Pump and dump schemes happen when players manipulate the market by artificially inflating an asset’s price through hype and misinformation, creating a deceptive illusion of value.
In investment circles there are several elaborate methods with which scammers try to exploit unsuspecting traders. This article exposes one such method that is frequently used in unregulated investment markets – the pump and dump scheme.
Pump and dump are a type of investment scam where scammers buy an inexpensive coin by market cap, advertise (or pump) it, and then sell (or dump) it once the price has risen. The inflation of the price doesn’t reflect the coin’s underlying value, which means that the price plummets once the dumping is done.
How do pump and dumps happen?
Pump and dump schemes are elaborate and require wide collaboration and buy-in.
Searching for a target
The pump and dump scheme begins with scammers selecting a cryptocurrency to exploit. It is ideally a little-known or fresh-on-the-market cryptocurrency with a small market cap that the public does not know well (or at all). These coins typically have poor liquidity – low trading volume and meager supply and demand – meaning that very few people are buying or selling them. Once an appropriate candidate is selected, the scammers purchase a large quantity of tokens.
Pumping it up
The increase in demand spurred on by the purchases of the scammers does part of the job to inflate the price of the altcoin. To hype the coin even more, scammers aggressively promote it across social media and communication platforms. Endorsement by public personas or institutions, whether real or (as can happen) faked by the scammers, also plays an important role in the token’s hype.
“ hale manipulation” is an alternative pumping strategy. Instead of just promoting the cryptocurrency, the investor makes a substantial purchase to increase its trading volume and price through their own actions. This surge functions as additional bait for the unsuspecting trader.
FOMO never rests
Now, scammers can rely on human nature. Effortless profit sounds like a good deal, so when people see an obscure coin rapidly growing in price, they are likely to want to hop onto the charging bull. This process, termed as fear of missing out or FOMO, is well-known in investment circles. It is the basic principle that makes pump and dump work.
The best time to dump
Once a large enough number of external investors take the bait and the hype starts dying out, it’s time for the scammers to sell what they own. The currency has reached the point where the scammers believe that its selling price is at the maximum. The scammers then sell their coins at an inflated price and pocket the profit.
Aftermath: Who dropped the nuke?
The increase in supply and the drop in demand that follows start to decrease the falsely inflated price swiftly. Dumping a sizeable amount by the scammers sends the token’s price plummeting. Seeing the downward spiral and recognizing that the currency has no inherent value, external investors want to sell, too, to minimize losses. However, this usually happens too late, and those who missed the dump typically end up with worthless coins.
How to avoid these scams
Pump and dump schemes are not easy to recognize.
Patterns on trading charts make no distinction between a pumped coin and a coin for which the increase in price is genuine. If purchasing coins at the initial coin offering (ICO) or investing in obscure tokens, traders always need to DYOR (do your own research) and only trade what they understand.
When investing, pay attention to exceptional price jumps (everything above 80% in a day or two is usually considered suspicious) and be careful with small market cap cryptocurrencies. If your research on crypto rewards no good reason for the price surge, that’s often simply because there is none. Steer clear. Your investments are better placed elsewhere.
Ways to protect yourself from pump and dump schemes
If traders do not feel comfortable identifying pump and dump schemes, there are several other ways they can protect themselves, such as:
- Beware of hype: Blindly following hype or social media trends may come back to bite you. Traders must think critically and evaluate their trades based on fundamental or technical analysis.
- Diversification: Traders can reduce risk by spreading their money across multiple assets.
- Watch for influencers: Influencer marketing has a large role in pump and dump schemes, as they can be paid or manipulated to promote certain tokens.
Further, it’s important for traders to follow basic security measures. Purchasing tokens based on hype could easily lead to you clicking on a website you shouldn’t have or sharing sensitive information to catch the latest trends. When trading cryptocurrencies, make sure you are using strong passwords, enable two-factor authentication on your apps and store your crypto in secure wallets.
Legal consequences of pump and dump schemes
Participating in pump and dump schemes, whether as an organizer or a knowing participant, can have legal ramifications. Regulatory and Law Enforcement Authorities like the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) actively pursue those involved in these fraudulent activities.
Organizers
Those who orchestrate and participate in the schemes can face severe penalties including:
- Criminal charges: Charges may include securities fraud, market manipulation, wire fraud, and conspiracy.
- Fines: Significant fines which can reach millions of dollars, depending on the scale.
- Imprisonment: Jail time is a possibility for organizers.
- Civil lawsuits: Investors who suffered losses may file civil lawsuits to recover damages.
Knowing participants
Those who knowingly participate in pump and dump schemes (like influencers, KOLs, etc.) can also face penalties like:
- Fines: Financial penalties for profiting from the scheme.
- Trading restrictions: Bans from trading in certain markets.
Pump and dump essentials
- Pump and dump schemes artificially inflate the price of a cryptocurrency through coordinated buying and the spread of misleading information, creating a false sense of value.
- Scammers exploit the "fear of missing out" (FOMO) psychology to lure investors into buying the hyped-up cryptocurrency at inflated prices.
- Both organizers and those who knowingly participate in pump and dump schemes can face serious legal consequences, including fines, imprisonment, and reputational damage.