Crypto Scams and Taxes

Summary: This blog explores the growing threat of cryptocurrency scams and their tax implications. It provides practical advice on spotting and avoiding scams, reporting them to authorities, and understanding how lost and stolen crypto impacts taxes.

Introduction: The Double-Edged Sword of Cryptocurrency

Cryptocurrency has been hailed as the future of money, revolutionizing the way we think about transactions, investment, and finance. But with great potential comes great risk. The decentralized, anonymous nature of cryptocurrencies is both its charm and its curse, making it fertile ground for scammers. Crypto scams are not just about losing your hard-earned assets, they can also wreak havoc on your taxes. Imagine losing your coins in a scam, only to find out that you still owe taxes on them. Shocking, right?

In this blog, we’ll explore how crypto scams work, the most common types, and crucially their tax implications. More importantly, we’ll show you how to protect yourself and how crypto tax calculators can help ease the burden. Let’s have a look!

What is a Crypto Scam?

A crypto scam is any scheme designed to deceive individuals into giving up their digital assets, often by exploiting their lack of knowledge or trust in digital platforms. These scams can take many forms, but the end goal is always the same: steal your cryptocurrency.

Popular Example: One of the most notorious scams was the Bitconnect Ponzi Scheme. Launched in 2016, it promised massive returns on investment. The platform’s value soared, but in 2018, it collapsed, taking billions of dollars of investors’ money with it. The scammers vanished, leaving investors high and dry, while still being on the hook for taxes on their ill-fated gains.

Beware of These Common Crypto Scams

Scammers often take advantage of the complexity and anonymity of digital currencies to target unsuspecting investors. Here are some of the most famous and commonly occurring types of crypto scams:

1. Phishing Scams

Phishing is one of the most common types of online scams, and the crypto world is no exception. In this scam, fraudsters pose as legitimate services, like exchanges or wallet providers, and send emails or messages designed to trick you into giving away sensitive information, such as your private keys or login credentials.

• How it works: You receive an email or text that appears to be from a legitimate service, asking you to log in via a fake link. Once you enter your details, the scammers gain access to your crypto wallet and drain your funds.
• Real-world example: Many phishing scams have targeted users of popular exchanges like Coinbase or Binance, where fake emails asked users to update their account details, leading to stolen funds.

2. Pump and Dump Schemes

This scam involves artificially inflating the price of a cryptocurrency by spreading false or exaggerated news to create buying frenzy. Once the price skyrockets, the scammers sell off their holdings, causing the price to plummet and leaving unsuspecting investors with massive losses.

• How it works: Scammers use social media or private groups to hype up a particular coin, encouraging people to buy it. When the price rises due to the demand they create, the scammers sell off their coins, crashing the market.
• Real-world example: Many lesser-known altcoins have fallen victim to pump and dump schemes. The scam often occurs on unregulated exchanges or with newly launched cryptocurrencies.

3. Rug Pulls

A rug pull happens when the developers of a cryptocurrency project abandon it after raising significant funds from investors, often through an Initial Coin Offering (ICO) or decentralized finance (DeFi) project. They drain the liquidity or run away with the funds, leaving investors with worthless tokens.

• How it works: Developers create a seemingly legitimate project, often hyped up through social media and influencers. After raising substantial capital, they abruptly withdraw all funds and disappear.
• Real-world example: The Squid Game token rug pull in 2021 is a notable case. It gained attention because it was named after the popular Netflix series, attracting a large number of buyers. Soon after, the developers sold all their tokens and vanished, leaving investors with nothing.

4. Ponzi and Pyramid Schemes

Ponzi and pyramid schemes promise high returns with little risk by using funds from new investors to pay earlier investors. These scams often collapse when there aren’t enough new participants to keep the scheme afloat.

• How it works: In a Ponzi scheme, investors are promised high returns, but the returns are paid from the funds of newer investors, not from actual profits. Eventually, the scheme collapses when there aren’t enough new investments to pay the earlier participants.
• Real-world example: Bitconnect was a classic Ponzi scheme in the crypto world. It promised high daily returns on investments but turned out to be an elaborate fraud that collapsed, causing billions of dollars in losses.

5. Fake Initial Coin Offerings (ICOs)

A fake ICO is when scammers create a fraudulent project and promote it as a legitimate investment opportunity. Investors are lured into buying tokens, only for the project to disappear once enough money has been raised.

• How it works: Scammers promote a token sale through websites, social media, and forums. Once investors pour their funds into buying the tokens, the creators shut down the project and vanish with the funds.
• Real-world example: The Pincoin ICO scammed investors out of $660 million. The company behind Pincoin, Modern Tech, disappeared after raising funds, leaving investors without any way to recover their money.

6. Fake Wallets and Exchanges

In this scam, fake wallets or exchanges are set up to look like legitimate platforms. These platforms trick users into depositing their cryptocurrency, which is then stolen by the scammers.

• How it works: Users are directed to download fake wallet apps or sign up for exchanges that appear credible. Once you deposit your funds, they are transferred to the scammer’s account, and the platform shuts down.
• Real-world example: There have been numerous fake exchanges and wallet apps that have stolen user funds. One such case involved the Poloniex fake exchange scam, where users were tricked into depositing their funds on a platform that mimicked the popular exchange.

7. Giveaway Scams

These scams prey on people’s desire to get something for free. Fraudsters pose as celebrities, influencers, or companies, offering to “double” your cryptocurrency if you send them a small amount first. In reality, once you send your coins, you’ll never see them again.

• How it works: Scammers create fake social media accounts or websites posing as popular figures or companies, offering a “limited-time” cryptocurrency giveaway. Victims send crypto in hopes of receiving more, but the scammers keep it all.
• Real-world example: The infamous Twitter hack in 2020 saw multiple high-profile accounts, including those of Elon Musk and Joe Biden, post fake Bitcoin giveaways, scamming people out of over $120,000.

8. Cloud Mining Scams

Cloud mining allows people to mine cryptocurrencies without owning mining hardware by paying a company to do it for them. However, in cloud mining scams, the mining service is fake, and once you’ve invested your money, the company disappears.

• How it works: Victims pay for a subscription or a package that promises a certain amount of mining power. The scam company promises regular payouts but eventually stops making payments and vanishes with the investors’ money.
• Real-world example: MiningMax was one such cloud mining scam that promised daily returns to its investors. However, it turned out to be a Ponzi scheme, and its operators were charged for fraud.

How to Spot and Avoid Scams

Spotting a scam before it happens can save you from a world of financial loss and legal headaches. Here are some key signs and strategies to help you identify and avoid crypto scams:

1. Unrealistic Promises of High Returns: One of the biggest red flags in any investment opportunity, especially in crypto, is the promise of guaranteed high returns with little to no risk. Scammers often lure people with the promise of quick profits, but in the volatile world of cryptocurrencies, no legitimate investment can guarantee returns.
   • How to Avoid: Be skeptical of any platform or person promising consistent, high returns. Always ask yourself: Is this too good to be true? Chances are, it is.
2. Pressure to Act Quickly: Scammers often try to create a sense of urgency, making you feel like you’ll miss out on a once-in-a-lifetime opportunity if you don’t act immediately. Whether it’s through aggressive marketing or limited-time offers, they want you to rush into decisions without fully researching.
   • How to Avoid: Take your time. If you’re being pressured to act quickly, it’s a sign something isn’t right. Do thorough research before committing to any investment.
3. Unverified Platforms and Fake Websites: Some scammers set up fake websites or platforms that closely mimic legitimate crypto exchanges or wallets. These sites often look very professional and can trick even experienced users into giving away personal information or depositing funds into fraudulent accounts.
   • How to Avoid: Always double-check URLs and ensure that the website has an SSL certificate (look for the “https” and padlock symbol). Use well-known, trusted platforms for your transactions, and never click on links from unsolicited emails or messages.
4. Suspicious Social Media Messages: Social media is one of the most common platforms for scammers to spread fraudulent schemes. You may receive random messages from people claiming to be crypto influencers or from accounts offering too-good-to-be-true giveaways. If someone claims they will double or triple your cryptocurrency if you send them some first, it’s almost certainly a scam.
   • How to Avoid: Never trust unsolicited messages or offers from unknown sources. Even if they seem to come from high-profile accounts, verify the authenticity by checking official websites or news sources before engaging.
5. Lack of Transparency: Legitimate crypto projects are typically very open about their teams, technology, and business plans. If a project is vague about its mission, has anonymous developers, or avoids sharing critical information like how they will generate returns, it’s a red flag.
   • How to Avoid: Research the team behind any project. Look for detailed whitepapers, roadmaps, and a history of achievements. If the team members are anonymous or hard to find, proceed with caution.
6. No Proof of Reserves: In legitimate exchanges or wallet services, companies often publish proof of reserves to show that they are holding the actual assets they claim to. Scammers, however, will not offer any proof or third-party verification that they possess your funds.
   • How to Avoid: Only use platforms that offer transparent proof of reserves or have been verified by trusted third parties. Avoid services that seem shady or refuse to provide such assurances.
7. Phishing Attacks: Scammers may impersonate legitimate platforms or services by sending you emails or text messages asking you to log in to your account. Once you click on their fake link and enter your credentials, they gain access to your real accounts.
   • How to Avoid: Never click on links in unsolicited emails or messages. Always log in to your accounts directly from the official website, and use two-factor authentication for added security.
8. Anonymous or Unregulated Exchanges: Some scammers create exchanges that appear to be legitimate but are actually unregulated, which means there’s no accountability or recourse if your funds are stolen. These exchanges often operate in regions where regulations are loose or nonexistent.
   • How to Avoid: Stick to well-known, regulated exchanges with a history of security and customer service. Be wary of new, unknown platforms that don’t clearly explain where they are regulated or headquartered.
9. Fake Giveaways and Airdrops: Fake giveaway scams often pose as promotions from famous figures or companies. Victims are usually asked to send a small amount of crypto to a specific address in exchange for a larger payout later. This is a trick, once your crypto is sent, it’s gone forever.
   • How to Avoid: Never send funds to participate in a giveaway. Legitimate giveaways or airdrops don’t require you to send cryptocurrency upfront. Always verify promotions from official sources.
10. Use Cold Wallets: For added protection, especially for long-term storage, consider using a cold wallet (hardware wallet) that is not connected to the internet. This drastically reduces the chances of your assets being stolen in a hacking or phishing attempt.
    • How to Avoid: Store large amounts of crypto in cold wallets, and only use hot wallets (online wallets) for small, everyday transactions.

Tax Implications of Crypto Scams

You might wonder, “If the money I made from selling cryptocurrency was lost or stolen in a scam, am I still liable to pay taxes on it?” Sadly, the IRS doesn’t care how you lost your assets. They’re more interested in whether you made gains from them. Let’s explore various scenarios and how they impact your tax obligations.

1. Can You Deduct Losses From a Crypto Scam?

One of the first questions many victims ask is whether they can deduct the cryptocurrency they lost in a scam from their taxes. The answer, unfortunately, depends on several factors.

Under the Tax Cuts and Jobs Act of 2017, personal theft loss deductions, which used to allow people to write off losses from scams, were largely eliminated. However, there are specific circumstances where you may still be able to deduct scam-related losses:

• Business-Related Losses: If you were involved in a crypto scam as part of a business activity (such as an exchange or a crypto-based business), you may be able to claim the loss under ordinary business expenses.
• Casualty and Theft Loss: As of now, theft loss deductions for individuals are very limited. The IRS only allows theft loss deductions if they occur in a federally declared disaster area. Sadly, crypto scams do not fall into this category, meaning you cannot claim them under personal theft loss.

Bottom line: If your crypto losses were part of personal investments, you likely won’t be able to deduct them. However, if they were tied to a business, there may still be options available, though it’s wise to consult with a tax professional for guidance.

2. Are Coins Lost in a Crypto Scam Subject to Taxation?

Here’s the kicker: Even if the money (FIAT currency) from your crypto sale is lost or stolen in a scam before it reaches your account, you may still owe taxes on it. The IRS views cryptocurrencies as property, meaning that tax events occur when you realize gains or losses on them, whether you sell, trade, or otherwise dispose of your crypto. It all comes down to the timing of your transactions and losses.

How to Report Cryptocurrency Scams

If you’ve been the victim of a crypto scam, the first step is to report it. Here’s how:

1. Report the Scam to the Platform or Exchange

If the scam occurred on a specific exchange or platform, the first step is to notify the platform’s customer support. Many reputable exchanges have fraud departments dedicated to handling such complaints.

• What to Do: Contact the exchange where the scam took place. Provide them with as much detail as possible, including transaction IDs, email exchanges, and any suspicious activity you noticed.
• Why It Matters: Prompt reporting may help the platform freeze assets or track suspicious accounts, potentially mitigating the damage.

Example: If you were scammed through a phishing site posing as Binance, immediately notify the official Binance support team with the details.

2. File a Complaint with the Federal Trade Commission (FTC)

In the U.S., the FTC handles complaints related to consumer fraud, including cryptocurrency scams. While they may not be able to recover your funds directly, filing a report helps raise awareness and may lead to broader investigations.

• What to Do: Visit the FTC Complaint Assistant at ReportFraud.ftc.gov and provide detailed information about the scam.
• Why It Matters: The FTC aggregates reports, which helps identify larger trends and leads to potential law enforcement action.

Example: If you’ve been a victim of a giveaway scam, filing a report with the FTC ensures the scam is documented and adds to the national database for fraud.

3. Report to the Securities and Exchange Commission (SEC)

If the scam involved an investment scheme, such as a fraudulent Initial Coin Offering (ICO) or a Ponzi scheme, you should report it to the SEC. The SEC focuses on securities fraud and violations related to investment products.

• What to Do: Go to the SEC’s Tips, Complaints, and Referrals page at SEC.gov | Report Suspected Securities Fraud or Wrongdoing to report the scam.
• Why It Matters: If the scam involved securities or investments, the SEC may take legal action and offer restitution to victims through court orders.

Example: If you were misled into investing in a fake cryptocurrency project through a fraudulent ICO, the SEC can investigate the scam.

4. Report to the Internet Crime Complaint Center (IC3)

The IC3, part of the FBI, specializes in cybercrime, including cryptocurrency-related fraud. This is an essential step if the scam was a sophisticated phishing attack, hacking, or any form of online fraud.

• What to Do: File a complaint on the IC3 website at ic3.gov. Provide any supporting evidence, such as screenshots, transaction details, and communications with the scammers.
• Why It Matters: The IC3 has resources dedicated to cybercrime investigations and may coordinate with law enforcement to track down perpetrators.

Example: If you were a victim of a phishing scam that resulted in unauthorized transactions from your crypto wallet, report it to the IC3.

5. Contact the Commodity Futures Trading Commission (CFTC)

If your scam involved derivatives or other financial products based on cryptocurrencies, the CFTC might have jurisdiction over the case. They handle cases related to fraud, manipulation, and abuse in commodity markets, including crypto derivatives.

• What to Do: Submit a complaint through the CFTC Whistleblower Program or directly at Submit a Tip | CFTC.
• Why It Matters: The CFTC investigates fraud involving commodity futures and options, which can include crypto futures.

Example: If you lost money in a scam involving crypto futures contracts, the CFTC is the right agency to handle your case.

6. Report to Your Country’s Financial Authority

Different countries have their own regulatory bodies responsible for handling financial fraud. If you live outside the U.S., look for your country’s equivalent to the FTC, SEC, or CFTC.

• What to Do: Research your country’s financial authority or cybercrime unit. For example, in the UK, you would report to the Financial Conduct Authority (FCA) or Action Fraud.
• Why It Matters: Scammers often operate across borders, so reporting to your local financial authority can help initiate international cooperation to investigate the scam.

Example: If you’re based in the UK, reporting to the FCA or Action Fraud would be crucial in addressing your case.

7. File a Report with the IRS

If you’ve been the victim of a cryptocurrency scam, you may need to notify the IRS, especially if the scam has tax implications, such as stolen funds or lost investments. Reporting the scam ensures that you document any financial losses for tax purposes.

• What to Do: Use IRS Form 4684 (Casualties and Thefts) to report losses from a scam that may be eligible for a theft loss deduction. This form is used to report casualties and theft losses. While it’s limited in its application, particularly for personal losses, it’s still the go-to form for reporting scam-related incidents, especially for business activities. If you’re claiming losses, make sure to keep meticulous records of the scam. This includes emails, transaction logs, and correspondence with exchanges or platforms involved. The IRS may require detailed proof to verify your claim. This form has limited use and can only be filed by individuals if the loss is declared a federal disaster.
• Why It Matters: Properly reporting the loss ensures you stay compliant with tax regulations and may help reduce your tax liability.
• Today, losses from cryptocurrency scams like phishing, hacks, or theft are generally not deductible as a personal casualty or theft loss unless part of a Ponzi scheme or another specific situation under the safe harbor rules.

8. Spread Awareness and Educate Others

While reporting to authorities is essential, it’s also important to share your experience with the broader crypto community. By spreading awareness, you can help others avoid falling into the same traps.

• What to Do: Post about your experience in crypto forums, subreddits, or social media groups. Include the details of the scam, what to look out for, and how others can protect themselves.
• Why It Matters: Sharing your story can raise awareness, helping to protect others from similar scams and fostering a safer crypto ecosystem.

Example: If you were scammed in a giveaway fraud, post about your experience on platforms like Reddit or Twitter to warn other users.

How can CRPTM Help

Scam or no scam, taxes are inevitable. A crypto tax calculator can help you organize your records, track scam-related losses, and adjust your tax liabilities accordingly. Platforms like CRPTM streamline the process, ensuring that all your taxable events are accounted for, even if you’ve lost assets in a scam. You can also use these calculators to determine if you qualify for any deductions related to theft losses.

The role of a crypto tax calculator in this context is indispensable. Not only does it save you time, but it can also save you money by ensuring accuracy in your tax reporting.

Conclusion: Protect Your Crypto, Protect Your Future

Crypto scams are a harsh reality of the digital financial world, but they don’t have to ruin your investments or cause sleepless nights over taxes. By staying informed, cautious, and using tools like CRPTM, you can navigate the complex landscape of crypto taxes with more confidence.

As cryptocurrency continues to evolve, so too will the scams and the tax regulations surrounding them. By keeping a watchful eye on both, you can avoid the pitfalls that so many have fallen into and ensure that your crypto journey remains smooth, secure, and profitable. The next time a suspiciously good offer comes your way, remember: if it sounds too good to be true, it probably is.

Stay smart, stay secure, and always calculate your taxes, even in the face of scams!

Disclaimer: The information presented on this website is intended for general informational purposes only and should not be interpreted as professional advice from CRPTM. CRPTM does not offer financial advice. We strongly recommend seeking independent legal, financial, tax, or other professional advice to determine how the information provided on this website applies to your specific circumstances. CRPTM assumes no liability for any loss incurred, whether due to negligence or otherwise, resulting from the use of or reliance on the information contained herein.