Pump and Dump: How To Spot And Avoid It
Pump and dump is a way of manipulating crypto markets by disseminating misinformation about an asset, resulting in an increase of the price (pumping), and subsequently selling it (dumping). This practice is particularly challenging to control in the crypto space because there is not enough government regulation.
How Does Pump and Dump Work?
The main objective behind a pump and dump scheme is to artificially inflate the price of an asset, a crypto coin in this case, and then sell it off when the price has increased. This allows the organizers of the scheme to profit off of the sudden increase in price.
The only people who profit from pump and dump schemes are the organizers. These schemes are often promoted through instant messaging (IM) apps like Telegram and other social media platforms.
Sometimes crypto pump and dump schemes don’t even last for more than five or ten minutes, but they have can have very short-term effects on the price and volume of a coin. According to a study by Tao Li, Baolian Wang, and Donghwa Shin, the price of a coin increases by 25% in the first 70 seconds on average, after which the price starts to decrease. This study also found that the price begins to increase five minutes before the scheme has even started. This is because the scheme organizers start buying before announcing the name of the coin in their groups. The organizers collectively decide on a time when they are going to pump the price of a coin and then they advertise the coin to other traders by promising them instant profit.
Some Telegram groups offer “premium memberships” to their group members so they can receive pump signals earlier than regular group members. In order to profit off of these schemes, one has to buy and sell very quickly, but this can be difficult sometimes because organizers tend to dump as soon as they announce the name of the coin they’re pumping.
For example, a pump and dump group once increased the price of the coin SLS by 950%. The price of the coin before pumping was 0.0046 BTC, but after the group revealed the name of the coin, its price went up to 0.0438 BTC. Once the group started dumping, SLS’s price went back down to 0.0059 BTC.
The anatomy of a pump and dump scheme (Source: empirica.io)
Why Do Pump and Dump Schemes Happen?
When the price of a coin goes up, it creates a feeling of “FOMO,” or fear of missing out. Pump and dump organizers allure traders by telling them that they will miss out on rewards if they don’t throw their money into the coin. As more people start buying the coin, the price moves up, which attracts even more traders. But when the organizers start selling the coin, the hype dies and the price begins to plummet. This results in huge losses for other traders.
Lack of government regulation and the global nature of the cryptocurrency market are the two factors that usually allow these schemes to happen. In the past, pump and dump schemes were promoted through call centers and the organizers mostly used incomplete or misleading information to convince traders to buy stocks.
But now the Internet makes it much easier to spread misinformation. As a result, platforms such as YouTube and Telegram have become widely used for pump and dump schemes.
This type of fraud was rare in the past because many of the people who were promoting stocks were registered brokers who could have easily lost their license and faced legal problems had they spread misinformation, but because crypto pump and dump organizers are not accountable to anyone, they are free to lie as much as they want.
Another way that scammers organize a pump and dump scheme is through an initial coin offering (ICO). Organizers pump the price of a coin through an ICO which is usually backed by a person who is well known in the crypto world. When the price has increased, the team behind the coin starts dumping, resulting in a loss for investors.
These schemes usually target altcoins that are new and have low trading volumes. This is important because the prices of coins like Bitcoin or Ethereum require a lot of money to be moved, which is why scammers don’t go after them.
How to Identify a Pump and Dump Scheme
Being able to spot a pump and dump scheme is a great way to make sure that you don’t lose your money. Sometimes it can be hard to tell if you’re being scammed, but there are signs that you can look out for. Here are some of them:
- One of the biggest signs of a pump and dump scheme is when the price of a coin rises suddenly without any news or event to explain it.
- If you notice that the price of a coin increases concurrently with the promotional activity by a person or a group, there’s a good chance that it’s a pump and dump scheme.
- You might see false comments, messages, or promotional posts from people about events related to the coin theyare promoting on platforms like YouTube, Reddit, and Telegram. These posts usually promise that you will double your money quickly. This is false advertising done by people who are involved in the pump and dump scheme.
- If a low market cap coin suddenly starts appearing all over Facebook, Twitter, and YouTube, then it’s a sign that the coin is being pumped by scammers.
How to Avoid Pump and Dump Schemes
The most important thing you can do to avoid becoming a victim of a pump and dump scheme is to not give in to FOMO. When someone tells you that you will miss out on huge profits if you don’t invest in a coin, make sure your investment decisions are backed by research and not emotions.
In addition, investors should stay updated with crypto-related news so you know which coins and groups to avoid. When you find out about a coin that’s pumping, the first thing you should do is understand the reasoning behind it. Is there any legit news that’s driving the increase in the price or is it just hype created by a Telegram group? If it is the latter, then you know it is a scam.
Avoid investing in altcoins that have a small market cap unless you have done your research and you have faith in the utility of these coins. Examine the media coverage of the coin. A legitimate project will have a presence on platforms like YouTube, GitHub, and other social media sites.
Check if there is an actual team behind the coin because it is very easy to create your own coin and then pump its price. A good investor knows that the development team is just as important as the coin so make sure you do thorough research.
Is Pump and Dump Illegal?
In 2017 and 2018, John McAfee promoted a new coin every day on his Twitter without revealing to his followers that he had already bought the coins prior to posting the tweets. He posted about coins like Dogecoin (DOGE), Reddcoin (RDD), and Verge (XVG).
McAfee’s actions resulted in him getting charged with commodities and securities fraud, wire fraud, and money laundering by the Commodity Futures Trading Commission (CFTC). This was the first time the CFTC took action against someone engaging in a crypto or digital asset pump and dump scheme.
In 2018, when Tesla’s stock’s price increased by 6% after Elon Musk’s tweet about taking Tesla private, he had to pay $40 million to settle SEC charges against him. However, when he was accused by Magda Wierzycka, CEO of Sygnia of pumping and dumping Bitcoin in early 2021, Musk wasn’t held accountable. In fact, Musk denied the claims.
In the stock market, the U.S. Securities and Exchange Commission (SEC) has made it clear that pump and dump is an illegal scheme that has legal consequences. The SEC hasn’t said anything definitive about crypto pump and dump schemes and because most organizers on Telegram, which is an encrypted messaging app, use anonymous IDs, it can be hard to track who is participating in the scheme.
As mentioned above, crypto assets are traded globally and there are no government regulations. This makes it even harder to take legal action against people who organize pump and dump schemes.
The SEC warned people against engaging in pump and dump schemes in 2017, but the crypto space continues to remain unregulated and these schemes are still rampant. Crypto pump and dump schemes have not been declared illegal as of yet.
There is not enough regulation in the crypto world, which can make it easy for scammers to get away with pump and dump schemes. Prices of altcoins are especially easy to manipulate because they don’t require a large amount of money to be moved.
Despite warnings by the SEC, pump and dump organizers continue to scam new and uninformed traders and investors. The only way that one can avoid losing money in a pump and dump scheme is by doing market research and probing into the coin’s social media pages and seeing what its development team has been up to.
Until countries introduce laws against this practice, pump and dump schemes will continue to exist and scammers won’t stop taking advantage of new traders. If no action is taken, these schemes will only become more common. If you want to avoid becoming a victim, just make sure to do your research on the coin!