Susceptibility of Bitcoin to Fraud

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Bitcoin was created in 2009 by a computer programmer who went by the alias Satoshi Nakamoto. This latest innovation was a peer-to-peer digital currency that was open source. Bitcoin is not a physical commodity. It is not legal tender, is not backed by any country or legal body, and its distribution is not governed by a central bank. It is a private scheme in which no formal financial institutions are involved. Most digital currencies are controlled by a third party or an individual. However, the Bitcoin mechanism is decentralized, with all participants participating at every stage of the exchange (Conti, Lal, & Ruj, 2017). As a result, Bitcoin is vulnerable to theft. This paper explores how bitcoins work, the risks involved using it, how the Bitcoin is vulnerable fraud and ways or deterring such fraud.

Functioning Of the Bitcoin

Bitcoin relies on a technology called cryptography, a kind of communication that avoids being intercepted by a third party, to control the production of the digital currency and validate transactions. Every transaction is stored in a decentralized lager visible to all user on the network but does not show the real identity and information of the affected users (Lee, Long, McRae, Steiner, & Handler, 2015). Cryptography technology makes it possible for certain types of users called miners, to compile blocks of transactions and endeavor to prove that the seller has received the said amount of Bitcoins from the buyer. In doing this verification, the miners are paid by a present computer algorithm whereby they receive 25 new Bitcoins (Conti, Lal, & Ruj, 2017).

How to Acquire Bitcoins

First, all users are required to download the relevant software. After downloading, there are three primary ways to obtain the Bitcoin. One, on a fee the user can exchange common currency such as the euro or dollar online. The cost of Bitcoin in comparison to other currencies depends on the law of supply and demand. The second way is to get the Bitcoin by exchanging goods or services. The third way is getting the Bitcoin by acting as a miner (Conti, Lal, & Ruj, 2017).

Risks of Holding Bitcoins

Persons or companies that use Bitcoins are faced with many types of threats, some of which can be controlled if precautions are taken. The first risk is that related to exchange rate. Bitcoin is more volatile than other ordinary currencies (Lee et al., 2015). For instance in fall 2013 within one month, Bitcoin shot from US$ 200 to US$ 800, a huge increase. In June 2011 when there were hacking claims, the exchange rate dropped drastically from 17.50 to only a single cent. However, the exchange rate recovered soon afterward (Trautman, 2014). This volatility of the Bitcoin is a significant obstacle for businesses in embracing the Bitcoin. A precautionary strategy is always to convert Bitcoins into common currency and leave a few Bitcoins at risk. Some payment can offer this kind of service by automating the transactions. On the same note, there is the risk of Bitcoin failure whereby tragic events make the market unavailable, and the exchange rate drops to zero. This situation may arise when the government takes steps to control the Bitcoin. Although it is difficult for states to eliminate the use of Bitcoin, their interventions may make the Bitcoin to disappear underground. Furthermore, any mishap in the functioning of Bitcoin protocol may result in Bitcoin failure (Lee et al., 2015). Generally to this risk, one needs to have the number of Bitcoins that one can afford to lose (Trautman, 2014).

Bitcoins and Money Laundering

The major challenge facing by regulators of virtual currencies is whether these currencies can fit in the definition of currency found in state laws. Particularly courts have been faced with difficulties of whether to categorize Bitcoin as a currency for the aim of law enforcement and regulation to address criminal activities (Moser, Bohme & Breuker, 2013). Although Bitcoins is a virtual currency, people use it just like the ordinary currency to exchanging for services and goods. Many legitimate businesses use the Bitcoin as a form of payment including selling of clothes, music, hotels and restaurants, games. However, due to the uncontrolled nature of the Bitcoins, criminals get attracted to this form of transactions (Singh, 2015). Data indicate that cybercriminals use virtual currencies and electronic payments as a method of laundering money and to exchange goods and services related to criminal activities. Like the other ordinary currencies, Bitcoins give criminals opportunity for fraud. Bitcoin, being decentralized, virtual currency makes it more susceptible to fraudulent money transfers and malware and botnets (Moser, Bohme & Breuker, 2013). All transactions for the use of Bitcoin are recorded online, but users are recognized by a somewhat randomly generated address which makes them anonymous. This kind of anonymity is not similar to that found in transactions using other currencies. Therefore Bitcoins enables illicit activity to continue without being observed. Bitcoin does not have a central entity and thus cannot perform due diligence, managing anti-money laundering programs, detecting and reporting illicit activity, and processing legal requests (Singh, 2015).

If the exchange rates of Bitcoins become stable, and use of Bitcoins become widely accepted, cyber crimes are likely to be on the increase as criminals will be able to exchange illicit goods and services. In June 2011, Silk Road, an online market trading illegal drugs, transacted by use of Bitcoins only. Silk Road made it possible for users to interact anonymously with the buying and selling of illicit goods such as narcotics. In the same period, it was claimed that LulzSec received more than 18000 US dollars from supported and fans. Bitcoin made it possible for LulzSec to acquire donations ions without making the receivers or recipients known (Trautman, 2014).

Theft of Bitcoins

Malicious people targeting to defraud others people of Bitcoins can take advantage of Bitcoin intermediary service providers and a person’s Bitcoin wallet since there the Bitcoin system does not have a central server. By use of hacking techniques, criminal can compromise user computers and accounts to steal Bitcoins. Other techniques apply the use of botnets to compromise a user’s computer giving them instructions to mine Bitcoins. For instance, in June 2011, a computer security firm reported that they had discovered “Infostealer.Coinbit” a malware capable of stealing Bitcoins from compromised computers’ Bitcoin wallet. The malware was able to infiltrate users’ computers and move the user’s Bitcoin wallet to a server in Poland (Trautman, 2014). Another report indicated that a user had claimed, in a Bitcoin forum, that 25000 Bitcoins had been stolen from their computer. At that time the exchange rate was $20 per Bitcoin meaning the money taken was half a million dollars (Singh, 2015).

Fraudulent Services with the Aim of Mining Bitcoins

Malicious people can take advantage of the method of generation of Bitcoins and instruct computers to mine Bitcoins. The criminals first place malware on a user’s computer and use these compromised computers to generate Bitcoins. Because mining Bitcoins in large scale required a large amount of electrical energy and processing power, some miners, as an alternative, ‘borrow’ processing power from larger computer systems by use of computer intrusion. Also, criminals use unauthorized networks for mining Bitcoins (Singh, 2015).

High Yield Investment Programs

High yield investment programs (HYIP) are Ponzi schemes transacted online where people get promised very high interest on deposits. These schemes in the long run collapse and others replace them which are managed by the same criminals. These schemes depend on virtual currencies for deposits and withdrawals. The traditional HYIP are centralized and therefore are subjected to state regulations which curb fraudulent activities (Vasek, & Moore, 2015).

Bitcoin-only HYIPs. Other than the traditional HYIPs, malicious people have formed HYIPs which transact using Bitcoins only. These come in various forms. Some claim to be legal investment schemes. Others present themselves as online Bitcoin wallets which promise high daily rates of interest on deposits in the wallet. Although these schemes are fraudulent, they convince innocent people, besides, those who believe that they are investing in a legitimate Ponzi scheme. Some offer interest on an hourly basis. As expected of fraudulent schemes, they operate for a short period then collapse leaving scammers with some funds (Vasek, & Moore, 2015).

Double Spending

A user in Bitcoin can be able to send two ambiguous transactions one after another and thus be able to use the same coins in two different transactions. In Bitcoins, miners validate and process all transactions. They make sure that the Bitcoins that have not been spent are known from the previous transaction output which would form the input for the next transaction. This principle is applied at run-time to serve as a protection against double spending (Conti, Lal, & Ruj,). Conti, Lal, and Ruj provide proof-of-work methods as a solution to double spending which limits the capacity of a malicious person. Because of anonymity in Bitcoins, prevention is better than taking action against fraudster. There are three ways of preventing double spending. First, a “listening period” where the seller links a listening period to each received transaction and monitors the incoming transactions during this interval of time. The seller only delivers the commodity if a double-spending attempt is not noticed. Secondly, there is “inserting observer’s” technique where the seller makes use of observers within the network. The observer will transmit all transactions to the seller and thus increase the chance of noticing double spending. The third way is to “forward double spending attempts” where each Bitcoin peer transmits all double spending attempts such the seller can get such transactions before sending the product (Conti, Lal, & Ruj, 2017).

Preventing or Detect Fraudulent Activities When Using Bitcoins

Singh (2015) cautions that if a wallet is stolen, the user should act swiftly and transfer the currency out of the wallet. Once the wallet has been taken, the criminal would have to spend the Bitcoins in the wallet by purchasing something or transferring to his wallet. To avoid losing the Bitcoins the user should spend the Bitcoins by buying something using the Bitcoins in the wallet before the criminal does.

Keeping User Computer Clean

Today, many malware have been generated which do Bitcoin mining or just steal the Bitcoins. One way of avoiding these frauds is by selective clicking on offers and by use of up to date antivirus and applications (Vasek, & Moore, 2015).

Encryption of Use’s Wallet

Bitcoins are not physical money. Using Bitcoins means the user is dealing with encryption keys. To ensure user’s safety kept the encryption keys secret. A better way is to back up and encrypt. Bitcoin has a provision for encrypting wallets which would pose a challenge for thieves in stealing the Bitcoins (Singh, 2015).

User to Have Multiple Wallets

If the user has a fear of malware he should avoid changing passwords, wallet encryption notwithstanding. The best thing is to make new wallets and transfer the Bitcoins and use unique, stronger passwords.

Bitcoin regulation

A regulatory approach which targets Bitcoin entities that deals with virtual money for common currency should be invoked. Regulatory authorities should classify the institutions dealing virtual currency appropriately and subject them to money-service-business (MSB) regulations (Federal regulations). These laws demand that organizations file Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs) which allows the government to determine the identity of any person who exchanges Bitcoins into more than $10000 (Singh, 2015). Singh further claims that this mechanism would make it more criminals in Bitcoins to be less anonymous and also encourage the use of virtual currencies transparently and with accountability.

Regulation of virtual currency institutions can potentially deter fraud in many other ways. The institutions should be able to reveal the identity of users, engaging in some transactions according to bank secures act (BSA’s) requirements. These regulations are particularly useful for the USA since many criminal prefer converting Bitcoin to USD because of its widespread use. Since currency exchange must involve the use of real money, demanding user identifications would make it more difficult for criminals to get money out of Bitcoins (Moser, Bohme, & Breuker, 2013).


Bitcoin relies on a technology called cryptography, a kind of communication that avoids being intercepted by a third party, to control the production of the digital currency and validate transactions. Every transaction is stored in a decentralized lager visible to all users on the network but does not show the real identity and information of the involved users. This kind of anonymity is enabled illicit activity to continue without being observed. Bitcoin does not have a central entity and thus cannot monitor and subject Bitcoin operations to state statutes. Fraudulent activities in Bitcoins include theft of Bitcoins, double spending, and dishonest miners. Some ways of controlling fraud include being more cautious with online offers, use of updated anti-malware, using listening period and inserting observers


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December 28, 2022


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Bitcoin Computer Currency

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