Fraud Analysis for Cryptocurrency Investments

Investments in crypto are growing in volume, with more retail investors and funds adding this asset class to their portfolios. However, the crypto market is much less regulated and transparent than the stock market. A large number of fraudulent or worthless cryptos appear on the market every week. This makes fraud analysis for your next crypto investment a must-do step. In this article, we cover the major ways of carrying out your due diligence to spot cryptocurrencies that might deliver more headaches than returns.

Fraud Analysis as a Compulsory Complement to Technical and Fundamental Analyses

Investments in the stock market require thorough use of the fundamental analysis and frequently also technical analysis methods. Given the highly regulated nature of stock exchanges, you can focus on analysing a particular asset’s market performance and fundamentals to make a decision on its investment attractiveness.
Things work somewhat differently in the crypto market. There is next to no oversight with regard to the issuance, distribution, or operation of cryptos. This makes fraud analysis a necessary complement to technical and fundamental analyses when evaluating a crypto asset. Fraud analysis in crypto is much more than checking who’s at the helm of the project. This type of analysis in crypto is not simply a part of the fundamental analysis exercise. Crypto fraud analysis is so multi-step and in-depth that it forms a separate dimension of its own.
To clarify the terminology, by fraud analysis, we don’t mean the use of sophisticated forensic software to identify fraud. Crypto fraud analysis is a set of checks that can be carried out by any investor or fund manager using online tools.
Below we list 8 major ways you can, or rather should, carry out fraud analysis on a cryptocurrency of interest to you.

Eight Major Checks for Crypto Fraud Analysis

1. Review Coin Distribution: A major source of information for your crypto fraud analysis is the blockchain explorers, which exist for all legitimate chains. Since most new coins are issued on Ethereum, there is a good chance your investigation will involve the use of Etherscan, the most popular explorer for this blockchain.
You can use Etherscan to review the distribution of coins for a particular project. The top addresses by ownership share are always listed on each coin’s page. If the distribution is skewed very heavily towards the team or early investors, this could be a red flag. Another red flag is the very high concentration of coins in just a few network addresses, even when these addresses are not explicitly identified as part of the project team. In fact, such concentration is even more suspicious than the transparently declared large ownership shares of the team and investors.
2. Track Transaction Volume: Use Etherscan to track the transaction volume for a particular crypto. If there is a very large spike in transaction volume without a clear explanation or notable market developments, this could be a sign of a fraudulent or manipulated coin.
3. Verify Contract Address: Cross-check with the project’s website and documentation online, and then use Etherscan to verify the contract address for the coin. Scammers may create fake coins with similar names and logos to legitimate projects in order to trick investors into sending funds to the wrong address.
4. Analyze Coin Burn Events: Use Etherscan to analyse the coin burns of a particular project. If the project team is burning coins in large amounts without a clear explanation, this could be a sign that they are trying to artificially increase the value of the remaining coins. Coin burns are also used to manipulate publicly declared team and investor ownership shares. For instance, a project might issue 1 million coins, of which 20%, i.e., 200,000, are allocated to the team. This is not a very high share by any stretch of the imagination. The 20% share is then publicly declared at the coin launch to avoid any suspicion during this critical stage for any crypto project. Some time later, the project burns 600,000 coins, reducing the total supply to just 400,000. Now, the project team has 50% (the same 200,000) of the coin ownership, a far higher percentage that might raise questions.
5. Monitor Airdrops: Airdrops are free coin giveaways that are deposited to crypto users’ network addresses. They are used typically for marketing and promo purposes and to increase loyalty among coin holders. Airdrops can be a legitimate marketing method, unless they are over-used or used to deposit funds to only a limited number of the same addresses on a regular basis. Etherscan allows you to review the airdrops of a particular project. If the project is airdropping a large amount of coins to some addresses without a clear explanation in their marketing materials, this could be a sign of fraud.
6. Check for Fake Social Media Accounts: Etherscan is not the only tool for crypto fraud analysis. An important part of spotting a fraudulent project is identifying fake and bot social media accounts heavily promoting the project. You can use our social media sentiment tool, PUMP, to conduct this step in your due diligence. For any crypto tracked by PUMP, you can see the number of social media signals generated by bots and separately by humans. Projects with a very high number of social media signals, i.e., posts, reposts, comments, likes, generated by bots warrant a much closer look.
7. Research Project Team: Besides Etherscan and PUMP, another important tool for fraud analysis is the actual website and documentation provided by the crypto project. A key part of this information is the team behind the project. Crypto coins are not equities, some are launched by anonymous individuals and teams, and little knowledge exists about their purposes, professionalism, or integrity standards. An identifiable project team and their professional background are important fraud analysis factors.
8. Research Project Whitepaper: Any crypto project worth its salt has a whitepaper, which describes in detail all the major points of the coin – purpose, tokenomics, use cases, supply details, and more. Trustworthy projects have thorough whitepapers. Fraudulent projects often have whitepapers that are minimalist; thin on details and specifics; don’t describe the use cases for the new coin; use copied or plagiarised material from other projects; or they might not even have a whitepaper.

The eight steps above are critical as part of your crypto fraud analysis. If a project doesn’t pass scrutiny on some of these points, it doesn’t necessarily mean that there is fraud involved. However, taken together as part of a comprehensive framework, these steps will let you spot coins that might be just a bit too suspicious to invest in. There are no number-based pass marks here. Similar to fundamental analysis, crypto fraud analysis involves making a qualitative judgement call.