On Cryptocurrency Pump and Dump Schemes
If the markets do not operate well while new entrepreneurial ventures are being established, this potential new method of financing projects is at risk of subversion.
This is a guest post by Professor Joshua Gans of Rotman School of Management, University of Toronto, and Professor Neil Gandal, Berglass School of Economics, Tel Aviv University, contributing advisors to the Orbs project.
Cryptocurrencies and resulting changes in technology have created opportunities to conduct pump and dump schemes: This is where market participants engage in relatively small, but coordinated, trades designed to lead to large increases in observed prices, in the hope of taking advantage of those prices to sell larger volumes of cryptocurrency. For all but the largest and more established cryptocurrencies, many others involve markets that are illiquid and characterized by very low trading volumes on most days, with occasional volume and price spikes.
While most discussion of these schemes is anecdotal, a recent study (Hamrick et. al, 2018) set out to quantify the scope of these schemes on Discord and Telegram, two widely popular group messaging platforms with 130 million users and 200 million users respectively. Both platforms can handle large groups with thousands of users, and they are the most popular outlets for pump and dump schemes involving cryptocurrencies.
Technologies like Telegram and Discord allow people to easily coordinate such schemes. Telegram is a cloud-based instant messaging service and uses Voice over Internet Protocol (VoIP). Users can send messages and exchange photos, videos, stickers, audio and files of any type. Messages can be sent to other users individually or to groups of up to 100,000 members. As of March 2018, Telegram had 200 million active users. Discord, first released in 2015, has similar capabilities and 130 million users as of May 2018. Discord and Telegram are primary sources for cryptocurrency pumps and have been used for pump and dump schemes on a large scale. Perhaps because of the regulatory vacuum, many of the pump groups do not hide their goals.
Hamrick et. al. (2018) identified 3,767 different pump signals advertised on Telegram and another 1,051 different pump signals advertised on Discord during a six-month period in 2018. The schemes promoted more than 300 cryptocurrencies. These comprehensive data provide the first measure of the scope of pump and dump schemes across cryptocurrencies and suggest that this phenomenon is widespread and often quite profitable.
Three other (essentially) concurrent papers also examine pump and dump schemes on cryptocurrencies, but with a different emphasis. Kamps and Kleinberg (2018) use market data to identify suspected pump and dumps based on sudden price and volume spikes. They evaluate the accuracy of their predictions using a small sample of manually identified pump signals. Xu and Livshits (2018) use data on roughly 200 pump signals to build a model to predict which coins will be pumped. Their model distinguishes between highly successful pumps and all other trading activity on the exchange. Li et al. (2018) use a difference-in-difference model to show that pump and dumps lower the trading price of affected coins.[1]
Hamrick et. al. (2018) is different from the other concurrent work in several important ways. First, it collects as many pump signals as possible from channels on Discord and Telegram. They are all evaluated, and not just confined to successful pumps. Second, reported pumps for all coins with public trading data are investigated, not only those taking place at selected exchanges. This allows the incorporation of ecosystem-wide explanatory variables such as the number of exchanges on which a coin is traded in order to assess what makes a pump and dump scheme successful.
Why should we care about pump and dump schemes in cryptocurrencies? These schemes are indicative of inefficiencies in the operation of cryptocurrency markets and can create vulnerabilities for those utilizing them. In particular, smaller cryptocurrencies are associated with token issuing for the purpose of creating new entrepreneurial ventures. If the markets do not operate well while those businesses are being established this could subvert this potential new method of financing ventures.
References:
Hamrick, J, Rouhi, F., Mukherjee, A., Feder, A., Gandal, N., Moore, T., and M. Vasek, “The Economics of Cryptocurrency Pump and Dump Schemes. Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3303365, 2018.
Kamps, J., and B. Kleinberg, To the moon: defining and detecting cryptocurrency pump-and-dumps. Crime Science, 7(1):18, 2018.
Li, T., Shin, D., and B. Wang. Cryptocurrency pump-and-dump schemes. Available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3267041 , 2018.
Xu, J., and B. Livshits. The anatomy of a cryptocurrency pump-and-dump scheme. Available at: https://arxiv.org/abs/1811.10109, 2018.
