Understanding Cryptocurrency Pump-and-Dump Strategies: How They Work and Why They Are Fraudulent

Cryptocurrency pump-and-dump strategies represent a form of manipulative trading where scammers aim to make quick profits by artificially inflating the price of a cryptocurrency and then profiting from its subsequent drop in value. This article delves into the mechanics of a pump-and-dump strategy, highlighting how these tactics work and why they are considered fraudulent.

Keywords:

Cryptocurrency pump and dump, manipulative trading, fraud in cryptocurrencies

What is a Cryptocurrency Pump-and-Dump Strategy?

A pump-and-dump strategy is a fraudulent practice where scammers buy a large amount of a cryptocurrency in a short period, driving up its price, and then sell it at a higher price to unsuspecting investors. This creates a hype around the cryptocurrency, making it appear more valuable and attracting more buyers. Once the price reaches a peak, the scammers sell their holdings, and the price often crashes, leaving the buyers with little to nothing.

The Mechanics of a Pump-and-Dump Strategy

Pumping

The pump phase involves scammers buying a large number of the cryptocurrency to drive up its price. They use various tactics, including:

Advertising the coin on social media using bots and influencers. Spreading misleading information about the coin to attract users and investors. Creating fake positive reviews and speculation.

These activities create a wave of excitement and interest in the cryptocurrency, driving up the demand and price.

Dumping

Once the price has stabilized and is rising, the dump phase begins. Scammers sell their holdings at the inflated price, often within hours, before the true nature of the scheme becomes apparent. This creates a glut of selling on the market, causing the price to drop rapidly.

Examples and Techniques

Although pump-and-dump schemes are typically unational, they often follow a standardized pattern:

Scammers buy a cheap, lesser-known cryptocurrency. They attract attention to the coin through manipulative techniques. The price rises gradually as more people buy in. Once the price peaks, the scammers sell off their holdings. Experienced buyers spot the pattern, causing a sharp drop in the price.

Manipulation often occurs on exchanges where the trading volume is low, allowing the scammers to control the price. Sometimes, they spread their activity across multiple exchanges to maximize the impact.

Real-world Case Studies

These schemes are often carried out on Telegram, a platform that allows for group chats and decentralized communication. A notable example was the Telegram pump-and-dump schemes in July-October 2018. Jiahua Xu and Benjamin Livshits, in their paper 'The Anatomy of a Cryptocurrency Pump-and-Dump Scheme', examined over 300 crypto pump-and-dump schemes. They found that scammers consistently succeeded with an average return of 80% due to the irrational exuberance of early adopters and the quick profit opportunities.

Regulatory Scrutiny and Legal Consequences

Financial regulatory bodies, such as the Securities and Exchange Commission (SEC), have categorized pump-and-dump schemes as fraudulent activities. They have provided detailed guidance and regulatory frameworks to combat these manipulative practices.

For instance, the SEC states that:

Any manipulation of a security's price in order to profit from the mispricing is deemed fraudulent.

The SEC has actively pursued cases involving pump-and-dump schemes, using legal mechanisms to deter such activities and protect investors.

How to Spot and Avoid Cryptocurrency Pump-and-Dump Schemes

To avoid falling prey to pump-and-dump schemes, investors should:

Be cautious of unsolicited investment advice or promises of quick profits. Conduct thorough research and due diligence on the cryptocurrency and its community. Stay away from cryptocurrencies with high trading volumes spikes and little to no fundamentals. Report suspicious activities to regulatory bodies and exchanges.

Understanding the mechanics of a pump-and-dump strategy is critical for investors to make informed decisions and avoid falling victim to these fraudulent activities.