What are ‘pump and dumps’ and what’s being done to prevent them?
Cryptocurrencies are so new that most autocorrects do not yet register the word and recognize it as a misspelling. Some people see this emerging market as an exciting opportunity, while others see it as a risky and potentially dangerous one due to its decentralized nature.
Lawmakers have even referred to cryptocurrency as ‘The Wild West” because of the lack of security, ambiguity, and secrecy of some blockchain-based companies. However, most people still remain unaware that decentralized does not mean unregulated.
One of the most common scams associated with cryptocurrency is a ‘pump and dump scheme.’ According to the SEC, a pump and dump scheme happens when a company drives up the price of a stock, or in this case, a digital cryptocurrency coin or token, by publically making false claims or misleading statements, encouraging people to buy or sell based on inside information (SEC, 2013).
These people are usually paid promoters or company insiders that create a buying frenzy, who in turn gain by selling their coins once the price is ‘pumped.’ When the value of the cryptocurrency reaches its peak or a desirable value, those who initiated the pump and dump will begin to sell off the coins.
Ultimately, once these people “dump” the cryptocurrency, the value of the coin falls dramatically and public investors who bought in at the inflated price lose out. In 2018 alone, an analysis done by the Washington Journal found 175 pump and dump schemes in the crypto market. One of the companies identified in this analysis was Cloakcoin, which used social media and Telegram channels to announce that sales should be made at an exact time.
Although many of these ‘pump and dumps’ are planned and even announced publicly on social media channels, there are many which are not. Since the cryptocurrency market is still a relatively small and tight-knit community, it can be easy for crypto-company employees to become privy to information, and use it to manipulate the market to their benefit, or choose to participate in buying and selling based on inside information.
Laws and Regulations to Prevent Pump and Dumps
In the United States, market manipulation is illegal under rule 10b-5 of the Securities Exchange Act of 1934, which prohibits manipulative and deceptive practices. However, regulating cryptocurrencies under this law is not possible in many cases as most crypto-exchanges are not registered or regulated under SEC laws. Though it is true that regulation goes against the nature of having a decentralized asset, the SEC is not the only one concerned about the potential harm if digital currency trading continues to be seen as ‘the wild west.’
In 2018 ten cryptocurrency firms came together to form the Association for Digital Asset Markets (ADAM) in order to create a code of conduct for digital assets that will be added to the existing laws and regulations in order to bolster security and reduce market manipulation.
Currently, each exchange also comes with its own rules and regulations, some are more credible than others and the SEC had urged people to understand that not all are registered, reliable or act ethically. This does not mean that they are all bad, but it does mean that investors should do their own due diligence before investing.
The Wall Street Journal found trading groups manipulated the price of digital tokens to the tune of $825 million in trading activity over the course of the last six months, resulting in hundreds of millions of dollar in losses for those who fell for the scams.
To go hand in hand with AML or anti-money-laundering laws, many cryptocurrency coins and tokens have begun to only accept KYC or Know Your Client verified customers. In order to invest in many coins, investors must first meet the KYC regulations put in place by each company. According to the Bitcoin Exchange Guide, the purpose of KYC verifications is to stop those who are underaged, an illegal resident, or criminally motivated from participating.
This allows law enforcement to identify and pursue criminals within the system. Although some people still view this as a violation of their anonymity, the practice is becoming more and more common, as many cryptocurrency companies and exchanges also fear hacks and falling victim to criminal activity.
Are Current Laws Enough?
Because the world of digital asset trading is still relatively new, it is clear that more regulations and laws are needed and that each year we will see an increase until market manipulation can be stopped. Fuscado (2108) wrote “…the Wall Street Journal found trading groups manipulated the price of digital tokens to the tune of $825 million in trading activity over the course of the last six months, resulting in hundreds of millions of dollar in losses for those who fell for the scams.”
Right now cryptocurrency is still ‘the wild west’ and it is largely up to the investor to do research on each exchange and company before investing, or invest at their own risk.
Though there are regulations in place to prevent this kind of corruption in the cryptocurrency market, there is still a lot of work that needs to be done to ensure the safe and ethical trading of digital assets. The SEC regulates IPOs, but since this goes against the decentralized nature of blockchain, many investors will need to change their perception and support increased regulation to help the industry grow in the right direction.
Not everyone likes this idea because some enjoy speculative high-risk, high-reward trading and feel that further regulations could jeopardize the market. Each exchange needs to be held to a higher standard, greater scrutiny of exchanges would help, however, right now it is up to the people themselves to do their own research and invest wisely.
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