PUMP AND DUMP
It so happens that many people start investing in financial assets like stocks and cryptocurrencies because it provides a means of astronomical profit within a short time frame. Perhaps a person has seen a friend or some other person invest a few pennies into an asset and makes ridiculous returns on investment, like 20,000% or some other wild number; in a matter of days, hours, and even minutes. Seeing a person make profits around hundreds of thousands from investing just a little amount in such a short time definitely gives one the impression that investing in these assets is a get-rich-quick scheme of some sort, one you want to benefit off. While truly, good traders do make a lot of profits with well calculated and analyzed trades, it does not work like a rogue money machine for the most part. What that person with ridiculous returns has benefitted from is most probably a pump and dump scheme.
Breaking it down to as simple as possible, a pump and dump scheme is a ploy by one or more investors to buy very high quantities of a cheap asset, and sell very high buy tricking other investors to buy into the market. The investors tend to favour relatively cheap assets with very low liquidity and market cap. This is because information about these assets are usually insufficient, and their values make it easy to accumulate a large quantity for a negligible amount. Their illiquid nature also makes it very easy for their prices to change due to a wider bid ask spread (the difference between the lowest price selling order and the highest buying order) and a lower order book depth. What then is involved in a pump and dump scheme?
· IDENTIFICATION OF ASSET: As mentioned above, the first step involves the initial investors finding a low cap, low value, low liquidity, and relatively obscure asset they would want to use for their scheme. They could choose to go for an existing asset, or even create a new one entirely (this is quite common in cryptocurrencies). Once they do this, they accumulate very large amounts of these assets for a little price, or perhaps even for free.
· PROPAGANDA STAGE: This takes them to some sort of “propaganda stage”, where they start spreading information about the asset they have chosen. This used to be quite some task for them to accomplish, but social media and the internet generally has made it much easier. Channels like Telegram, WhatsApp, and Discord are now very common amongst these investors, where they can add a lot of people and make false statements about their earmarked assets. These statements are overly positive and fraudulently misleading, enough to convince the unsuspecting new investors to rush in and start buying the asset while it is cheap, before the rest of the world realizes its “unbelievable potential” and it would be too late to make all the profits they want.
· PUMPING STAGE: This is where the unsuspecting investors have taken the bait and have started buying these assets because of the fear of missing out (FOMO). As the demand and liquidity of the asset suddenly spikes, the price action follows and a pump occurs. The size of the pump is dependent on how many people the investors were able to convince, and how much of the asset they were able to convince them to buy. At the peak of this pumping stage, the initial investors that set the scheme in motion cash in on their assets at a price much higher than what they got it for, and make a ton of money.
· DUMPING STAGE: Once the pumping stage has passed its peak, the later investors are then left with large amounts of the ordinarily cheap asset. Due to its low value and functionality, there is nothing to help the asset maintain its price after the buying frenzy has subsided, and it starts going back towards its real value. Investors are now looking to cut their losses and are desperate to sell, with so many sellers in the market but little or no buyers.
It is noteworthy that not all forms of pump and dump take this involve positive propaganda. In the event that the initial investors are shorting the asset instead, their aim is simply to drive a negative sentiment into the market after placing their trades. This form is popularly referred to as “Short and Distort’.
Some similarities are apparent between pump and dump schemes and Ponzi schemes. Although they differ quite as much, their common ground is they involve misleading later investors for initial investors to benefit off. Should you participate in a pump and dump? If you’re lucky enough to join a pump and dump scheme and exit at just the right time, you can make a lot of money from it. The chances are slim, however. The planners most probably see you as a pawn and you are well behind the curve. It is much safer for your investment portfolio and mental health if you avoided it altogether. Should you plan a pump and dump scheme? Definitely not, except you want to get on the wrong side of the authorities and a whole lot of angry investors!
