China Warns of Stablecoin Risks Amid Surge in Crypto Fraud

China has issued a stern warning against the risks of illegal fundraising associated with stablecoins. This caution comes amidst a surge in cryptocurrency market activity, where some entities are exploiting the hype to lure unsuspecting investors. The warning underscores the need for heightened vigilance and compliance in digital financial practices, as the growing adoption of stablecoins has led to an increase in fraudulent projects. These projects often generate assets with no backing, using the intuitive price tracking of stablecoins to the US dollar or other currencies to inspire confidence in investors.

The Shenzhen government has also issued a warning about a new wave of stablecoin scams. These scams exploit financial innovation and stablecoins as gimmicks to extract fiat assets in exchange for tokens with no provable backing. Some of these projects enable gaming, Ponzi schemes, and money laundering, going beyond the scams related to existing stablecoins. The authorities have discovered illegal institutions using these tactics to deceive investors. Users are urged to avoid offers to deposit funds to unregistered institutions and to flag any unregistered institutions aiming to raise funds for stablecoin issuance. The recent crypto fraud is unrelated to entirely fake investments used in phishing scams. In the case of illegal fundraising, the investors have no resort to compensation or attempts to retrieve funds.

The risks associated with stablecoins are not limited to illegal fundraising. Falcon USD (USDf), a rapidly rising cryptocurrency introduced as the “synthetic dollar,” has raised concerns after losing its stability just a few months after its launch. USDf, backed by the controversial market maker DWF Labs, fell below the $1 peg, dropping to $0.98. This event has sparked fears of a potential repeat of the Terra (LUNA) incident, where the algorithmic stablecoin UST lost its peg to the dollar, leading to the collapse of the Terra ecosystem. USDf, with a market value of $540 million, is purportedly backed by “diversified crypto assets.” However, growing concerns about the quality of these assets have led to speculation that Terra could trigger the first major stablecoin crisis since the UST crash. LlamaRisk, a risk consultancy for decentralized finance (DeFi), has raised concerns about the inclusion of USDf as collateral on lending platforms. In a Resupply forum post published last month, it criticized the lack of transparency in USDf’s reserve structure and the nature of the assets used as collateral. The platform was previously the victim of a $9 million hack last month.

Following the criticism, DWF Labs’ managing partner Andrei Grachev made a statement on X (formerly Twitter). He provided information about Falcon’s reserve structure, transparency principles, and risk management strategies. He stated that 89% of USDf is backed by stablecoins and Bitcoin (BTC), while the remaining 11% consists of altcoins. Grachev also suggested that “some competitors are running coordinated FUD campaigns because they are unable to compete fairly.” According to Falcon Finance’s “Transparency Dashboard,” USDf is 117% collateralized with $635 million worth of crypto assets. However, only $25 million of these reserves are on-chain, while the remaining $610 million are held off-chain. Only 15% of this amount is in stablecoins, while 85% is classified as “other.” In the latest reserve report, independent auditor HT Digital stated that asset valuations were calculated only with CoinGecko price data, but important factors such as liquidity, volatility or the price impact that may occur if the assets are offered for sale were not taken into account. It was also announced that no review was conducted on the control, ownership or security of these assets. Following the criticism, Grachev said that the Dashboard will be updated next week and the distinction between stablecoins, BTC and altcoins will be clearly listed.

Despite being a new company in the crypto market, DWF Labs has been in the news for its lack of transparency, accusations of manipulating low-volume tokens, and allegations of wash trading by a former Binance employee. Some analysts believe that DWF Labs is trying to “cash out” its portfolio by printing USDf with illiquid or small-cap tokens. A similar method was used by Curve Finance founder Michael Egorov last year, causing a massive liquidation chain that caused the CRV token price to drop by 30%. The Chinese authorities have called on users to increase their vigilance, avoiding offers to deposit funds to unregistered institutions. Users are also urged to flag any unregistered institutions aiming to raise funds for stablecoin issuance. The recent crypto fraud is unrelated to entirely fake investments used in phishing scams. In the case of illegal fundraising, the investors have no resort to compensation or attempts to retrieve funds.

Risky stablecoins are much fewer compared to asset-backed USDT and USDC. However, some are still in circulation, posing the risk of de-pegging. For new, unvetted projects with little connection to DeFi infrastructure, the stablecoins may be merely a gimmick, with no way to access funds. While USDT and USDC can be tracked and frozen, newly minted stablecoins for small-scale projects remain difficult to trace, and most are created without an option to freeze or control funds. Small projects also pose risks of rug pulls or flawed smart contracts. The Chinese authorities have called on users to increase their vigilance, avoiding offers to deposit funds to unregistered institutions. Users are also urged to flag any unregistered institutions aiming to raise funds for stablecoin issuance. The recent crypto fraud is unrelated to entirely fake investments used in phishing scams. In the case of illegal fundraising, the investors have no resort to compensation or attempts to retrieve funds.