Friendly fraud: The crypto world’s hidden enemy

Disclosure: The views and opinions expressed herein are solely those of the author and do not represent the editorial views and opinions of crypto.news.

When you think about crypto-related fraud risks, improper chargebacks may not be the first thing that comes to mind. In fact, since transactions in crypto are irreversible, accepting crypto often protects merchants from the risk of improper chargebacks.

But crypto refunds can be a major problem for exchanges that handle crypto purchases using fiat currencies. In fact, friendly fraud is increasingly putting a real strain on exchanges’ operations, hindering their ability to build trustworthy relationships with traders, financial institutions, and regulators.

In response, Visa has now implemented new rules governing fiat-to-crypto transactions. This is a hopeful sign, but it’s also a reminder that crypto stakeholders need to get serious about managing friendly fraud. Indeed, companies’ ability to implement effective processes to manage and mitigate friendly fraud will be a key test of the crypto space’s ability to mature in the months and years ahead.

How is friendly fraud affecting the crypto world?

Cryptocurrencies have now truly entered the mainstream: Today, 580 million people, equivalent to 7% of the world’s population, own cryptocurrencies, and global ownership has increased by a third in the past year alone.

The rapid adoption of crypto presents huge opportunities for economic growth, financial inclusion, and technological innovation. But it also presents challenges: While there are many legitimate reasons to love crypto, bad actors are also increasingly drawn to digital currencies. In fact, the very qualities that make crypto so appealing—its anonymity, flexibility, transaction speed, and irreversibility—also make it a magnet for friendly scammers.

Think of it this way: If someone buys a couch using a credit card and then uses a fraudulent chargeback to reverse the transaction, they’re left with a couch they didn’t pay for. But if they buy Bitcoin (BTC) or Ethereum (ETH) using a credit card and then reverse that transaction, they’re effectively holding pre-laundered cash that can be easily, untraceably, and at scale transferred or spent.

As a result, friendly fraud is on the rise. Social engineering scams are also on the rise, with criminals becoming increasingly adept at tricking users into authorizing fraudulent transactions, often leading to transaction reversals as scammed consumers attempt to get their money back.

Meanwhile, the extreme volatility of the crypto market adds another layer of complexity to refund management. Many buyers view crypto as a speculative play, not just a store of value. When crypto prices rise, the buyer wins—but when crypto falls, exchanges often see an increase in friendly fraud as buyers use the refund process to reverse ill-fated transactions and recoup their losses.

Risk in stock markets

Inevitably, the rise of friendly fraud is resulting in significant losses for crypto exchanges as they bear the costs of reversing trades and trying to manage the increased administrative burden of dispute appeals. But the impact is not limited to financial losses. Refunds are also straining exchanges’ relationships with consumers, forcing them to apply new levels of scrutiny and due diligence that are seen as antithetical to crypto culture.

Meanwhile, behind the scenes, fraudulent chargebacks can subject exchanges to a flood of disputes that skew refund-to-transaction ratios and push them into payment networks’ high-risk monitoring programs. Once in these programs, companies face higher fees, significant fines, and ultimately the risk of losing card processing privileges altogether if rates aren’t brought back into line.

And of course, amid the fallout from the FTX crash, crypto exchanges are now facing increased scrutiny from global regulators. A series of rule changes and licensing requirements will leave exchanges scrambling to keep up, leaving them with even less time and resources to address the issue of refunds.

Visa’s new rule book

But regulatory changes aren’t the only policy considerations for crypto operators. Visa’s updated rulebook for fiat-to-crypto transactions also marks a major shift in the payments giant’s approach to fraud prevention in the crypto space.

Under the new regulation, crypto exchanges and access providers will face increased scrutiny and liability around transaction monitoring, risk management, and refund liability. Merchants will be required to provide greater transparency to customers at the point of sale with clear disclosures about fees, volatility risks, and refund policies.

Specifically, transactions involving multiple digital assets or a mix of crypto and non-crypto products will need to be processed separately, creating operational complexity for platform operators. The rules also introduce new requirements around merchant category codes (MCCs) and other technical transaction details that could impact everything from confirmation rates to interchange fees.

For exchanges, navigating these changes will require a combination of agility, technical knowledge, and robust fraud prevention solutions. Partnerships with experienced payments experts who deeply understand the intricacies of card network rules will also be critical.

Prevention and reduction

To effectively combat cryptocurrency refunds, exchanges will need a multi-pronged approach encompassing both preventative measures and effective dispute management.

On the prevention side, carriers should focus on building customer trust through clear communication and 24/7 support. This includes clear terms and conditions, transparent refund and return policies, and responsive customer service. Clear billing disclosures on credit card statements can also help prevent confusion or unintentional chargebacks.

When it comes to managing disputes, exchanges need systems that can handle the unique chargeback reason codes and evidence requirements associated with crypto transactions. This is where leveraging the power of AI and machine learning can be a game-changer for chargeback reduction. AI/ML tools can be used to optimize the evidence generation process by discovering vulnerabilities and running tests to improve win rates across traders on these vulnerabilities. This provides a more tailored response on a per-case basis and continues to improve over time.

On the other hand, AI and ML for fraud prevention can analyze large swaths of transactional data to identify patterns and red flags. These tools adapt to evolving fraud tactics in real time, providing a proactive approach to detecting and preventing fraudulent activity before it escalates. By continuously learning from new data, AI/ML systems improve their ability to protect exchanges against sophisticated fraud schemes.

Using this cutting-edge technology, businesses can maximize their win rates and keep their refund rates below thresholds that would cause increased scrutiny from card networks.

Building a trusted crypto ecosystem

Ultimately, the continued success of the crypto industry depends on its ability to build trust with users, regulators, and the broader financial system. Effective friendly fraud mitigation will be a critical component of building that trust.

By investing in a robust infrastructure and keeping up with changing regulatory requirements, exchanges can not only protect their own businesses but also contribute to a safer and more secure ecosystem for all participants.

Roenen Ben-Ami

Roenen Ben-Ami, Justt’s co-founder and Chief Risk Officer, is an expert in payments and chargeback reduction. Together with co-founder and CEO Ofir Tahor, he has shaped the company’s product and vision since its inception in 2020. Previously, Roenen led the Chargeback and Merchant Risk teams at Simplex, a payment service provider that successfully recovers millions of dollars annually.