How To Protect Yourself From Cryptocurrency Pump and Dumps
Back in 2000, Michael Lewis (author of The Big Short) covered the story of a high-schooler charged with stock-market fraud. It was the first time the Securities and Exchange Commission (SEC) had investigated a minor and it’s proof that reality can be stranger than fiction.
If we take the view that markets are rational, it might seem bizarre that a 15-year-old could manipulate stock prices and earn hundreds of thousands of dollars in the process. But that’s exactly what Jonathan Lebed did, from the comfort of his bedroom.
How? Well, if you’re unfamiliar with the case, the answer is simple. Lebed just bought cheap stocks, then posted on finance message boards using multiple accounts, urging others to do the same. Each time, interest in that stock exploded and prices shot up.
Lebed then sold his own holdings and moved on.
That’s all it took to wreak havoc in the stock market: a bunch of hyped up messages telling people to buy.
This is the basic template for a traditional stock pump and dump. An individual or group will buy a low-valued stock, often priced at a penny. Then they’ll spread misinformation, claiming the stock is under-valued and about to shoot up in price.
If enough investors believe their claims and buy, the price will indeed go up — which validates those claims and attracts more interest. Eventually, the pump and dump organisers sell and the scheme collapses.
So that’s how a stock pump and dump works — which brings us to cryptocurrency.
Stock pump and dumps have been around for a long time. But the recent rise of ICOs (Initial Coin Offerings) and altcoins (cryptocurrencies other than Bitcoin) created new opportunities for these schemes.
The CFTC (Commodities Futures Trading Commission) explained in a statement that these scams have a long history and make use of new technologies. Any time a new asset appears that’s vulnerable to price manipulation, pump and dump schemes pop up.
Altcoins are not intrinsically bad — some represent potentially useful new technology, some are jokes, some are experiments, some are intended as scams, many are just benign and have little use. But the ease of making them and the speed at which misinformation spreads online makes them ideal for pump and dumps.
Cryptocurrency pump and dumps follow the same template as stocks. The organisers will buy an unknown, usually worthless altcoin. Having filled their wallets at a near-zero price, they use emails, social media and forum posts, fake news articles, and designated chat groups to spread misinformation. Often, they’ll claim that altcoin is set to reach the same popularity as Bitcoin, backing this up with ‘insider information’ or ‘technical analysis.’
The ease of manipulating small market cap altcoins has led to the creation of designated pump and dump groups. Ranging in size from a handful of members to hundreds of thousands, these groups work together to orchestrate price inflation.
The members agree to all buy at the same time, until the price reaches a pre-agreed level. As the price rises, it lures in other investors who aren’t part of the scheme, but who think it’s a sign of true value.
Then they all sell at once. Seeing as the altcoins in question are usually worthless, the price can go to zero within seconds. Anyone who doesn’t sell at the precise right moment loses. Organisers are often the only ones to profit, particularly if they charge for group membership.
Unlike a runaway market, a pump and dump is intentional, and organised by a single person or group. Although it doesn’t discredit any underlying value, they often focus on worthless assets.
Cryptocurrency exchanges aren’t fully regulated for now, so these schemes are in a legal grey area. The CFTC offer rewards for whistleblowers who report pump and dumps, but they’re difficult to track and regulators in many countries haven’t acted yet. That means it’s up to you to educate yourself and make smart decisions, if you plan on getting involved with altcoins.
How to protect yourself from pump and dumps
Cryptocurrencies are very appealing to first time investors — it’s easy to get involved, you could make a huge profit, and there’s constant media hype. It’s fantastic that more people are learning about investing. But this is also a magnet for scammers and fraudsters who profit from misconceptions and misunderstandings.
Greed is a powerful driving force. When you’re constantly hearing stories of people getting rich from a modest purchase of ICO tokens, it’s easy to be drawn in. Distinguishing between a price rise motivated by intrinsic value and a pump and dump isn’t easy.
So, how can you protect yourself from pump and dumps?
The simplest answer is to avoid ICO tokens or small market cap cryptocurrencies. Stick to established, trusted coins with large networks, high trading volumes and a qualified team behind them — like Bitcoin and Ethereum.
These are too large to be easily vulnerable to pump and dumps. Fraudsters target small market cap coins for the same reason they target small market cap stocks: it’s far easier to manipulate prices.
One of the most common questions we hear at Luno is: why don’t we support ICO tokens, Bitcoin forks, or more altcoins?
The answer is that we always put the safety and security of our customers first. When a cryptocurrency is new and has a small market cap, it’s vulnerable to pump and dumps, and other kinds of fraud.
There’s a lot of experimentation in this space and hopefully it will lead to some interesting new ideas. But, for now, most are risky if you’re not extremely experienced with investing.
If you do decide to get involved with altcoins, your first step should be to research. A lot. Investing begins with education, not with buying.
Sure, some people do get lucky and make a lot of money from an altcoin they picked at random. But it is pure luck. Unless you’ve researched the fundamentals, you’re far more likely to end up losing most or all of your investment.
Prices — of anything — are based on supply and demand. Altcoins are plentiful in supply, that’s for sure. But without genuine demand, there’s nothing to prop up the prices long-term.
Before buying any altcoin, consider asking yourself:
- Does this sound too good to be true?
- Do I understand exactly what I’m buying? What does this coin do?
- Does this investment have fundamental value? Is this coin in any way useful? Is it solving a real-world problem?
- Who made this coin? Do they have relevant experience?
- Are they promising guaranteed returns? (This is impossible and should be a red flag)
- Am I under pressure to buy fast or spend more than I can afford? Is this an emotional or logical decision?
- Where am I getting my information from? Am I basing my decisions on forum or social media posts, or reputable sources? Could my sources be paid or otherwise untrustworthy?
- If the price is rising, is there any real justification for it? Has it happened slowly or suddenly?
- Would I be comfortable holding this altcoin long-term?
From your answers and your gut feeling, you should hopefully get a sense of whether it’s a good idea or not.
