How to Spot a Pump and Dump
If it sounds like a pyramid scheme, you are right. If it sounds like artificial inflation, you are right. Pump and dump schemes made headlines before Bitcoin was created. Recently, several news stories have pointed to many scams attempting to manipulate cryptocurrency prices through this scheme.
While digital currencies are relatively new, they are prone to old scams. The novel blockchain technology that backs cryptocurrencies can be used to create an artificial financial mania. Like the popular Tulip mania that occurred in the Dutch Republic between 1634 and 1637, what this scheme banks on is the ability to create an illusory surge of public interest in a particular asset such that easy and massive wealth seems to be within reach of the average investor. The cryptocurrency's price soars past its fundamental value, and everyone is buying to avoid missing out.
Eventually, an inflection point is reached once the price is fully "pumped." The people behind the scam begin to sell the cryptocurrency for a higher price. Dumping the coin and pocketing the profit while innocent investors watch the price plummet.
What are pump and dump schemes?
Pump and dump schemes, which fraudulently manipulate prices by disseminating false information, have existed in economic contexts since at least the 1700s. With the advent of new technology related to cryptocurrency trading, the issue has a wider scope.
This scam takes advantage of individual investors while earning huge profits for con artists. They may include social media influencers who are compensated for encouraging people to purchase a particular digital coin in order to increase its value.
The three phases of a pump and dump operation
This type of scam targets new and small-cap coins. These types of coins do not require a lot of money to manipulate, so they are easy picks. Rarely will you hear of a Bitcoin pump because it will require a lot of money. Many small-cap coins do not have any real use cases. The scammers simply create the illusion of importance by roping in celebrities and industry thought leaders to make the cryptocurrency look more interesting.
The number of pump and dump scams has steadily increased. In a 2018 report by the Wall Street Journal, crypto pump and dump schemes accounted for $825 million in trading activity in six months, causing hundreds of millions of dollars in losses. In that year, from January to July, there were 125 pump-and-dump scams that manipulated the price of 121 different coins.
According to Chainalysis data, they made up 1% of total illicit revenue in 2020. In 2021, they accounted for a whopping 37%.
How does this scam operate?
A pump and dump scheme operates on two levels:
Insiders of the token promote and stir the price while they sell slowly.
Scammers target a particular token and rally the token community to buy, triggering a soar in price. Whoever buys last is left with an empty bag.
Whichever one operates, there's a team of tech-enabled, motivated, and organized players at the centre. This team often includes internal investors who provide funding to buy the token and raise demand.
While the investors fund the artificial demand for the token, another team fuels the disinformation campaign, trumpeting non-existent use cases or completely false details about the token. With social media and instant messaging apps, marketing the good word about the token is easier. Platforms like Telegram, Twitter, Facebook, and YouTube have become breeding grounds for these marketers.
These marketers use famous people to help sell the tokens because they want to get people interested. Fear of missing out (FOMO) is what makes this scam work, so outside investors and traders rush to buy the token. The price crashes as investors realize too late that they invested in a scam.
How to spot crypto pump and dump
Generally, the first step to spot a bad investment is to do your own research. Look up the token, read the white paper, check the exchanges on which it is listed, the order book, and the token timeline. If it's too good to be true and has no clear purpose or utility, it's most likely a scam.
Second, an investor should understand that scams are modelled by psychological tricks. It's important to understand if FOMO is contributing to your decision on whether to invest or not. Always be self-aware. Are you investing because you don't want to miss out? Well, you may end up holding an empty bag.
Last year, some anonymous developers launched the SQUID token, riding on the success of the Netflix hit show Squid Game. Before the pump, SQUID was worth about two cents. Soon after the marketing ploy hit, the coin went from $0.01 to $38 within a week. The perpetrators rode on the FOMO and made off with $12 million. Invest in various tokens. Only invest your money after you have carefully evaluated a project. If it crashes, take your money out while there's still time.
Another psychological trick these fraudsters use to ensnare you is the idea that everyone in a pump group is an insider. The truth is, as Coffeezilla puts it, “there is an insider within an insider club in all of these pump and dumps." "Only true insiders are aware of the pump and dump signals before others."
If you're not a founding member of the token community, your investment will only amount to zero. Why is a fashion influencer suddenly talking about some cryptocurrency? Your answer: it's most likely a scam. Influencers and celebrities are a major part of legitimizing a scam token. Their reputation (though paid for) is staked as a reason to buy.
A sudden spike in the price of a relatively unknown coin points to the "pump phase" of the coin. You can see on the price chart a sharp price hike. This is a red flag.
The unregulated crypto industry opens the door for fraudulent players in the market. The high and fast profits from these pump and dump schemes entice scammers to take advantage of unsuspecting investors.
A vigilant investor knows to always be on the lookout for these scam schemes. You don't invest more than you're willing to lose while spreading your investment across different tokens. Only invest your money after you have carefully evaluated a project. If it crashes, take your money out while there's still time.
Author: Ibrahim Anifowoshe
Ibrahim is a writer with extensive experience writing about the crypto industry. He has reported widely and written educational content on the space.