A Big Problem for Crypto Exchanges. Here’s the Fix.

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

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

Still, as the sector’s current wobbles show, joining the crypto revolution brings 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 the opportunity to point out that volatility is far from the only problem that merchants face when exploring the use of Bitcoin and other cryptocurrencies.

In fact, there’s one big challenge that many crypto proponents overlook. Chargeback fraud is increasingly becoming a major headache for crypto exchanges. It has the potential to cause knock-on problems for many other kinds of digital merchants. 

Chargebacks: A burden on exchanges 

That might sound counterintuitive. Protection against payment fraud should, in theory, be a major selling point for digital currencies. Crypto transactions take place on decentralized electronic ledgers, and are secure by design. A transaction can’t be reversed once it’s been agreed to by both parties. Conventional chargebacks simply aren’t possible: when a deal is locked in, there’s no going back.

But rather than eradicating “friendly fraud,” crypto payments kick the can away from the merchant, and onto the crypto exchange where the digital currency was originally bought. True, a purchase made using crypto can’t be disputed directly — but if a customer originally bought crypto using their credit card, then that root transaction can still be disputed. 

Confused? Here’s an analogy. A shopper goes to an ATM and takes out $100. With that cash, 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 cash they spent. 

In this scenario, the shop selling the jeans is a business offering crypto payments at checkout. The ATM is the exchange from which the customer initially purchased their crypto. There’s no legal framework to hold merchants accountable if a buyer wants to reverse a purchase made using crypto. So the unhappy customer’s only recourse is to raise a chargeback claim against the crypto exchange, alleging that their payment card was used illegally.  

Chargebacks: Open to abuse

Worse still, it’s not just unhappy customers who are using (and abusing) chargebacks against crypto exchanges. As we all know, the crypto space can be a bit of a Wild West, and consumers who get hit by scams designed to separate them from their digital coins could wind up seeking compensation though any means possible. This is even if it means abusing the chargeback system by disputing their original, legitimate fiat-to-crypto purchases. 

Then there’s the question of volatility. With currency values swinging by double digits over the course of a single day, chargebacks can cause serious problems for exchanges. Customers could use transaction disputes as a hedge against lost value. If a currency slumps in the weeks after a transaction is made, the customer might be tempted to use a chargeback to recoup their original fiat investment, for instance. Taken to an extreme, such strategies could allow unscrupulous investors to offload the risk of crypto speculation onto exchanges. This is while they are free to pocket their returns 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’s just as easy to file a chargeback claim against an exchange. As I told my co-panellists in Berlin, many crypto marketplaces are now losing between 10% and 20% of their bottom line to chargeback claims. Given the industry’s extremely thin margins, that represents an existential threat to all but the most profitable crypto platforms.

Chargebacks cost exchanges money, but fighting fraudulent disputes can be costly too. Either way, exchanges are left with fewer resources to invest in customer service, product development, and innovation. This makes it harder for them to capitalize on crypto’s rapid expansion.

What’s the solution?

The long-term fix will be to develop new protocols that give crypto transactions the same consumer protections as credit-card payments. This ensures that chargebacks are chiefly handled by merchants, not exchanges.

Says Motie Bring, the Nuvei chief commercial officer, “You have to have the right mechanisms in place if you’re to have consumer trust.”  

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

First and foremost, crypto marketplaces must ensure they have a thorough customer verification system. Anonymity and fraud go hand-in-hand, so it’s important to gather as much customer information as possible during the onboarding process. Of course, requesting large quantities of information won’t always sit well with prospective crypto customers. Binance has navigated this challenge by offering a frictionless sign-up process, but then requiring certain additional checks (such as ID verification) before coins can be bought 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 to win more disputes while sharply reducing the degree to which chargeback disputes drain their resources.

Crypto’s vibrant future

Crypto payments are here to stay, and exchanges will play a vital role in helping both crypto novices and veteran traders to gain access to cryptocurrencies of all kinds. But in a Web3 world, it’s vital to recognize the new risks that the mainstreaming of crypto brings for both merchants and exchanges.

Until regulations catch up, these risks will keep on growing. That’s why it’s vital that exchanges act now to put proper, tech-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 will need to find an effective and scalable solution to managing 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 mitigation. Previously, Roenen led the Chargeback and Merchant Risk teams at the payments service provider Simplex, which successfully recovered millions of dollars a year. He also served for nine years in an elite military intelligence unit in the Israel Defense Forces, attaining the rank of captain and spearheading the creation of an innovative operations department focused on change leadership, human resource development, and risk management.

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