Crypto Consumer Protection: Why ‘Wait and See’ Is No Longer an Option

What was once an edgy new market full of interesting, unfamiliar names – Bitcoin, Ethereum, Tether, non-fungible tokens (NFTs) – and promises of high financial returns has now become better known for its scandals and potential for large, unexpected losses. While the consequences for the leaders of disgraced crypto firms like Terra and FTX remain to be seen, the need to provide better protections for their customers is increasingly urgent, especially for those who are low-income and least able to weather losses from frauds, hacks, and market volatility. 

Here, we've summarized an initial review of consumer risks faced by crypto users in emerging markets and developing economies (EMDEs) and the need to address these risks in financial consumer protection (FCP) frameworks. Due to limited research on the impact of crypto use on low-income consumers and few concrete measures taken by FCP regulators thus far, there are more questions than answers. We hope this blog will challenge the global FCP community and those interested in promoting a responsible digital finance ecosystem to move more decisively to protect vulnerable crypto consumers. 

Who buys crypto… and why? 

Cryptocurrencies are traded by millions of users around the world. There are more than 20,000 cryptocurrencies in circulation, led by Bitcoin. Daily trading volume was estimated at more than USD 275 billion on more than 400 platforms in November 2022. Ownership has also grown rapidly, from around 5 million in 2016 to an estimated 220 million people in June 2021, and 320 million in 2022. Critically, the largest growth of crypto use has been in EMDEs – comprising 18 of the top 20 countries for crypto – where access to traditional financial services is still challenging. The top four countries in terms of crypto adoption in 2022 were Vietnam, the Philippines, Ukraine and India. These trends indicate a growing potential for risk of loss for consumers in EMDEs who may be lower income and more vulnerable to financial shocks 

Although most crypto activity appears to be for speculative purposes, there are several potential benefits of cryptoassets in EMDEs. For example, crypto might be useful in cross-border transactions to reduce the number of intermediaries and the time, fees, and costs involved. Also, cryptoassets could serve as an alternative option to remit funds and facilitate payments in economically fragile countries or conflict zones (including in a humanitarian context) where the banking and payments infrastructure is weak or severely disrupted. However, it remains to be seen whether these benefits could be consistent and widespread. 

Crypto use is also driven by less rational motivations. Advertisements for crypto, especially those targeting youth, often exploit sentiments such as fear of missing out, the lure of a glamourous lifestyle and easy money, and mistrust or disillusionment with traditional financial services. One research study identified similar behaviors in crypto investors as in those engaged in gambling and high-risk trading. 

Crypto poses multiple consumer risks

According to our initial research, the main risks facing crypto consumers include volatile prices, fraud, and vulnerability to cyber-attacks .  

Exposure to loss from extreme price volatility

The value of cryptoassets can fluctuate greatly, but this is not always disclosed to potential buyers. Many cryptoassets are aggressively promoted using marketing materials, celebrity endorsements, and advertisements on social media that may be unclear, incomplete, and misleading. 

This has led amateur buyers to experience losses due to crypto’s inherent price volatility. Losses during the most recent “crypto winter” (a period of falling prices similar to a bear market) have been steep. The total value, or market cap, of the largest 100 cryptocurrencies as of November 14, 2022, was about US$830 billion, a 70% drop from a market cap of USD 2.7 trillion only a year ago.

Figure 1: peaks and valleys of the cryptocurrency market 2018-present
Image courtesy of CoinMarketCap (click for interactive graph)

Easy target for fraudsters and hackers

Cryptoasset use has driven an increase in digital financial services fraud in EMDEs, such as cryptoasset-based Ponzi schemes. Some schemes persuade unsuspecting buyers to transfer funds to unscrupulous actors promising to invest in cryptoassets on their behalf. In 2019, China-based PlusToken Ponzi scheme scammers defrauded people out of USD 3 billion worth of cryptoassets. It is estimated that more than 2 million people were impacted.  

Several crypto service providers have also experienced cyber-attacks and serious operational problems. Some large cyber incidents led to the bankruptcy of crypto service providers and the loss of customers’ funds. According to Chainalysis, as of October 2022, hackers had stolen over USD 3 billion across 125 hackings from exchanges, DeFi platforms, and other crypto service providers. Hackers stole over USD 600 million from a network that runs the popular game Axie Infinity, considered the largest hack in crypto history to date. Thousands of players went into debt to play the game. Many Filipinos were playing to help support their families and were hit especially hard by these losses. 

Basic consumer protections are lacking

While buying and selling crypto has become increasingly mainstream, consumer understanding of the risks and suitability of the investment is often inadequate . A survey of fintech regulators by the World Bank and Cambridge University cites a lack of transparency and unsuitable or unfair sales practices among the highest risks to crypto consumers, along with fraud and market losses. Lack of consumer protections including recourse and redress are also concerns (see chart below). In its response to this survey, the SEC Philippines indicated that it considers unsuitable or unfair practices, fraud and related misconduct, and loss due to price volatility as the largest risks posed to consumers by digital assets/cryptocurrencies.

The initial small size and novelty of the crypto market led many regulators to take a wait-and-see approach to regulating crypto generally. Adding to the complexity of policy choices, cryptoassets are not easily defined (i.e., are they a security, commodity, or means of payment?) nor are they constrained by geographic boundaries. However, in the wake of recent cases of fraud and scandal, the crypto market has been receiving heightened attention. 

Many countries are now looking closely at how they should approach regulation of cryptoassets and taking the first steps in that direction (e.g., Hong Kong, South Africa FSCA, the UK). However, crypto products and providers are still outside the FCP regulatory perimeter in most EMDEs, with regulatory efforts focused mainly on awareness raising and financial education, aka “buyer beware.” As a result, customers do not benefit from the rights and protections available in regulated financial services, such as transparent and comprehensive disclosures, advertising and marketing standards, suitability assessments, complaints functions, and recourse mechanisms.   

The initial small size and novelty of the crypto market led many regulators to take a wait-and-see approach to regulating crypto.

Lack of sound regulation and supervision further aggravates consumer risks due to crypto firms’ weak governance and risk management, uncertain operational resilience, and opacity. A key issue for consumers is many cryptoassets are not subject to fund safeguarding rules (such as those that exist for mobile money in many EMDEs) or investor protection mechanisms.

Customer funds are also at risk when they are commingled with other assets of the crypto service providers or the fund safeguarding practices are not subject to proper audit and internal controls. These safeguards are important to minimize the risk of loss or misuse of customers’ assets during the normal course of business and facilitate the return of customers’ assets in the event of insolvency of the crypto service provider. Recently, crypto service providers such as Voyager, Celsius, and FTX suspended customer withdrawals and filed for bankruptcy. Their customers face the risk of never recovering their funds. Recent estimates of potential loss for FTX customers is more than US$8 billion. 

Customers may also face losses from insolvent crypto firms depending on the language in customer agreements and local insolvency regimes. For example, crypto customers may have lower priority than a firm’s other creditors (e.g., secured lenders) in the event of bankruptcy and have to line up among all other unsecured creditors and suppliers when trying to get their money back. Ordinary bankruptcy procedures are usually lengthy and do not guarantee there will be assets designated specifically to reimburse customers. For example, Mt. Gox, which was one of the first crypto exchanges, failed in 2014 and customers still haven’t received their funds.  

A proportionate approach to consumer protection is urgently needed  

The information asymmetries in the crypto world are far too great to leave customers to their own devices.  There are different approaches that EMDE authorities can consider in dealing with crypto risks. These are not mutually exclusive and could include containment or regulation of the crypto sector or an outright ban. Some EMDE authorities have responded by prohibiting the issuance or holding of cryptoassets (e.g., China, Nepal, Tunisia) or their use for certain purposes, such as payments (e.g., Türkiye). While an outright ban may be appealing given the risks and oversight challenges, such prohibitions may be impractical to enforce. This has been the case in Nepal and China which, despite their explicit bans on cryptocurrency, are among the fastest-growing cryptocurrency markets in the world. 

A general ban on crypto may also stifle positive innovations that underpin the activities (such as distributed ledger technology, or DLT) over the longer term. Many central banks have been conducting DLT experiments, for instance, due to perceived benefits for payments and settlements. Other experts in this space believe that DLT has the potential to support solutions for low-income customers in EMDEs to make fast, low-cost cross-border remittance transactions due to greater efficiency and a lower number of intermediaries and settlement costs. It remains to be seen whether these experiments will bear fruit. 

Love it or hate it, the use of cryptoassets is growing rapidly in EMDE countries and regulators need to ensure that vulnerable consumers are protected from harm. 

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