How to Identify and Avoid Pump-and-Dump Schemes

NBX Editorial
Nov 16, 2020 · 8 min read

With Bitcoin continuing to grow, ETH2 on the horizon, and DeFi coming back to life, it’s important to review what pump-and-dump-schemes are and how to avoid them.

The cryptocurrency markets already move faster and experience more volatility than just about any other financial market in existence. Additionally, most of them are still thinly traded, which refers to markets having such a small number of regular traders that they’re more easily prone to market manipulation. Due to all of this, a form of market manipulation called a pump-and-dump scheme has proliferated and held strong across the crypto industry since 2017. Just as with social engineering and Ponzi schemes, the more you know about this particular scheme’s structure, the easier it will be for you to avoid it. For that reason, we’ve penned this post as the next in our series on crypto-centric scams and schemes.

What is a pump-and-dump scheme?

A pump-and-dump scheme is a form of market manipulation that’s been around long before cryptocurrencies existed. If you’ve seen the movie, The Wolf of Wall Street, then you already have a foundational idea of how pump-and-dump schemes work in the equity markets. As WealthLab points out, in a pump-and-dump scheme, “an investor or a group of investors promote a stock that they purchased at a low price. They then manipulate the share price and drive it higher to achieve significant gains.” In the movie and real life, Jordan Belfort, who was the head of an investment firm called Stratton Oakmont, based all of his business on such a scheme.

To start, he would have his employees purchase certain stocks with little value and little trading volume that they’d previously researched. At that point, they’d then cold call lists of investors to try to get them to buy up as much of these “penny stocks” they were targeting as possible. Once this purchasing frenzy hit what Stratton Oakmont thought was its highest point, its traders began to sell their shares en-masse, leaving most if not all others involved high-and-dry. Before he pled guilty to charges related to market manipulation in 1999, Belfort made millions off of such scams as did several of his top “traders.”

What caused the spread of pump-and-dumps into the crypto space?

Once Initial Coin Offerings began to proliferate in 2017, numerous pump-and-dump schemes began to surface as well.

Generally all pump-and-dumps would begin in the same fashion. A small group of scammers would open a Telegram group starting with a list of possible members that they’ve gained from touting their trading abilities on Twitter. Following this, these groups would move through all sorts of lists of known cryptocurrency users to try to attract as many people as they could, including giving existing members affiliate bonuses for each new member they bring in.

The motivation behind this drive for growing a pump-and-dump’s Telegram group has always been cut-and-dry. Since these scams’ creators always started by buying up a large supply of a thinly-traded coin or “small-cap Altcoin,” they relied on their group to buy and consequently, grow the coin involved to a certain price range, so that they could sell it for a considerable profit. To protect their first-mover advantage, the scammers and their close confidantes would hide said coin’s identity until the last possible moment or in other words, when the group reached a critical mass of members and when the coin reached a critical mass of social media-based hype.

How does a pump-and-dump look on a trading chart?

As shown below through a chart from a real pump-and-dump, the upward manipulation or pump would be kick-started during a significant red candle, which indicates selling pressure taking over a market almost completely or in simpler terms, that the coin involved is thinly-traded.

Image Credit to Business Insider

Once the pump-and-dump’s targeted was revealed and group members began buying it, the price immediately jumped in a matter of moments, until it hit the point at which the upper wick begins to greatly outpace the candle itself, which the last candle illustrates. Just like Business Insider stated in their 2017 investigation, it’s after this point that the pump came to an end and the coin fell back to its previously stagnant trading and price levels. This resulted in typically significant losses for most of those involved, save for the scheme’s founders, and any others who had advanced knowledge of it. All in all, by the end of 2017, it was estimated that pump-and-dumps accounted for hundreds of millions of dollars of losses on the side of the average investor.

Do pump-and-dump- schemes still occur in crypto today?

Though pump-and-dumps have become less frequent than back in 2017, they’re still around on the crypto markets. If you were to go to Youtube right now and search “pump and dump scam crypto,” you’d come upon a horde of examples of individuals and organizations still touting the supposed benefits of getting involved in a pump-and-dump.

It even seems as if those hyping up pump-and-dump schemes number more than those educating people on their risks.

Overall, the crypto industry, as a whole, isn’t doing quite enough to help its investors, especially newcomers, understand and avoid pump-and-dumps. Since 2017, coverage has fallen off in this respect. While they weren’t technically illegal yet back then, they are now, due to the crypto markets being better regulated, which makes such education all the more important.

Why do pump-and-dump-schemes still attract investors?

Jon Walsh, who is the Senior Vice-President of Strategy for Europe at EMX Digital and dedicates a lot of his time to uncovering crypto-scams, was asked the question above and responded:

“Pump and dump schemes are always going to be attractive to anyone that thinks they’ll be able to make a fast buck, it’s no different to getting a tip on a horse race. The simplest way for people to avoid them is to understand that if you’re being getting free information regarding an upcoming pump, you’re almost certainly one of the last to know and the odds of you selling at the top are nigh on impossible as the originators of the tip will ensure they sell theirs before you know anything about it. The best advice in investing is not going for short-term opportunities based on a whisper, but to learn the market, how it reacts to different scenarios it has faced, learn the historic movements of the coin/stock you’re looking at, and understand what the economics behind it all is. You could get lucky, but it’s better to be good.”

Truthfully, this is the best encapsulation of the continuing appeal of pump-and-dump schemes that could be given. As Walsh states, people will always be attracted to them because they’re just another form of get-rich-quick scheme. Furthermore, engaging in one is akin to gambling as he points out. You might get lucky once, but you won’t get lucky all of the time. Traders and investors that take the time to understand the forces affecting their markets, including the “economics” of coins as Walsh says, tend to win out over the long-term.

How do I protect myself from pump-and-dump schemes?

Protecting yourself from being affected by a pump-and-dump scheme starts with understanding its structure as described above, then following a few simple rules of thumb:

  1. First, don’t join groups on Telegram, Facebook, or any other social media service or app that tout “free signals.” This is usually code for a pump-and-dump scheme because these “free” signals turn out to be notifications that a pump is about to happen with certain members of that group leading it.
  2. On the flip side, some groups may offer leading or future predictions on the prices of certain cryptocurrencies in exchange for a membership fee like 0.1 BTC. Treat those with the same skepticism, especially if their predictions are presented as being accurate most of the time, or even worse, all of the time.
  3. Furthermore, you should never listen to one particular influencer’s opinions about coins to buy. Instead, take in as many different opinions as you can, do your own research, and base all of your investment decisions based on your conclusions, and not those of others. Blindly following the “buy signals” of crypto influencers is another trend that led to many people being affected by pump-and-dumps because some crypto influencers also tend to hype-up a coin so they can profit from the later rush of other investors to it. Youtube and Twitter contain many obvious examples of people still doing this, even though influencers like John McAfee are being prosecuted for the same alleged activities.
  4. Above all, remember that pump-and-dumps are a form of gambling, but they’re also illegal because they’re a type of market manipulation. As the CFTC pointed out in their warning, “the bottom line: customers should not purchase virtual currencies, digital coins, or tokens based on social media tips or sudden price spikes.” If you engage in these schemes even so and profit from them, then you’re also likely liable for any possible charges that may be brought against them. In the present time, regulatory agencies like the United States’ Commodity Futures Trading Commission offer sizable rewards for exposing pump-and-dump groups.

What comes next?

We hope that this post helps you to feel more confident about identifying and avoiding pump-and-dump schemes. As time goes on, remember that we plan to continue to be by your side, providing more valuable content on this subject and others, to paint a comprehensive picture of the crypto industry. If our efforts interest you, make sure to follow this blog. In our next post, we’ll discuss why cryptocurrencies aren’t the ideal vehicle for money laundering and what exchanges and other institutions do to track such activities. As always, if you have any thoughts or questions about this post, reach out to us any time here, on Twitter, or our website!

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Norwegian Block Exchange (NBX) is a pioneering, forward-thinking, and client-oriented Norwegian cryptocurrency exchange, custodian and payment system. Trade with us at nbx.com, follow us on Twitter or Facebook📲✔️

Disclaimer: Content provided does not constitute financial advice.

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NBX Editorial

Written by

NBX Editorial: The voice of the Norwegian Block Exchange, a pioneering cryptocurrency exchange & payments platform that’s dedicated to the tokenized future.

Norwegian Block Exchange

Norwegian Block Exchange (NBX) is a pioneering, truly Norwegian cryptocurrency exchange, custodian and a payment system. Sign up at https://nbx.com ✔️

NBX Editorial

Written by

NBX Editorial: The voice of the Norwegian Block Exchange, a pioneering cryptocurrency exchange & payments platform that’s dedicated to the tokenized future.

Norwegian Block Exchange

Norwegian Block Exchange (NBX) is a pioneering, truly Norwegian cryptocurrency exchange, custodian and a payment system. Sign up at https://nbx.com ✔️

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