment of speculators from other countries.

Risk reduction

Speculators need to identify the scope of risks that they themselves should be personally accountable for. Investors need to remain rational, and acquire deeper knowledge of the nature of digital currencies, especially of their uncertainties and high risk. They should bear the assumed risk completely by themselves when conducting speculative acts, based on their free will, and adequately comprehend the risk. In short, speculation under free will is an inherent condition for speculators to bear risks.

However, speculators’ risk-bearing should also be based on two external conditions. First, the project should be legal. Digital currency speculations are embedded with many fraudulent risk associations, which include non-existent digital currencies or investment projects, and virtual currencies fraudulently representing themselves as digital currencies. Risks and losses caused by perpetrators’ illegal acts should not be borne by speculators. Second, speculators need to be sufficiently informed of the risks before they make speculative decisions. Since digital currencies are complex and new, the responsibility of speculator awareness should be shouldered by project initiators, who should undertake the obligation of informing clients of risks. An important reason underlying blind investment is the exaggerated high profit of digital currencies, and a deliberate aversion to discussing their high risks. In addition, the general public knows very little about the way that digital currencies work, and the methods of this speculation. Therefore, it is necessary to ensure that speculators are fully informed of the risks.

Meanwhile, it is important to clearly indicate the supervisory role of regulators with digital currencies. Private investment involves capital flow between initiators and investors. However, when there is a gap between their investment positions, fraudulent conducts are likely to occur. That is why it is essential to set up a third-party supervisory platform.

A clearly assigned supervisory organization and well-targeted supervision are key to preventing fraud in digital currency speculation. Also, a financial regulator who specializes in digital currencies should be established to conduct unified supervision of digital currencies, which is a common supervisory measure in many countries. Some examples include Japan’s Financial Services Agency, which supervises domestic transaction behaviors concerning digital currencies, and the Monetary Authority of Singapore, which supervises intermediaries for virtual currencies inside the country. Research and development, as well as management practices, in China’s digital currencies indicate that the People’s Bank of China is the main supervisor for the country’s digital currencies.

To best play their role in this regard, supervisory authorities for digital currencies must have at least the following essential functions. First, the supervisor needs to supervise related institutions that are in operation. Specifically, this includes registering and overseeing their establishment, alteration, and revocation, while paying special attention to trading institutions’ authenticity and operation capability. It also includes publicizing these institutions’ basic information and investigation results.

Second, the supervisor needs to examine the investment projects of digital currencies. All enterprises that initiate public investment projects with digital currencies have to declare, and go through, investigations by the supervision department. This is how the government can help the general public authenticate a digital currency or an investment project, in a bid to reduce the risk of fraud involving digital currencies.

Third, the supervisor needs to ensure two-way risk informing. The regulator has the obligation to inform both the public and enterprises of potential risks, which is an abstract administrative act that doesn’t target individuals, but the public as a whole, releasing in time the new type of risks that have emerged along with digital currencies. Finally, the supervisor needs to exchange information with other institutions. Supervision of digital currencies involves various fields, such as illegal and criminal activities, tax administration, and currency. No single department can address all issues completely by itself. Thus it is necessary for the regulator to communicate with other institutions in time.

Sheng Haojie is from Anhui University Law School.