A big problem for crypto exchanges. Here is the solution.

Chargebacks: Digital currency marketplaces must defend themselves against fraudulent transaction disputes, says Roenen Ben-Ami, co-founder and Chief Risk Officer at Justt.ai.

Crypto has gone mainstream: currencies like Bitcoin are now owned by hundreds of millions of people worldwide, and are accepted by a growing number of online merchants. For online traders, ignoring crypto is a risky proposition. Crypto will play a key role in tomorrow’s payment infrastructure, and it is important for forward-thinking retailers to plan for the future.

Still, as the sector’s current swings show, joining the crypto revolution comes with some serious challenges. I recently had the opportunity to discuss the role of crypto in digital commerce at the Merchant Risk Council (MRC) in Berlin. I took this opportunity to point out that volatility is far from the only problem merchants face when exploring the use of Bitcoin and other cryptocurrencies.

In fact, there is one major challenge that many crypto devotees overlook. Chargeback fraud is increasingly becoming a major headache for crypto exchanges. It has the potential to cause major problems for many other types of digital sellers.

Chargebacks: A burden on exchanges

It may sound counterintuitive. Protection against payment fraud should in theory be an important selling point for digital currencies. Crypto transactions take place on decentralized electronic ledgers, and are secure by design. A transaction cannot be reversed once both parties have agreed on it. Conventional reversals are simply not possible: once a deal is locked, there is no going back.

But instead of rooting out “friendly fraud,” crypto payments kick the can away from the merchant and onto the crypto exchange where the digital currency was originally purchased. Granted, a purchase made using crypto cannot be disputed directly – but if a customer originally purchased crypto with their credit card, then that is the root transaction can still be disputed.

Confused? Here is an analogy. A shopper goes to an ATM and withdraws $100. With that money, they go to a store and buy a pair of jeans. A week later, they decide they don’t want the jeans anymore, but they can’t get a refund from the retailer. So instead, they file a claim against the ATM that originally gave them the money they used.

In this scenario, the store selling the jeans is a business that offers crypto payments at checkout. The ATM is the exchange from which the customer first bought their crypto. There is no legal framework to hold sellers liable if a buyer wants to reverse a purchase made using crypto. So the disgruntled customer’s only recourse is to file a chargeback claim against the crypto exchange, alleging that their payment card was used illegally.

Reversals: Open to abuse

Even worse, it’s not just disgruntled customers who use (and abuse) chargebacks against crypto exchanges. As we all know, the crypto space can be a bit of a wild west, and consumers who are hit by scams designed to separate them from their digital coins can end up seeking compensation in any number of ways. This is even if it means abusing the chargeback system by disputing their original, legitimate fiat-to-crypto purchase.

Then there is the issue of volatility. With currency values ​​fluctuating by double digits in a single day, reversals can cause serious problems for exchanges. Customers can use transaction disputes as a hedge against lost value. If a currency falls in the weeks after a transaction is made, the customer may be tempted to use a chargeback to recover their original fiat investment, for example. Taken to the extreme, such strategies can allow unscrupulous investors to transfer the risk of crypto speculation to exchanges. This is while they are free to pocket the return if a currency’s value rises.

Such cases are far more common than you might think. Today, anyone with a smartphone can buy crypto. It is just as easy to submit a chargeback claim against an exchange. As I told my fellow panelists in Berlin, many crypto marketplaces are now losing between 10% and 20% of their bottom line due to chargebacks. Given the industry’s extremely thin margins, it represents an existential threat to all but the most profitable crypto platforms.

Chargebacks cost change, but fighting fraudulent disputes can also be costly. Either way, the exchanges are left with fewer resources to invest in customer service, product development and innovation. This makes it more difficult for them to take advantage of crypto’s rapid expansion.

What is the solution?

The long-term solution will be to develop new protocols that give crypto transactions the same consumer protection as credit card payments. This ensures that chargebacks are mainly handled by sellers, not exchanges.

Says Motie Bring, Nuveis’ commercial director, “You must have the right mechanisms in place if you are to have consumer trust.”

But with crypto regulations evolving at a breakneck pace, the chargeback burden on exchanges won’t ease anytime soon. So what is the immediate solution?

First and foremost, crypto marketplaces must ensure that they have a thorough customer verification system. Anonymity and fraud go hand in hand, so it is important to collect as much customer information as possible during the onboarding process. Of course, asking for large amounts of information will not always sit well with potential crypto customers. Binance has navigated this challenge by offering a frictionless registration process, but then requiring certain additional checks (such as ID verification) before coins can be purchased or withdrawn.

Proper onboarding can support chargeback disputes, but with modern AI and machine learning, it’s also possible to leverage new technologies to scale, automate and optimize chargeback mitigation efforts. Done right, such approaches can help exchanges win more disputes while reducing the extent to which chargeback disputes drain their resources.

Crypto’s Vibrant Future

Crypto payments are here to stay, and exchanges will play an important role in helping crypto newbies and veteran traders alike gain access to cryptocurrencies of all kinds. But in a Web3 world, it is important to recognize the new risks that the mainstreaming of crypto brings to both merchants and exchanges.

Until regulations catch up, these risks will continue to grow. That’s why it’s important that exchanges act now to put proper, technology-enabled chargeback mitigation strategies in place. Dishonest transaction disputes are becoming a major pain point for today’s crypto exchanges – and if the crypto space is to truly go mainstream, exchanges need to find an efficient and scalable solution to deal with fraudulent chargebacks.

About the author

Roenen Ben-Ami, co-founder and Chief Risk Officer of Justt.ai, is an expert in the field of payments and chargeback reduction. Previously, Roenen led the Chargeback and Merchant Risk teams at payment service provider Simplex, which successfully brought in millions of dollars a year. He also served for nine years in an elite military intelligence unit in the Israel Defense Forces, achieving the rank of captain and leading the creation of an innovative operations department focused on change management, human resource development and risk management.

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