Navigating Pump and Dump Schemes in Cryptocurrency: What to do

Trading Made Easy 2023-09-14 22:39:34

The world of cryptocurrency trading is akin to the untamed frontier of the Wild West, characterized by rapid growth and constant change. This emerging market has captured widespread attention, boasting fervent followings, celebrity endorsements, and an active presence in investment discussions. Bitcoin, the most prominent cryptocurrency, garners over 150,000 daily mentions on Twitter and frequently features in prominent media outlets such as Fox, Bloomberg, Forbes, and The Wall Street Journal. The rise of cryptocurrencies has even created a new class of millionaires, with over 100,000 crypto millionaires now in existence.


However, much like the Wild West of yesteryears, the cryptocurrency realm is a lawless domain marked by uncertainty and greed. Opportunistic individuals are exploiting the lack of regulatory oversight to engage in tactics that would be illegal in traditional financial markets. One such clandestine scheme that operates below the regulatory radar is the "pump and dump."



What Is a Crypto Pump and Dump Scheme?

The concept behind a pump and dump scheme is straightforward: a group of unscrupulous actors deliberately acquires an asset, often small-cap stocks or thinly traded securities, and promotes it vigorously to unsuspecting investors using false information (the "pump"). Once the heightened activity drives up the asset's price, these perpetrators sell their holdings (the "dump"), leaving those who bought into the hype holding devalued assets as the artificial demand dissipates.


Traditionally conducted in boiler rooms via telephone, pump and dump schemes have evolved in the digital age, with the internet and automated trading algorithms facilitating their execution. The fundamental strategy remains unchanged: identify a low-volume asset, inflate its potential returns on message boards, chat groups, and social media, promise substantial gains, and subsequently liquidate the position when the buying frenzy commences, causing the price to soar.


Today, the key distinction is the swiftness with which these schemes unfold; the time frame between entry and exit can be as brief as a few minutes or, at most, a couple of days.


How Does Crypto Pump and Dump Work?

Crypto pump and dump schemes essentially represent old tactics in new packaging. Their effectiveness hinges on several factors:


  1. Asset Selection: Perpetrators choose assets with low trading volumes because these are more likely to exhibit favorable reactions when trading activity increases. Such assets are also frequently new coins issued through initial coin offerings (ICOs), as it is easier to generate hype around an unknown asset compared to one with an established history.


  1. Short Interest: Bad actors often target assets without short interest, eliminating downward pressure on the asset's price during the pump.


  1. Stability: Ideally, the chosen asset has a relatively stable price, enabling perpetrators to offload it in case the manipulation fails, thereby avoiding potential losses from market volatility.


Once the target is identified, bad actors gradually accumulate the asset over days or weeks to avoid triggering suspicion or sudden price spikes.


The pump phase is characterized by coordinated efforts in online chat groups like Discord and Telegram, where groups suggest participation in a pump and dump. These groups, such as Voyager Pump or Galactic Pump, promote coins to their members, claiming to receive coin recommendations from an algorithm or bot to prevent early access. In reality, these coins have already been purchased, and there is no genuine algorithm. The countdowns to the dump on Discord accounts create a sense of urgency and fear of missing out (FOMO) among investors.


Enticed by false information and rising prices, more traders join the frenzy, further driving up the price. However, as the excitement peaks, the original schemers behind the promotion initiate the dump phase, capitalizing on substantial gains.


By the time the information reaches platforms like Twitter or Reddit, the scheme has already unfolded, and those who entered late find themselves holding depreciated assets, as there are no buyers in sight. The cycle ends, and the group moves on to the next target.



Pump and Dump vs. Rug Pull: Differentiating Scams

While pump and dump schemes are prevalent, another scam gaining momentum is the "rug pull." In a rug pull, a developer creates a cryptocurrency project with the intention of absconding with investors' funds. The scam involves extensive promotion of the coin to generate hype, often through paid advertising on high-traffic websites.


Rug pulls typically occur on decentralized exchanges (DEXs) with limited oversight. Scammers launch a coin on a DEX, tether it to another cryptocurrency like Ethereum, and heavily promote it online. After unsuspecting investors exchange their legitimate cryptocurrency for the new coin, the scammers drain the liquidity pool, rendering the asset worthless.


Sometimes, the initial hype phase of a rug pull resembles a pump and dump, as creators artificially inflate the price to induce FOMO and attract more victims. To avoid falling prey to rug pulls, investors should scrutinize liquidity and lockup mechanisms in token pools and conduct thorough research before investing.



Can You Profit from Crypto Pump and Dump?

While pump and dump schemes result in significant price fluctuations that can lead to substantial gains, profiting from them, whether knowingly or unknowingly, relies on timing and execution. To profit, an investor needs to:


  1. Identify the Right Group: Investors must have confidence that the group they follow will act swiftly to inflate prices artificially.
  2. Exit Promptly: Investors should be able to exit the trade in time to capitalize on the price increase. Employing trailing stop loss orders can help minimize losses by automatically selling the asset when prices decline sharply.


Is Crypto Pump and Dump Illegal?

The legality of crypto pump and dump schemes varies by jurisdiction. In the United States, pump and dump schemes are illegal in traditional financial markets. However, the regulatory landscape for cryptocurrencies is less clear. Depending on how cryptocurrencies are classified (e.g., as money, property, securities, or commodities), they may fall under the purview of different regulatory bodies, such as the Internal Revenue Service (IRS), the Commodity Futures Trading Commission, the Securities and Exchange Commission, or the Financial Crimes Enforcement Network (FinCEN).


As a result, the current legal framework leaves a regulatory gap for pump and dump schemes in the crypto space. Nonetheless, regulatory efforts are evolving to address these issues, and some perpetrators may face tax-related consequences.



Things to Consider Before Investing in a Crypto Project

Before investing in any cryptocurrency project, consider the following factors:


  1. Fundamental Analysis: Evaluate the digital asset's fundamentals, including its team, developers, advisors, and investors. Research their backgrounds and experience to gauge their ability to execute the project successfully.
  2. White Paper: Thoroughly read the project's white paper to understand its objectives, technology, timelines, and problem-solving approach.
  3. Market Demand: Assess the importance of the problem the project aims to solve and whether there is market demand for its solution.
  4. Competition: Analyze the competitive landscape to identify potential rivals and determine whether the project offers a unique solution.
  5. Technical Soundness: Verify the project's technical soundness by examining its source code, if available, and checking for third-party audits.
  6. Marketing: Consider the marketing efforts and community support, as a strong community and effective marketing can drive adoption.




The cryptocurrency space offers both opportunities and risks, much like the Wild West. While there are legitimate projects and communities focused on regulating the technology and ensuring investor safety, it is essential to exercise caution, conduct thorough research, and stay informed about potential scams like pump and dumps. Regulatory efforts are gradually evolving to address these challenges, making it crucial for investors to remain vigilant and informed in this rapidly changing landscape.


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