What is Pump and Dump Scheme: Spotting the Scam

You have probably heard of pump-and-dump schemes before. They occur when investors take advantage of an asset that sees a steep price increase (pump) followed by an even faster price drop (dump). These schemes can take place with various assets, including cryptocurrencies and over-the-counter transactions.

A pump and dump scheme refers to a kind of fraud involving artificial, deliberate inflation of the price of an asset through false, exaggerated, or misleading information about the asset’s value. The fraudsters of a pump-and-dump scheme typically have an established position in the cryptocurrency/stock and sell their positions after the hype leads to a higher price. They oversell the purport benefits to entice novice buyers.

At the same time, the new buyer or investor will likely lose a significant part of their capital as the price of a stock or asset will quickly drop. The pump and dump schemes involving microcap stocks are considered illegal activities.

Pump and dump schemes are common among small-cap digital assets and small companies/corporations. While bad actors in the past used cold calls, the internet now offers cheaper and easier ways of contacting more investors using social media, spam email, investment research websites, etc.

How Does a Pump and Dump Scheme Work?

• Traditionally, pump-and-dump schemes were conducted using cold calling.
• The internet has made this illegal practice more prevalent.
• Fraudsters post false information on digital platforms to entice investors to buy cryptocurrency quickly.
• They claim to have inside information about upgrades or developments that will increase the asset’s price.
• Once buyers purchase, the fraudsters sell their coins/shares, causing the asset price to drop dramatically.
• New investors often lose money due to falling for false or misleading promotions.
• Douglas Horn, chief architect of Telos Core Developers, explains that pump actors dump their tokens into the FOMO they create.

• This results in a price crash, leaving new investors with crypto coins of lower value than what they paid.
• Certain cryptocurrencies, like Bitcoin, Ether, and Dogecoin, are commonly found in such scams.
• Influencers like Elon Musk can significantly affect the value of these well-established digital assets.
• Developers can create their own crypto tokens using existing blockchains like Ethereum or Solana.
• Tokens can be created easily, with billions of coins often valued at fractions of a penny, which can artificially inflate the price.
• For example, one Shiba Inu (SHIB) token costs $0.00001774, allowing the purchase of over 54,000 coins for less than $1.

Types of Pump and Dump Schemes

Online scammers use various types of pump and dump schemes to cash-in big gains. Some of them include:

1. The classic cryptocurrency pump and dump scheme

The classic procedure involves scammers manipulating information regarding a cryptocurrency. This may involve faking the following of a coin, fake news releases, and the circulation of certain “insider” details that can promote a coin and create an urge of missing out.

2. Boiler room

A boiler room refers to a small brokerage company that uses various brokers employing deceitful sales practices to sell dubious investments, including penny stocks, to buyers. The brokers typically sell affordable shares that the firm purchases or sells as a market maker by cold calling. The brokers working in boiler rooms try to trade as many shares as possible, thus boosting the price. Once the stock price surges, the company sells them for a profit.

How Do You Know if It’s a Cryptocurrency Pump and Dump Scheme

One of the easiest ways to spot a pump and dump scheme is when an unknown cryptocurrency suddenly grows substantially without a real reason. You can view this info on the coin’s price chart.

Also, paid news articles hyping a small-cap coin in combination with a surge in social media activity covering that particular cryptocurrency could be an indication of a pump and dump scheme taking place. If an unheard coin with a low market cap abruptly appears all over Facebook or Twitter, one must be wary of potential stock fraud.

Examples of Pump and Dump

A popular e-sports group known as the ‘FaZe Clan’ earlier terminated one of its associates and suspended three other members amid reports of operating a crypto pump and dump scam involving microcap stocks.

In July 2021, the four FaZe Clan members took part in a pump-and-dump for a coin named SaveTheChildren. The scammers, along with some influencers, promoted the asset to their follower base. Once the coin price rose, they started selling the coins they were allotted to take part in the scam, with some of them earning an estimated $25,000.

An earlier study conducted by the University of Technology Sydney and the Stockholm School of Economics uncovered 355 cryptocurrency pump-and-dump scams that took place over seven months, raising concerns for the SEC. The people involved in these schemes reportedly made millions through stock fraud.

Such pump and dump scams mostly take place when there is not enough information for investors and crypto buyers. For instance, the Squid game crypto token skyrocketed in value. The coin’s founders inflated the coin and later vanished with $3 million in profits made from investors.

A similar crypto pump and dump instance happened with Floyd Mayweather Jr and Kim Kardashian too. The pair reportedly pumped the price of EthereumMax. Soon after the prices reached an all time high, company executives grabbed the profits and left the coin holders with worthless assets. Later, investors went on to file a class-action lawsuit accusing Mayweather and Kardashian of being a part of the scheme.

How to Avoid Pump-and-Dump Schemes

• Understand if fear of missing out (FOMO) is influencing your cryptocurrency investments.
• Recognize that not everyone is getting rich from Bitcoin, Ether, or Doge, and many may even dump their shares.
• Conduct thorough research before investing in cryptocurrencies.
• Know that individuals with coding skills can easily create cryptocurrencies and microcap tokens.
• Investigate new tokens in the market that claim to generate wealth.
• Review the company white paper during the initial coin offering (ICO) for detailed information.
• Understand the company’s objectives, token details, and founding team before investing in any securities and exchange commission regulated assets.
• Acknowledge that pump and dump schemes create artificial buzz around a coin.
• Beware of hype on social channels like Discord, Telegram, and Twitter promoting microcap stocks.
• If someone suddenly promotes a new coin, it may be an attempt to inflate the price as part of a scam.
• Invest only what you can afford to lose to mitigate risk.
• While profits are possible from pump and dump schemes, it’s safer to assume you may lose your investment.

Pump and dumps generally happen with coins with low market caps and trading volumes. By steering clear of illiquid cryptos, your chances of losing money in a pump and dump reduce significantly. Investors are also generally asked to not take up investment advice from social media forums or paid news articles to prevent market manipulation.

Sudden price hikes in random coins signal a potential cryptocurrency pump and dump scheme. As a rule of thumb, remember that any person or group promising they know the next token to pump likely has an ulterior motive to buy the stock before it rises. Therefore, avoiding such investments is a good practice.

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Are Pump and Dumps Legit?

Pump and dump schemes have been around for years and their creators have mastered the craft in making them appear very real and legit. Investors must be careful about such schemes and fraudsters trying to profit from new, naive investors.

When Should I Sell Pump and Dump?

Experts believe that participating in cryptocurrency pump and dump schemes is very risky. The risk of quick and big wins certainly seems to outweigh their benefits.

One cannot run away from the risk factor while investing in altcoins, especially the new ones. The crypto community has witnessed crypto tokens lose more than 99.9% of their value from their peaks and seldom recover.

Many crypto assets have small market caps, making them easy to be manipulated at any time. However, this changes rapidly as the cryptocurrency market grows and more regulations are enforced across countries, impacting how investors buy the stock.

There is no right time to buy or sell a token in a pump and dump crypto scheme because investors could stand to lose all their capital if they miss a small window to exit artificially inflated prices. Hence, investors are advised to turn away from such scams altogether.

How do you predict pump and dump crypto?

When a new crypto project launches, pay attention to the ICO. New investors tend to lose sight of the obvious when they get intoxicated by the promise of a new, budding project and rising prices.

It is easy to fall for scams in an unregulated market, such as crypto. Here are some tips to predict a pump and dump in the cryptocurrency market and stay away from them.

-If you spot new, unknown crypto promoted by internet strangers, do not rush to jump on the bandwagon, as they may be promoters of a scam. Do your own research (aka DYOR), check the whitepaper, and get familiar with the project. Investors must do this for any digital asset to decide if the token has any long-term potential.
-If a crypto project does not have a clear purpose, seems unrealistic, appears too good to be true, or has an unclear development roadmap, trust your instinct to avoid false or misleading claims. These are all investment red flags.

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