Fraudsters secured $14 billion in cryptocurrency in 2021, thanks in large part to the rise of Decentralized Finance (DeFi) platforms, According to new data from blockchain analytics firm Chainalysis.
Losses from crypto-related crime are up 79 percent from the previous year, driven by higher rates of theft and fraud.
Fraud was the largest form of crypto-based crime in 2021, followed by theft – most of which happened through hacking crypto businesses. The company says that DeFi is a big part of the story for both, in another warning to those involved in this emerging sector of the crypto industry.
“DeFi is one of the most exciting areas in the broader cryptocurrency ecosystem, presenting tremendous opportunities for entrepreneurs and crypto users alike,” Chainalysis wrote in the annual Crypto Crime Report.
“But DeFi is unlikely to realize its full potential if the same decentralization that makes it so dynamic also allows fraud and theft to become widespread.”
Wild West of DeFi
DeFi is a rapidly growing segment of the crypto market that aims to exclude intermediaries, such as banks, from traditional financial transactions, such as obtaining a loan.
With DeFi, banks and lawyers are replaced by a piece of programmable code called a smart contract. This contract is written on a public blockchain, such as Ethereum or solana, and is executed when certain conditions are met, eliminating the need for a central broker.
“The financial system basically sends money with different terms and conditions attached to it,” said Joy Krogh, chief investment officer at Pantera Capital, an asset manager focused on crypto and blockchain.
DeFi transaction volume grew by 912% in 2021, according to Chainalysis statistics. The impressive returns on decentralized tokens like shiba inu have also fueled a feeding frenzy among DeFi tokens.
But there are a lot of red flags when it comes to dealing in this crypto system.
One of the problems with DeFi, according to Kim Grauer, head of research at Chainalysis, is that many of the new protocols being launched have vulnerabilities in code that hackers can exploit — 21% of all hacks in 2021 benefited from these vulnerabilities.
Grauer tells CNBC that while there are third-party companies that perform token audits and publicly assign secure protocols, many users still choose to work with risky platforms bypassing this step if they think they can get a significant return.
Crypto theft has increased by 516 percent from 2020, to $3.2 billion worth of cryptocurrencies. Of this total, 72 percent of the stolen funds were taken from DeFi protocols.
Losses from fraud increased by 82 percent to $7.8 billion in cryptocurrencies.
More than $2.8 billion of that total came from a relatively new but very popular type of scheme known as “rug pulling,” in which developers build what appear to be legitimate crypto projects, before eventually taking investors’ money and disappearing.
“Given the hype around DeFi, people may be more accepting of using less secure platforms due to the fear of losing out on potential gains,” he explained. Grayer.
Crime stats don’t tell the whole story
Cryptocurrency-related crime may be at an all-time high, but researchers have noted that the growth of legitimate cryptocurrency use is far outpacing the growth of criminal use.
Transactions involving illicit addresses represented an all-time low of just 0.15 percent of the total crypto trade volume of $15.8 trillion in 2021.
The research firm identifies illicit funds based on their relevance to the confirmed illegal activity. For example, money can be considered illegal if it is sent to or from the darknet market, or is known to have been stolen in a hack.
“The fact that the increase was only 79% – roughly an order of magnitude smaller – may be the biggest surprise of all,” Chainalysis wrote.
“Crime is becoming a smaller and smaller part of the cryptocurrency ecosystem,” the report continued.
The growth of crypto-based crime is partly due to the sophisticated suite of law enforcement tools, as well as the inherited transparency of blockchain technologies.
Unlike cash and other traditional forms of value transfer, each transaction is recorded in a publicly visible ledger, and with the right tools, Grauer says it’s possible to find out how much all cryptocurrency activity is associated with the crime.
“The authorities have been very successful in taking advantage of the transparency of blockchains to investigate and stop illicit activity,” Grauer said.
In November, for example, the IRS said it seized more than $3.5 billion in cryptocurrency in 2021 — all from non-tax investigations — representing 93 percent of all funds seized by the department during that time period.
Other law enforcement gains in 2021 include the Department of Justice’s $56 million seizure in a cryptocurrency fraud investigation, $2.3 million seized from the ransomware group behind the Colonial Pipeline attack, as well as an undisclosed amount seized by the bureau. The Israeli National Counter Terrorist Financing in a Terror Financing Case.