Pump-and-dump scams have been around for a long time, but with the increasing popularity of cryptocurrencies, they have become more widespread and sophisticated. This form of market manipulation involves artificially inflating the price of an asset through dishonest practices and selling it at a profit, leaving others with devalued tokens.
The decentralized and largely unregulated nature of the crypto market makes it easier for fraudsters to execute these schemes without facing significant consequences. These schemes can also lead to severe financial losses, so investors must be vigilant and learn how to spot warning signs to safeguard their assets.
Therefore, to help traders recognize pump-and-dump crypto scams is important to avoid becoming a victim of such scams, this article will explore the mechanics of pump-and-dump scams, how they affect investors, and offer strategies to avoid falling victim to them.
Key Takeaways
- Pump-and-dump scams involve artificially inflating a cryptocurrency's price through deceptive tactics, and then selling off at a profit.
- Social media platforms like X (formerly Twitter) and Telegram are used to facilitate these schemes by spreading hype.
- Victims face significant financial losses and erosion of trust in the market.
- For prevention, research, monitor trading volume, and be wary of celebrity endorsements to avoid scams.
The Basics of Pump and Dump Scam
Source - X (formerly twitter)
A pump-and-dump scam is a fraudulent scheme where the price of an asset, usually a low-cap cryptocurrency or penny stock, is artificially inflated through misleading promotions or heavy buying. Once the price reaches a peak, the manipulators sell off their holdings, leaving unsuspecting investors to bear the losses as the price crashes.
A 2018 study investigated the widespread occurrence of pump-and-dump schemes within the cryptocurrency market. Over a six-month period, researchers uncovered more than 3,400 instances of these schemes, primarily conducted through two group messaging platforms frequently used by cryptocurrency investors.
Pump-and-dump schemes were traditionally executed through cold calls, but the rise of the Internet has made these illegal activities even more widespread. Today, fraudsters use online platforms to lure investors by claiming to have insider information that will supposedly lead to a sharp increase in an asset’s value.
As investors rush to buy in, the perpetrators quickly sell off their shares, causing the asset’s price to plummet, leaving new investors with significant losses. These schemes typically target micro- and small-cap assets, which are easier to manipulate due to their low market capitalization.
With a smaller float, it doesn't take a large number of new buyers to drive the stock price up. The stock is often marketed as a "hot tip" or the "next big thing," with promises of an imminent announcement that will supposedly cause the asset to soar.
Although the specifics of each pump-and-dump scam may vary, the underlying strategy is always the same: artificially shifting supply and demand. These schemes usually focus on assets that are often illiquid and prone to sharp price movements when trading volume increases.
Once the scam group has inflated the asset price by attracting enough new buyers, they sell their holdings to capture substantial short-term profits, leaving unsuspecting investors to bear the losses.
“Unfortunately, cryptocurrencies are particularly well-suited for pump-and-dump scams because of the lack of regulation in the cryptocurrency market, its opaqueness, and the technical complexity of cryptocurrencies.”
How It Works
Crypto pump-and-dump scammers use several strategies to artificially inflate the price of cryptocurrencies for personal gain. To fully understand how these schemes work, it's important to go through the different phases the scammers use:
Communicating Basic Information
The first step is to relay crucial details to the participants. Scammers communicate the exchange where the operation will occur, the exact time the pump will start, and whether it will be accessible to all or ranked by tiers. If it's a "free for all," both VIP and regular members receive the information simultaneously.
However, in many cases, VIP members get early access to the details, sometimes hours or even days before regular members, giving them an advantage.
Announcing the Target Coin
In this phase, the target cryptocurrency is revealed multiple times as the pump date nears. Group members are informed about the target coin as soon as the pump begins, but this information is typically shared with higher-ranking members first.
Additionally, the name of the cryptocurrency is usually displayed in a blurred graphic that only humans can easily decipher. The purpose of this is to prevent bots from parsing the message using Optical Character Recognition (OCR) software, which can execute trades much faster than human participants.
Creating Hype to Attract Outside Investors
In the final stage, the fraudulent dissemination of information begins. The admins start tweeting about the price of the target coin, encouraging group members to build hype. This often triggers panic buying or creates a sense of urgency driven by FOMO (Fear of Missing Out).
Scammers rely heavily on social media platforms like Twitter, chat rooms, and forums to spread the word and draw in unsuspecting investors, further driving up the coin's price. By the time outside investors are drawn in by the hype, the orchestrators and early participants have already sold their holdings, leaving latecomers with significant losses when the price collapses.
One of the most infamous pump and dump schemes was carried out with BitConnect in 2017. Promoters falsely claimed that BitConnect had a revolutionary trading bot that guaranteed high returns, attracting a large number of investors.
At its peak, BitConnect reached a market cap of over $2 billion. However, the scheme collapsed when the platform was revealed to be fraudulent, leaving investors with massive losses.
Signs of a Pump-and-Dump Crypto Scam
Source: Pixabay
Pump-and-dump schemes in the cryptocurrency market are typically marked by rapid price fluctuations and unusual trading activity. Here are some key indicators to help identify these fraudulent schemes:
Sudden Price Spikes
A sharp, unexpected increase in the price of a cryptocurrency, often without any underlying news or developments, is one of the primary signs of a pump-and-dump scheme. These price surges are typically accompanied by high trading volumes, which pumpers use to lure in unsuspecting investors seeking quick profits.
Once the price peaks, the manipulators sell off their holdings, causing the price to plummet, leaving late investors with substantial losses.
High Trading Volume
A spike in trading volume without any real reason or news can be another indicator of a pump-and-dump scheme. Artificially increased trading volumes are used to create the appearance of heightened demand for the cryptocurrency.
However, this surge is driven by manipulation rather than genuine investor interest. As soon as the pumpers offload their holdings, the inflated volume subsides, and the price crashes, leaving investors with devalued assets.
Hype and Promotion
Social media hype is central to pump-and-dump schemes. Fraudsters use fake news, exaggerated claims, and aggressive marketing on social platforms to create a buzz around a particular cryptocurrency.
They often spread misleading information about upcoming developments or partnerships to generate excitement and fear of missing out (FOMO) among potential investors. Fake accounts and fabricated endorsements are frequently used to support the illusion of credibility and demand.
Lack of Fundamental Value
Pump-and-dump schemes often target cryptocurrencies with little to no inherent value or utility. These coins typically lack a well-defined business model or real-world application, making them easy targets for manipulation.
Fraudsters may create deceptive narratives to inflate the perceived value of the coin, using technical terms or buzzwords to confuse and mislead investors into thinking the project has more merit than it actually does.
Lack of Transparency
Many pump-and-dump schemes are orchestrated by anonymous individuals or groups, making it difficult to track their activities or verify the legitimacy of their claims. Fraudsters often use fake identities, anonymous accounts, and hidden communication channels to avoid detection.
A lack of transparency, particularly regarding the coin's developers, the project's goals, or the identities of those promoting it, should serve as a significant red flag for potential investors.
In essence, crypto pump-and-dump schemes pose a serious threat to the cryptocurrency market. Investors should be cautious when they see any of the signs listed above.
Thorough research and skepticism are essential before committing to any cryptocurrency investment, especially when the opportunity appears too good to be true.
Why Are Pump and Dump Scams Common in Crypto?
Source - Pinterest
Unlike traditional stock markets, the cryptocurrency market remains largely unregulated, making it a prime target for pump-and-dump scams. Additionally, the decentralized and anonymous nature of crypto transactions allows bad actors to operate with minimal oversight.
Several factors make pump-and-dump schemes more likely in the crypto space:
Low Market Caps
There are over 22,000 digital assets in the crypto market with many having low market capitalizations. Consequently, a relatively small amount of money can significantly affect their price.
This makes these tokens attractive targets for scammers, who can manipulate prices more easily than they could in the stock market.
FOMO (Fear of Missing Out)
Cryptocurrency investors are often driven by the fear of missing out on a potentially lucrative investment. When they see the price of a token rapidly increasing, they are more likely to jump in without fully researching the project, thereby becoming victims of the scam.
Lack of Regulation
While regulators like the U.S. Securities and Exchange Commission (SEC) have taken steps to address market manipulation in stocks, the cryptocurrency market remains largely unregulated. Scammers take advantage of this lack of oversight to orchestrate pump-and-dump schemes without fear of legal repercussions.
Also, note that in March 2021, the U.S. Commodity Futures Trading Commission (CFTC) issued a warning to consumers about the risks of pump-and-dump scams, particularly in newly launched or thinly traded cryptocurrencies. To combat these fraudulent activities, the CFTC introduced a whistleblower program.
Under this initiative, individuals who provide original information that results in enforcement actions leading to monetary sanctions of $1 million or more could be eligible for a financial reward ranging from 10% to 30% of the recovered amount.
Social Media’s Role in Pump and Dump Schemes
Social media platforms such as Twitter, Telegram, Discord, and Reddit play a central role in orchestrating pump-and-dump scams. These platforms are often used to generate hype and excitement around a particular token, making it easier to attract a large number of buyers.
Here's how social media fuels these scams:
Coordinated Pump Groups
Groups of investors or scammers will coordinate a pump on messaging platforms like Telegram and Discord. They often operate in private channels with thousands of members, instructing them to buy specific tokens at a certain time, thereby inflating the price.
Paid Promotions and Influencers
Some influencers and celebrities are paid to promote a specific cryptocurrency to their followers, many of whom may have little knowledge of how pump-and-dump schemes work. This endorsement gives the token an air of legitimacy, drawing in more unsuspecting investors.
For example, in 2021, Kim Kardashian faced criticism for promoting EthereumMax, a relatively unknown cryptocurrency. The token’s price surged after the promotion, only to crash shortly after as early investors sold off their holdings.
The popular entrepreneur was later charged by the SEC for failing to disclose that she was paid a sum of $250,000 for the promotion and was fined a hefty amount of about $1.2 million.
Bot Activity
Automated bots are frequently used to artificially pump up trading volumes, making a coin appear more active and popular than it really is. This creates the illusion of organic growth and triggers FOMO in inexperienced investors.
“It’s disheartening to see how many of the top cryptocurrencies are hand-waving, technically inept, or outright scams.“
- Naval Ravikant, Former CEO of AngelList
Impact on Investors
Pump-and-dump scams can have a devastating impact on investors, particularly those who are new to the cryptocurrency market. Some of the key consequences include:
Financial Losses
When the price of a token is artificially inflated, new investors buy in at high prices, thinking the asset will continue to rise. However, when the orchestrators dump their holdings, the price crashes, and these investors are left with losses.
For instance, in 2018, the SEC charged Erik T. Voorhees, the CEO of ShapeShift, for his role in a Bitcoin pump-and-dump scheme. Investors who bought in at the peak of the pump lost significant amounts of money when the price crashed.
Loss of Trust in the Market
Frequent pump-and-dump scams can erode trust in the cryptocurrency market. Investors may become wary of participating, fearing that they will fall victim to another scam. This can stifle innovation and prevent legitimate projects from gaining traction.
Regulatory Scrutiny
As pump-and-dump schemes become more prevalent, regulatory bodies like the SEC and Financial Conduct Authority (FCA) have started paying closer attention to the cryptocurrency space. While regulation can protect investors, it could also stifle the decentralized nature of cryptocurrencies.
Legal and Ethical Implications
Some may wonder whether crypto pump-and-dump schemes are legal, as they often involve simply generating hype around a coin to inflate its price on platforms like Telegram. While conducting pump-and-dump operations in the stock market is illegal and constitutes a financial crime, the legal standing of such activities in the crypto market is less clear.
Moreover, since cryptocurrencies are not universally classified as securities, these schemes might not technically violate any existing laws, despite being both legally and ethically controversial. Nonetheless, regulated crypto exchanges generally consider pump-and-dump schemes illegal and take steps to prevent such scams.
In the U.S., the SEC has the authority to prosecute individuals or groups who engage in this type of market manipulation. Furthermore, the SEC has increased its scrutiny of cryptocurrency-related pump-and-dump schemes in recent years.
In some cases, they have brought legal action against influencers and celebrities who promote these scams without disclosing their financial interest in the tokens. For instance, in 2022, the SEC fined several high-profile influencers for promoting certain stocks that were later revealed to be part of pump-and-dump schemes.
However, note that the regulatory landscape for cryptocurrencies is still developing, making enforcement more challenging.
“Cryptocurrency is an exciting innovation with the potential to bring growth to the American economy if properly nurtured and regulated.“
- Cory Booker, Senator from New Jersey
How to Avoid Pump and Dump Scams
Source - Pinterest
As an investor, it’s important to be aware of the red flags that may indicate a pump and dump scam. Here are some strategies to protect yourself:
Research the Cryptocurrency and Its Fundamentals Before Investing
It is important to perform comprehensive research before committing to any cryptocurrency investment. This involves analyzing the team behind the project, evaluating the roadmap and whitepaper, and assessing the market capitalization and trading volume of the cryptocurrency.
Be on the lookout for red flags such as fake news or excessive social media hype.
Use Technical Analysis to Identify Abnormal Price and Volume Movements
Technical analysis can be an effective method for spotting unusual price and volume fluctuations in the crypto market. By using charts and indicators to examine historical price and volume trends, you can identify irregularities that may signal pump-and-dump scams, such as sudden spikes in price or trading volume.
If a little-known token suddenly experiences a sharp increase in price with no apparent news or development to justify the rise, it may be a sign of an impending dump. Always investigate the reasons behind price movements before investing.
Avoid Investing Based on Hype and FOMO
Many investors are lured into pump-and-dump schemes by hype or FOMO. It's necessary to avoid making investment decisions driven by hype or the fear of missing out on quick profits.
Also, just because a celebrity or influencer is promoting a cryptocurrency doesn't mean it's a good investment. Always do your own research and be skeptical of tokens that rely heavily on endorsements for their marketing.
Stay Up-to-Date on News and Market Trends
Keeping abreast of news and trends in the cryptocurrency space can help you spot potential pump-and-dump schemes before they unfold. Follow credible news outlets and stay informed on broader market trends to make educated investment choices and safeguard against falling victim to such scams.
Avoid Unregulated Exchanges
Unregulated or obscure cryptocurrency exchanges are more likely to be home to pump-and-dump schemes. Stick to well-known, regulated platforms that have measures in place to prevent market manipulation.
Conclusion
Pump-and-dump scams are a serious threat to the integrity of the cryptocurrency market. These schemes prey on the fear and greed of investors, leaving many with significant financial losses.
By staying informed, conducting thorough research, and avoiding investments driven by hype, you can protect yourself from falling victim to these fraudulent schemes.
As the cryptocurrency market matures, increased regulatory scrutiny may help curb the prevalence of pump-and-dump scams. However, until more comprehensive regulations are in place, it is up to individual investors to remain vigilant and make informed decisions.
FAQs
What is a pump-and-dump scam?
A pump-and-dump scam involves artificially inflating the price of a cryptocurrency through dishonest practices and then selling it for profit, leaving investors with devalued assets.
How do social media platforms contribute to these scams?
Social media facilitates pump-and-dump schemes by spreading hype and coordinating group buying, often through private channels or influencer promotions.
What are the signs of a pump and dump scheme?
Signs include sudden price spikes, low trading volumes, and heavy reliance on celebrity endorsements without substantial backing.
How can investors protect themselves?
Investors should conduct thorough research, be cautious of low-volume tokens, and avoid making decisions based solely on social media hype.
